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                                  UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

                                   FORM 10-KSB

(Mark One)
|X|      ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES  EXCHANGE ACT
         OF 1934
                   For the fiscal year ended December 31, 2006

|_|      TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES  EXCHANGE
         ACT OF 1934

                For the transition period from ______ to ________

                         COMMISSION FILE NUMBER 0-25675

                              PATRON SYSTEMS, INC.
                 (NAME OF SMALL BUSINESS ISSUER IN ITS CHARTER)

            DELAWARE                                     74-3055158
(STATE OR OTHER JURISDICTION OF             (I.R.S. EMPLOYER IDENTIFICATION NO.)
 INCORPORATION OR ORGANIZATION)

    5775 FLATIRON PARKWAY, SUITE 230
             BOULDER, CO                                         80301
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)                       (ZIP CODE)

                                 (303) 541-1005
                           (ISSUER'S TELEPHONE NUMBER)

       SECURITIES REGISTERED UNDER SECTION 12(B) OF THE EXCHANGE ACT: NONE
         SECURITIES REGISTERED UNDER SECTION 12(G) OF THE EXCHANGE ACT:

                     COMMON STOCK, $0.01 PAR VALUE PER SHARE
                                (TITLE OF CLASS)

Check whether the issuer is not required to file reports  pursuant to Section 13
or 15(d) of the Exchange Act. |_|

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

Check if there is no disclosure of delinquent  filers in response to Item 405 of
Regulation S-B contained in this form, and no disclosure  will be contained,  to
the  best  of  registrant's   knowledge,  in  definitive  proxy  or  information
statements  incorporated  by  reference  in Part III of this Form  10-KSB or any
amendment to this Form 10-KSB. |X|

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

The  issuer's  revenues  for the  fiscal  year  ended  December  31,  2006  were
$1,188,045.

At March 28,  2007,  the  aggregate  market  value of the  voting  stock held by
non-affiliates of the issuer was $14,366,706.

At March 28, 2007, the issuer had 14,512,260  shares of Common Stock,  $0.01 par
value, issued and outstanding.

Transitional Small Business Disclosure Format (Check One)  Yes |_|  No |X|

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                              PATRON SYSTEMS, INC.
                              INDEX TO FORM 10-KSB

PART I                                                                                    PAGE
                                                                                          ----
                                                                                        
Item 1.  Description of Business .......................................................    3
Item 2.  Description of Property .......................................................    8
Item 3.  Legal Proceedings .............................................................    8
Item 4.  Submission of Matters to a Vote of Security Holders ...........................    9

PART II
Item 5.  Market for Common Equity and Related Stockholder Matters and Small
             Business Issuer Purchases of Equity Securities ............................    9
Item 6.  Management's Discussion and Analysis of Financial Condition and Results of
             Operations ................................................................   11
Item 7.  Financial Statements ..........................................................   23
         Report of Independent, Registered, Certified Public Accounting Firm ...........   24

         AUDITED FINANCIAL STATEMENTS

             Balance Sheet as of December 31, 2006 .....................................   25

             Statements of Operations for the years ended December 31, 2006
             and 2005 ..................................................................   26

             Statements of Stockholders' Deficiency for the years ended
             December 31, 2006 and 2005 ................................................   27

             Statements of Cash Flows for the years ended December 31, 2006
             and 2005 ..................................................................   28

         Notes to Financial Statements .................................................   29

Item 8.  Changes in and Disagreements with Accountants on Accounting and Financial
             Disclosure ................................................................   68
Item 8A. Controls and Procedures .......................................................   68
Item 8B. Other Information .............................................................   70

PART III

Item 9.  Directors, Executive Officers, Promoters and Control Persons; Compliance With
             Section 16(a) of the Exchange Act .........................................   70
Item 10. Executive Compensation ........................................................   72
Item 11. Security Ownership of Certain Beneficial Owners and Management and Related
             Stockholder Matters .......................................................   75
Item 12. Certain Relationships and Related Transactions ................................   79
Item 13. Exhibits ......................................................................   80
Item 14. Principal Accountant Fees and Services ........................................   80



                                       2



                                     PART I

                           FORWARD-LOOKING STATEMENTS

This Annual Report on Form 10-KSB contains forward-looking statements within the
meaning  of  Section  27A of  the  Securities  Act  of  1933,  as  amended  (the
"Securities  Act"),  and Section 21E of the Securities  Exchange Act of 1934, as
amended  (the  "Exchange  Act").  We use words  such as  "believes",  "intends",
"expects",  "anticipates",  "plans",  "may",  "will" and similar  expressions to
identify  forward-looking  statements.  Discussions  containing  forward-looking
statements   may  be  found  in  the  material   set  forth  under   "Business,"
"Management's  Discussion  and  Analysis of Financial  Condition  and Results of
Operations" and in other sections of the report. All forward-looking statements,
including, but not limited to, projections or estimates concerning our business,
including demand for our products and services, mix of revenue streams,  ability
to control and/or reduce operating expenses, anticipated operating results, cost
savings,  product  development  efforts,  general  outlook of our  business  and
industry,  competitive  position,  and adequate liquidity to fund our operations
and meet our other cash requirements, are inherently uncertain as they are based
on  our   expectations   and  assumptions   concerning   future  events.   These
forward-looking  statements  are subject to numerous known and unknown risks and
uncertainties.  You should not place  undue  reliance  on these  forward-looking
statements. Our actual results could differ materially from those anticipated in
the  forward-looking  statements  for many  reasons,  including  our  ability to
attract  customers for our products,  our ability to  effectively  integrate our
acquired businesses, and all other risks described below in the section entitled
"Risk Factors"  appearing in "Management's  Discussion and Analysis of Financial
Condition  and  Risk  of   Operations"   and  elsewhere  in  this  report.   All
forward-looking  statements  in this  document  are made as of the date  hereof,
based on  information  available to us as of the date  hereof,  and we assume no
obligation to update any forward-looking statement.

ITEM 1.  DESCRIPTION OF BUSINESS
CORPORATE BACKGROUND

Patron  Systems,  Inc., a Delaware  corporation  ("Systems") was formed in April
2002 to provide  comprehensive,  end-to-end  information  security  solutions to
global corporations and government  institutions.  Systems' business plan was to
acquire and  operate  high  profit  potential  companies  with  technologies  in
information  and homeland  security  applications  for businesses and government
institutions.

On October 11, 2002, Combined Professional Services,  Inc. ("CPS"),  Systems and
the  stockholders  of Systems  consummated a share exchange  ("Share  Exchange")
pursuant to an Amended and Restated Share Exchange Agreement, whereby CPS issued
to each Systems  stockholder,  on a one-for-one basis and in exchange for all of
the  outstanding  shares of Systems'  capital stock,  an aggregate of 25,400,000
shares of its common stock. Upon the closing of the Share Exchange,  the Systems
stockholders held approximately 85% of the outstanding capital stock of CPS, and
Systems  became a wholly owned  subsidiary  of CPS. The former  stockholders  of
Systems became the majority owners of CPS following the completion of the Shares
Exchange.  Accordingly,  Systems  was  deemed  to be the  acquirer  of  CPS  for
accounting  purposes and the  transaction  was accounted for as a reverse merger
and recapitalization of Systems.

On November 22, 2002, CPS announced that it changed its name to Patron Holdings,
Inc. ("Holdings"), effective as of November 21, 2002, and that it would trade on
the OTC Bulletin Board under the symbol "PAHG."

On March 27,  2003,  Holdings  merged  with and into  Systems for the purpose of
changing its state of  incorporation  from Nevada to Delaware  ("Redomestication
Merger").  Systems was the surviving corporation of the Redomestication  Merger,
and its Second Amended and Restated  Certificate of  Incorporation,  Amended and
Restated  Bylaws and Board of  Directors  became  the  governing  documents  and
governing  body,  respectively,  of the  surviving  corporation.  The  surviving
corporation  is referred to herein as "we," "us," the  "Company" or "Patron." In
connection  with  the  Redomestication  Merger,  Patron  filed  with  the  SEC a
successor  entity  report on Form  8K-12g-3,  whereby  Patron  succeeded  to the
reporting obligations of Holdings under the Exchange Act.

Subsequent  to the  Redomestication  Merger  and  prior to the  acquisitions  we
consummated on February 25, 2005 and March 30, 2005  (described  below),  we had
minimal  business  operations.  As of September  25, 2003,  all of our employees
except for our Chief Executive Officer had resigned. Upon the resignation of our
Chief  Executive  Officer on January 21, 2004,  we had no employees and only one
Director, the non-executive Chairman of the Board.


                                       3



In  April of 2004,  we  failed  to meet the  reporting  requirements  under  the
Exchange  Act. As a result,  our stock was no longer  eligible for  quotation on
NASDAQ's  Over-the-Counter  Bulletin  Board  quotation  system.  During 2005, we
completed  the filing of a Form 10-KSB  covering  the period from April 30, 2002
(inception)  to December 31, 2004,  completed the filing of Forms 10-QSB for the
periods ending March 31, 2005,  June 30, 2005 and September 30, 2005 and filed a
Form 8-K covering  each of the  acquisitions  completed on February 25, 2005 and
March 30, 2005.  During 2006,  we have filed in a timely  manner the Form 10-KSB
for the year ended December 31, 2005 as well as the Forms 10-QSB for the periods
ending March 31, 2006,  June 30, 2006 and September 30, 2006. We have filed in a
timely manner,  all SEC filings beginning with the filing of the Form 10-QSB for
the period  ending June 30,  2005.  Since  November  14, 2005 our stock has been
quoted on NASDAQ's Over-the-Counter Bulletin Board quotation system.

On February 25, 2005,  we  consummated  the  acquisitions  of Complete  Security
Solutions,  Inc. and LucidLine,  Inc.  pursuant to the filings of Agreements and
Plans of Merger  with the  Secretaries  of State of the States of  Delaware  and
Illinois, respectively. On February 28, 2005, we consummated a private placement
with accredited  investors in the amount of $3.5 million.  On March 30, 2005, we
consummated the acquisition of Entelagent  Software Corp. pursuant to the filing
of an Agreement  and Plan of Merger with the  Secretary of State of the State of
California. We discuss these transactions in further detail in this report.

On January 12, 2006, we issued a Stock  Subscription  Agreement & Mutual Release
to each of our creditors  and claimants  pursuant to which we would sell to such
creditors  and/or claimants shares of Series A-1 Preferred Stock in exchange for
a final and binding settlement with respect to any and all claims,  liabilities,
demands,   causes  of  action,   costs,   expenses,   attorneys  fees,  damages,
indemnities, and obligations of every kind and nature that such creditors and/or
claimants  may have with or against us.  Creditors  and/or  claimants  that have
accepted our offer have been issued and aggregate of 36,993,054 shares of Series
A-1  Preferred  Stock.  The shares of Series A-1 Preferred  Stock  automatically
converted  into  12,331,056  shares of Common Stock on July 31,  2006,  upon the
filing  of an  amendment  to  our  certificate  of  incorporation,  as  amended,
effecting a 1-for-30  reverse  stock  split.  There are  currently  no shares of
Series A-1 Preferred Stock outstanding.

Between March 27, 2006 and April 3, 2006,  pursuant to the  consummation  of the
Series A Preferred  Stock  financing for aggregate  proceeds of  $4,820,501,  we
issued to the purchasers of Series A Preferred  Stock an aggregate of 964 shares
of Series A Preferred  Stock and warrants to purchase an aggregate of 20,085,446
shares of Common Stock.  The 964 shares of Series A Preferred Stock are, subject
to certain  conditions,  convertible at the option of the holders thereof,  into
12,051,254 shares of Common Stock.

On April 18,  2006,  we entered  into a Stock  Purchase  Agreement  with  Walnut
Valley,  Inc.  pursuant  to  which  we sold  all of the  outstanding  shares  of
LucidLine to Walnut Valley for aggregate  consideration of $50,000,  including a
cash payment of $25,000 and the issuance of a Promissory  Note in the  principal
amount of $25,000 by Walnut Valley in our favor. The president of Walnut Valley,
Inc.  Rafiq  Kiswani,  was  the  former  president  of  LucidLine  prior  to our
acquisition  of  LucidLine  in  February  2005.  In  February  2005,  we paid to
LucidLine's  stockholders cash in the aggregate amount of $200,000 and issued an
aggregate of 146,667 shares of our common stock valued at $3,740,000.

On July 21,  2006,  the Board of  Directors  authorized  the  completion  of the
Creditor and Claimant  Liabilities  Restructuring  program.  Under this program,
debts, claims and liabilities  totaling  $24,467,871 were settled for 36,993,054
shares of Series A-1 Preferred Stock.

On July 31, 2006, the Company  effectuated a 1-for-30 reverse stock split of its
common stock following the  effectiveness of the amendment to its Second Amended
and Restated  Certificate of Incorporation which was approved by stockholders at
the 2006 Annual Meeting of Stockholders on July 20, 2006.

Effective   September  19,  2006,  we  merged  our   wholly-owned   subsidiaries
Entelagent,  CSSI and PILEC  Disbursement  Company (a non-operating  subsidiary)
("PILEC") into our company through the filing with the Secretary of State of the
States of Delaware and California, a Certificate of Ownership and Merger merging
Entelagent  Software  Corp.,  (a  California  corporation),   Complete  Security
Solutions,  Inc., (a Delaware  corporation) and PILEC Disbursement  Company,  (a
Delaware corporation) into Patron Systems, Inc., (a Delaware corporation).


                                       4



Beginning  on October 13, 2006 with the first  closing of the Series B Preferred
Stock  Financing and  completed on November 16, 2006 with the second  closing of
the  Series  B  Preferred  Stock  Financing  for  total  aggregate  proceeds  of
$3,952,716,  we issued to the purchasers of units in that financing an aggregate
of 790.54  shares of Series B  Preferred  Stock and  warrants  to purchase up to
2,410,222  shares of Common Stock. The 790.54 shares of Series B Preferred Stock
are,  subject to certain  conditions,  convertible  at the option of the holders
thereof, into 4,820,417 shares of Common Stock.

In November  2006,  we made a  definitive  decision to exit and pursue a plan to
sell our  PolicyBridge  software  product  business,  which was  acquired in the
Entelagent Software Corp. acquisition, in March 2005. Accordingly we present the
results  of  operations  of the  business  as  discontinued  operations  and the
remaining  assets  as  assets  held  for  sale  in  our  consolidated  financial
statements.  As of December  31,  2006,  our  activities  in this  business  are
strictly  limited to fulfilling  our  remaining  service  obligations  under the
existing maintenance and support agreements, the liability for which is included
in  liabilities  of  discontinued   operations  in  our  consolidated  financial
statements.  We are  actively  involved  in the  process of trying to identify a
prospective  buyer  of  the  PolicyBridge   business;   however,  there  are  no
commitments  to date. We cannot provide any assurance that we will be successful
in our efforts to identify a buyer of PolicyBridge.

PATRON'S BUSINESS PLAN

Patron  Systems,  Inc.  provides  application  software and services  focused on
business  process  management  (BPM)  in the  public  sector.  Patron's  current
application  software  offering,  FormStream,  is an open standards  information
sharing  tool that  addresses  the need for law  enforcement  and public  safety
agencies to share information  between local,  state and federal law enforcement
and  homeland  security  agencies.  FormStream  is  a  mobile  electronic  forms
(e-forms) application which provides a highly scalable,  open standard,  network
independent method for the distribution and synchronization of e-forms to mobile
devices. The implementation of FormStream allows its user agencies to update and
modernize their processes to utilize the sophisticated form and user based rules
and  process  routing   capabilities  of  FormStream  to  increase  officer  and
supervisor productivity, increase officer availability in the field, reduce back
office workloads involved with entry of data and review of data entered, provide
real-time  information  sharing  of field  generated  reports  and  other  field
generated  information  to officers and users within the  agency(s)  served by a
particular FormStream installation and provide the ability for an agency to meet
the  federally  mandated  requirements  to  provided  police  reports  and other
information  to the  state and  federal  governments  in  standard  formats  for
information  sharing  purposes.  FormStream  addresses  mobile e-form  creation,
capture and sharing over wireless networks and manages data in industry standard
formats  (forms:  .pdf,  XDP and XML; law  enforcement:  Global Justice XML data
model (GJXDM) and National Information Exchange Model (NIEM)).

By improving the information  flow and the processes  within law enforcement and
public  safety  agencies,  FormStream  allows  these  agencies to much more cost
effectively serve their  constituents and provide improved local law enforcement
as well as enhanced local, regional and national homeland security.

FORMSTREAM

FormStream  provides  a  complete  solution  for the  collection,  distribution,
management,  and analysis of form-based public safety,  government and corporate
information.  Based on the latest  e-forms  technology  and  utilizing  industry
standard formats (forms: .pdf, XDP and XML; law enforcement:  Global Justice XML
data model  (GJXDM) and the  National  Information  Exchange  Model  (NIEM)),  a
powerful routing capability,  and an open-standards approach, our mobile e-forms
creation,  capture,  sharing and analysis tools allow an  organization to easily
create forms that  replicate  their  present  ones,  routes these e-forms to the
appropriate people and allow secure  transmission,  storage and analysis of that
information. FormStream gives law enforcement, EMS, fire and other organizations
real-time  access to mobile field created data for use inside a department or in
a multi-jurisdictional information sharing system.

FormStream  provides a complete  e-forms  solution  that  enables easy filing of
incident  reports and other  mobile  field  created  reports  and  e-forms  from
vehicles using mobile data terminals and other mobile devices (smart phones, PDA
phones and tablet,  micro-notebook  and  sub-notebook  computers)  with wireless
network  connectivity.  Should a wireless connection be unavailable,  the mobile
devices  can  still  operate  and  reports  can  be  created.   FormStream  will
automatically  attempt a wireless connection until  synchronization  between the
mobile device and the FormStream  server is successfully  completed.  FormStream
offers a comprehensive secure transmission and storage solution for


                                       5



mobile  e-forms.  This  capability,  developed to comply with the very  rigorous
"chain of custody" and evidence rules that apply to police reports and other law
enforcement  documents and evidence,  provides  FormStream  users with a secure,
tamper-proof  means for  controlling,  transmitting and storing e-forms and form
data.  FormStream provides a secure "electronic case file" solution as well as a
high-availability  and redundant  solution for the storage and back up of public
safety data.

FormStream's wireless data transport application has been field tested in a wide
range of WiFi and  cellular  data  network  environments.  The  FormStream  data
transport  and  synchronization  software has been designed to operate in mobile
environments  where there is highly  variable  geographic  signal  coverage  and
highly variable signal quality and connection  quality.  This data transport and
synchronization  software is designed to operate  with low system  overhead  and
completely  accurate form and form data  transmission all while not clogging and
constricting the mobile data network.

FormStream provides secure electronic form creation,  movement,  and management.
FormStream makes fillable electronic forms creation easy. Forms may be completed
through  manual  entry  of  data  on the  mobile  device  or  through  automatic
population  of data  using one of  FormStream's  many data  integration  modules
(e.g.,  reading  barcode  data  on a  driver's  license).  Once  created,  these
electronic  forms can be  published  to  internal or  external  users.  Once the
electronic form is completed,  the user organization can  automatically  capture
form data and extract it into existing databases and legacy systems.  FormStream
provides  powerful  functionality  to  further  streamline  processes,  such  as
attaching payments and routing forms.

FormStream encrypts forms upon their creation by the officer, encrypts all forms
(both  in-process and submitted) in the officers field  computer,  provides each
submitted  form  with  DigiSeal(TM),  a tamper  resistant  seal  and  indicator,
maintains an audit-trail  for each form and as well as an encrypted copy of each
form  submitted  by each user  interaction  with  that  form.  Additionally  the
wireless  transmission  of the form is in an encrypted  format.  The encryption,
security  and audit  trail  functions  provide  both the  public  safety  agency
management and prosecutors with assurance of the security and non-repudiation of
the  forms  which  can  be  used  as  non-refutable  legal  documents  in  court
proceedings.

Each  electronic form that is used has a defined set of business rules including
approvals,  routings and other form processing  standards.  Using these business
rules,  FormStream provides the ability, for instance, for a form submitted by a
police   officer  in  the  field  to  be  sent  via  the   FormStream   wireless
synchronization to the submitting officers supervisor,  who may also be assigned
to a police car, for  approval.  This  ability to provide full mobile  device to
mobile device  communication of forms and form data is a significant  feature of
FormStream.

For law enforcement,  FormStream  integrates with a wide range of computer-aided
dispatch,  records  management  systems  and  message  switches  that  have been
utilized  in a  number  of  large  city and  metropolitan  area law  enforcement
applications.

The  implementation  of  FormStream  allows  its user  agencies  to  update  and
modernize  their  processes  to utilize  the  sophisticated  form and user based
business  rules  and  process   routings  to  increase  officer  and  supervisor
productivity,  increase  officer  availability in the field,  reduce back office
workloads  involved  with  entry of data and  review  of data  entered,  provide
real-time  information  sharing  of field  generated  reports  and  other  field
generated  information  to officers and users within the  agency(s)  served by a
particular FormStream installation and provide the ability for an agency to meet
the  federally  mandated  requirements  to  provided  police  reports  and other
information  to the  state and  federal  governments  in  standard  formats  for
information sharing purposes.

For commercial users and  applications,  FormStream  utilizes an  open-standards
approach using industry standard .pdf, XDP and XML forms and form data which can
be readily integrated into existing third-party applications.

COMPETITION

The number of competitors for our FormStream  software  application has risen in
the past few years and we expect  the  intensity  of  competition  in the market
segments  we intend to serve to  continue  to increase in the future as existing
competitors  enhance and expand their product  offerings and as new participants
enter these  market  segments.  Many of our  potential  competitors  have longer
operating  histories,  greater  name  recognition,   large  customer  bases  and
significantly  greater  financial,   technical,   sales,   marketing  and  other
resources.  In addition,  some of our potential  competitors  currently  combine
their products with their own and other companies' records


                                       6



management   systems  or  other  law  enforcement   products.   These  potential
competitors  also  often  combine  their  sales  and  marketing  efforts.   Such
activities may result in reduced prices,  lower gross and operating  margins and
longer sales cycles for the FormStream  product.  If any of our larger potential
competitors  were to  commit  greater  technical,  sales,  marketing  and  other
resources to the markets we intend to serve, or reduce prices for their products
over a sustained  period of time, our ability to successfully  sell the products
we intend to offer or increase revenue could be adversely affected.

PATRON'S TARGET ALLIANCE PARTNERSHIPS

In  conjunction  with our efforts to grow the  business  and access new markets,
management  will  pursue  alliances  with  companies  possessing   complimentary
technologies and strong  relationships in target vertical markets. In all cases,
one  of  the  key  objectives  of  these  relationships  is to  reduce  customer
acquisition costs. Examples of potential relationships include the following:

SYSTEM INTEGRATION  COMPANIES:  Patron's FormStream technology can be integrated
into broader  solutions for public safety,  government  and commercial  markets.
Organizations  that integrate  multiple  technologies  may possess unique market
access  and  domain   knowledge   about  these  markets,   increasing   Patron's
opportunities   where  such  alliances  are  formed.   Patron  has   established
relationships  with several systems  integration  companies  including  Advanced
Technology Systems, Inc., Datamaxx Group and TriTech Software Systems.

INDEPENDENT SOFTWARE VENDORS: There are a number of software companies providing
solutions  that  compliment the FormStream  application  solution.  Provided the
technologies are more complimentary  than competing,  there is an opportunity to
partner with third party software  companies to provide a more complete solution
to potential  customers.  Such alliances with other software  vendors could take
the  form of an OEM  relationship,  a  joint-marketing  initiative,  or a hosted
delivery model.

CONSULTING   COMPANIES:   There  are  a  number  of   consulting   organizations
specializing  in practice areas important to Patron's  solutions.  These include
large  government  contractors  as well  as  smaller  firms  focused  on  public
safety/first-responder   practice  areas.  Organizations  delivering  consulting
services  in  these  areas  market   themselves  as  subject   matter   experts,
recommending  both services and  technology  solutions  that reduce the risk and
improve the productivity of their clients.  Management  believes that FormStream
can be presented as a  differentiated  solution where partners in the consulting
business deem appropriate. The result could be an effective selling model, where
Patron solutions are introduced by relevant, subject matter experts.

SALES, MARKETING AND TECHNICAL SUPPORT

We market and sell our products and services  through our direct sales force and
other resellers.  Our sales force and our sales engineers and technical  support
personnel  provide ongoing  interaction  with current and future customers which
allows us to provide a high  level of  service  and  support  and to  strengthen
customer  relationships.  We  utilize  a variety  of  marketing  strategies  and
programs  to support  our  product  and  service  offerings.  These  include the
enhancement of our web-site,  the  development  of whitepaper  reports on client
success  stories  and  critical  issues  related  to the  market  focus  for our
products,  web-based  seminars and webcasts,  participation in major trade shows
and conferences,  e-mail-based  marketing campaigns,  telemarketing programs and
industry and technology analyst briefings.

RESEARCH AND DEVELOPMENT

Our engineering, maintenance and support efforts are focused on the maintenance,
enhancement and extension of our current FormStream product.  Due to our limited
capital  resources,  we have not had the  resources  to address  more  extensive
research and  development  initiatives.  We will continue to review  marketplace
opportunities to acquire  carefully  selected  companies that have developed (or
are  developing)  potentially  high  profit  products  in the area of  messaging
management.  We have incurred no research and development costs during the years
ended December 31, 2005 and 2006.

CUSTOMERS

During the year ended December 31, 2006,  our top four  customers  accounted for
25%, 18%, 18%, and 13% of net revenues.


                                       7



EMPLOYEES

As of  December  31,  2006,  we  employed a total of 25  full-time,  principally
salaried,  employees.  Our employees are not covered by a collective  bargaining
agreement. We believe we have a satisfactory relationship with our employees.

GEOGRAPHIC AREAS

We operate  our  business  and sell our  products  and  services  to  government
agencies and businesses in the United States.

ITEM 2.  DESCRIPTION OF PROPERTY

As of December 31, 2006, we leased 4,876 square feet of office space in Boulder,
Colorado.  We believe that the facility  utilized by us is well  maintained,  in
good operating condition and adequate to meet our current and foreseeable needs.
We do not have any and do not intend to make any,  investments  in real  estate,
real estate mortgages or persons primarily engaged in real estate activities.

ITEM 3.  LEGAL PROCEEDINGS

Effective  January 1, 2006, the Company and Mr.  Patrick  Allin,  former Company
Chief  Executive  Officer,  and the Allin  Dynastic  Trust  entered  into  Stock
Subscription   Agreement  and  Mutual  Release   agreements   (the  "Series  A-1
Agreements")  to settle all claims,  including  claims related to the settlement
agreement   entered  into  in  2005  which  settled   certain   employment   and
indemnification  related claims brought  against the Company in 2004,  under the
creditor  and  claimant  liabilities  restructuring  (Note 17).  The  settlement
resulted  in the  release  of all  claims  and the  reversal  of  $2,600,000  of
obligations  to  purchase  common  stock from Mr.  Allin and the Allin  Dynastic
Trust.  These  liabilities were  reclassified to stockholders'  equity since Mr.
Allin and the Allin  Dynastic Trust retained the shares that were subject to the
Company's repurchase obligation. In addition, the Company issued an aggregate of
2,500,000  Shares of Series A-1 Preferred  stock with a fair value of $1,500,000
to Mr.  Allin  and the Allin  Dynastic  Trust in  settlement  of  $1,317,089  of
liabilities  that were  payable in cash.  Accordingly,  the  Company  recorded a
$182,911 loss on this settlement based on the difference  between the fair value
of the Series A-1 Preferred shares and the liabilities payable in cash.

Sherleigh  Associates Inc. Profit Sharing Plan  ("Sherleigh")  filed a complaint
against the  Company,  Patrick  Allin,  former  Chief  Executive  Officer of the
Company, and Robert E. Yaw, the Company's non-executive Chairman, on February 3,
2004, in the United States District Court for the Southern  District of New York
(the  "Court")  alleging  common law fraud.  On April 24, 2006,  the Company and
Sherleigh  Associates  Inc. Profit Sharing Plan entered into a final and binding
settlement  of all  claims  as part of the  creditor  and  claimant  liabilities
restructuring (Note 17).

On January 5, 2006,  Mark P. Gertz,  Trustee in  bankruptcy  for Arter & Hadden,
LLP,  filed an Adversary  Complaint  for Recovery of Assets of the Estate in the
United  States  Bankruptcy  Court  Northern  District of Ohio Eastern  Division,
against the Company as successor in merger to Entelagent. On September 11, 2006,
the Company entered into a settlement and release  agreement with Mark P. Gertz,
Trustee in  bankruptcy  for Arter & Hadden,  LLP which  calls for the payment of
$32,500 in 13 installments of $2,500.

On May 4,  2006,  we  became  aware  that Lok  Technologies,  Inc.  had  filed a
complaint on or about March 30, 2006 against us,  Entelagent  Software Corp. and
unnamed  defendants in the Superior Court of  California,  County of Santa Clara
alleging  breach of contract,  breach of duty of good faith and fair dealing and
unjust enrichment  related to a license agreement and certain  promissory notes,
and seeking damages, interest, disgorgement of any unjust enrichment, attorneys'
fees and cost in an amount to be  provided.  Prior to receipt of this  notice of
litigation,  we had  recorded a note  payable  of  approximately  $320,000  plus
accrued interest of $159,432.  We believe that we have defenses to these claims.
We cannot provide any assurance that the ultimate  settlement of this claim will
not have a material adverse affect on our financial condition.

The Company was previously  subject to an  investigation by the SEC. On February
1, 2007, the Securities and Exchange  Commission  issued a letter to the Company
indicating that the SEC's  investigation  of the Company has been terminated and
that no enforcement action has been recommended to the Commission.


                                       8



ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

No matters were submitted for a vote by security holders during the three months
ended December 31, 2006.


                                     PART II

ITEM 5.  MARKET  FOR COMMON  EQUITY AND  RELATED STOCKHOLDER  MATTERS AND  SMALL
         BUSINESS ISSUER PURCHASES OF EQUITY SECURITIES

PRICE RANGE OF COMMON STOCK

Our common  stock is currently  quoted on the  Over-the-Counter  Bulletin  Board
("OTCBB") under the symbol "PTRN.OB." From May 21, 2004 until November 14, 2005,
our common stock was quoted on the Pink Sheets (the "Pink  Sheets") and prior to
May 21,  2004 we traded on the  OTCBB.  The  information  has been  adjusted  to
reflect a 1-for-30  reverse stock split of our common stock which took effect on
July 31, 2006.

The  following  table lists the high and low per share  closing sales prices for
the common stock as reported by the OTCBB or Pink Sheets, as applicable, for the
periods indicated:

2005:                                               HIGH                LOW
------------------------------------------        ---------          ---------
First Quarter ............................        $   34.80          $   19.50
Second Quarter ...........................            24.90              15.00
Third Quarter ............................            20.40               4.20
Fourth Quarter ...........................             4.20               1.50

2006:
------------------------------------------
First Quarter ............................        $    2.70          $    1.50
Second Quarter ...........................        $    2.31          $    0.93
Third Quarter ............................        $    3.25          $    0.96
Fourth Quarter ...........................        $    2.00          $    0.35

These quotations reflect inter-dealer prices, without retail markups, mark-downs
or commissions and may not necessarily represent actual transactions.

As of March 28,  2007  there  were  approximately  150  holders of record of our
common stock.  However,  we believe that the number of  beneficial  owners is in
excess of 500,  because a large  portion of the  common  stock is held of record
through brokerage firms in "street name."

DIVIDEND POLICY

Holders of our common stock are  entitled to  dividends  when and if declared by
the board of directors out of funds legally  available.  We have not declared or
paid any dividends on our common stock since inception and do not anticipate the
declaration or payment of cash dividends in the foreseeable future. We intend to
retain  earnings,  if any,  to finance  the  development  and  expansion  of our
business.  Future dividend policy will be subject to the discretion of the board
of directors and will be contingent upon future earnings,  if any, our financial
condition, capital requirements,  general business conditions and other factors.
Therefore,  there can be no  assurance  that  dividends of any kind will ever be
paid.

RECENT SALES OF UNREGISTERED SECURITIES

The following  unregistered  securities  have been authorized to be issued by us
during the three months ended December 31, 2006:


                                       9





                  TITLE AND AMOUNT OF SECURITIES        NAME OF         NAME OR CLASS OF
                    GRANTED/EXERCISE PRICE IF          PRINCIPAL      PERSONS WHO RECEIVED     CONSIDERATION
DATE OF GRANT               APPLICABLE                UNDERWRITER          SECURITIES            RECEIVED
-------------     -------------------------------     -----------    -----------------------   -------------
                                                                                   
October 2006      616.54/Series B Preferred Stock        None        45 Accredited Investors   $3,082,716(1)
                                                                      in Series B Preferred
                                                                         Stock Financing

October 2006            50,000/Common Stock              None             Richard Rozzi        $     0.00(2)

November 2006      174/Series B Preferred Stock          None        19 Accredited Investors   $  870,000(3)
                                                                      in Series B Preferred
                                                                         Stock Financing

  October /       1,879,725/Common stock Purchase        None        45 Accredited Investors   $     0.00(4)
November 2006                Warrants                                  purchasing Series B
                                                                         Preferred Stock

  October /        563,915/Common Stock Purchase         None         Laidlaw & Company (UK)   $     0.00(5)
November 2006                Warrants                                          Ltd.

November 2006      530,497/Common Stock Purchase         None        19 Accredited Investors   $     0.00(6)
                             Warrants                                  purchasing Series B
                                                                         Preferred Stock

November 2006      159,147/Common Stock Purchase         None         Laidlaw & Company (UK)   $     0.00(7)
                             Warrants                                          Ltd.


The above unregistered  securities were issued pursuant to an exemption from the
registration  requirements  of the  Securities  Act  under  Section  4(2) of the
Securities Act in a transaction not involving any public offering.


----------
(1)      On October  13,  2006,  we issued  616.54  shares of Series B Preferred
         Stock in consideration for $3,082,716.

(2)      On October  27,  2006,  Mr.  Rozzi  entered  into an  extension  of his
         existing  consulting  agreement with the Company to provided  financial
         public  relations,  financial  communications  and  investor  relations
         consulting  services.  In compensation for these services,  the Company
         agreed to issue the above noted shares.

(3)      On  November  16,  2006,  the  Company  issued  174  shares of Series B
         Preferred Stock in consideration for $870,000.

(4)      On October  13,  2006,  we issued  warrants  to  purchase up to 855,801
         shares of our common stock to 45  accredited  investors in  conjunction
         with the  investment by these 45  accredited  investors in our Series B
         Preferred  Stock  private  placement at an exercise  price of $2.40 per
         share.  On November 16, 2006 in conjunction  with the second closing of
         the Series B Preferred  Stock  private  placement at an $0.82 per share
         conversion price and an associated  warrant exercise price of $1.03 per
         share,  we  agreed  to  adjust  the  conversion  price of the  Series B
         Preferred  Stock  issued  in the first  closing  to the $0.82 per share
         value  associated  with the second  closing  and to adjust the  warrant
         exercise price for the warrants  issued in  conjunction  with the first
         closing to $1.03 per  share.  An  additional  1,023,924  warrants  were
         issued in conjunction  with this change.  The warrants have a term of 5
         years and an exercise  price of $1.03 per share.  The  warrants  had an
         aggregate value of $1,290,596.

(5)      On October  13,  2006,  we issued  warrants  to  purchase up to 256,734
         shares of our common stock to Laidlaw & Company (UK) Ltd. in connection
         with services  rendered to us as placement  agent for the first closing
         of the Series B Preferred Stock private  placement at an exercise price
         of $2.40 per share. On November 16, 2006 in conjunction with the second
         closing of the Series B Preferred  Stock private  placement at an $0.82
         per share conversion price and an associated  warrant exercise price of
         $1.03 per share, we agreed to adjust the conversion price of the Series
         B Preferred  Stock  issued in the first  closing to the $0.82 per share
         value  associated  with the second  closing  and to adjust the  warrant
         exercise price for the warrants  issued in  conjunction  with the first
         closing to $1.03 per share. An additional  307,181 warrants were issued
         to Laidlaw & Company (UK) Ltd. as placement agent for the first closing
         of the Series B Preferred Stock private  placement in conjunction  with
         this change.  The warrants have a term of 5 years and an exercise price
         of $1.03 per share. The warrants had an aggregate value of $387,177.

(6)      On  November  16,  2006,  we issued  warrants to purchase up to 530,497
         shares of our common stock to 19  accredited  investors in  conjunction
         with the  investment by these 19  accredited  investors in our Series B
         Preferred Stock private placement.  The warrants have a term of 5 years
         and an exercise price of $1.03 per share. The warrants had an aggregate
         value of $458,414.

(7)      On  November  16,  2006,  we issued  warrants to purchase up to 159,147
         shares of our common stock to Laidlaw & Company (UK) Ltd. in connection
         with  services  rendered  to us as  placement  agent  for the  Series B
         Preferred Stock private placement.  The warrants have a term of 5 years
         and an exercise price of $1.03 per share. The warrants had an aggregate
         value of $136,866.


                                       10



ITEM 6.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

THE FOLLOWING  DISCUSSION  OF OUR FINANCIAL  CONDITION AND RESULTS OF OPERATIONS
SHOULD BE READ IN CONJUNCTION  WITH THE  CONSOLIDATED  FINANCIAL  STATEMENTS AND
RELATED  NOTES  INCLUDED  ELSEWHERE IN THIS ANNUAL  REPORT ON FORM  10-KSB.  THE
FOLLOWING DISCUSSION CONTAINS FORWARD-LOOKING  STATEMENTS THAT INVOLVE RISKS AND
UNCERTAINTIES.   OUR  ACTUAL  RESULTS  COULD  DIFFER  SUBSTANTIALLY  FROM  THOSE
ANTICIPATED IN THESE FORWARD-LOOKING  STATEMENTS AS A RESULT OF SEVERAL FACTORS,
INCLUDING THE RISK FACTORS DISCUSSED BELOW.

OVERVIEW

From our inception  through  December 31, 2004, we were  principally  engaged in
developing  our  business  plan,   raising  capital,   identifying   merger  and
acquisition candidates and negotiating merger and acquisition  transactions that
we closed during the first quarter of 2005. On February 25, 2005, we consummated
the acquisitions of Complete  Security  Solutions,  Inc. ("CSSI") and LucidLine,
Inc.  ("LucidLine")  pursuant to the filings of  Agreements  and Plans of Merger
with  the  Secretaries  of  State  of  the  States  of  Delaware  and  Illinois,
respectively.  On February 28, 2005,  we  consummated a private  placement  with
accredited  investors  in the  amount of $3.5  million.  On March 30,  2005,  we
consummated the acquisition of Entelagent Software Corp. ("Entelagent") pursuant
to the filing of an Agreement  and Plan of Merger with the Secretary of State of
the State of  California.  From March 31, 2005 to December 31, 2005, we borrowed
$4,934,000 from a shareholder, Apex Investment Fund V, LP. During the year ended
December 31, 2005 we raised approximately  $6,343,000 in additional gross funds.
Net  proceeds  from  all  of  these   transaction   amounted  to   approximately
$10,649,000,  which were used  principally to fund  operations and repay certain
liabilities.  During  the  three  months  ended  December  31,  2005,  we raised
approximately  $1,634,000 in additional  gross funds in seven capital  financing
transactions.

Patron  Systems,  Inc.  provides  application  software and services  focused on
business process management (BPM) in the public sector. Our current  application
software offering,  FormStream,  is an open standards  information  sharing tool
that addresses the need for law  enforcement and public safety agencies to share
information  between  local,  state and federal  law  enforcement  and  homeland
security agencies. FormStream is a mobile electronic forms (e-forms) application
which provides a highly scalable, open standard,  network independent method for
the  distribution  and  synchronization  of  e-forms  to  mobile  devices.   The
implementation  of  FormStream  allows its user agencies to update and modernize
their  business  processes  to  utilize  the  sophisticated  form and user based
business  rules and  process  routing  capabilities  of  FormStream  to increase
officer and supervisor productivity, increase officer availability in the field,
reduce  back-office  workloads  involved  with  entry of data and review of data
entered,  provide real-time  information  sharing of field generated reports and
other field  generated  information  to officers and users within the  agency(s)
served by a particular  FormStream  installation  and provide the ability for an
agency to meet the federally  mandated  requirements  to provided police reports
and other  information to the state and federal  governments in standard formats
for information sharing purposes.  FormStream  addresses mobile e-form creation,
capture and sharing over wireless networks and manages data in industry standard
formats  (forms:  .pdf,  XDP and XML; law  enforcement:  Global Justice XML data
model (GJXDM) and National Information Exchange Model (NIEM)).

By  improving  the  information  flow  and the  business  processes  within  law
enforcement and public safety agencies, FormStream allows these agencies to much
more cost  effectively  serve their  constituents and provide improved local law
enforcement as well as enhanced local, regional and national homeland security.

CRITICAL ACCOUNTING POLICIES

The  preparation of our  consolidated  financial  statements in conformity  with
accounting  principles  generally  accepted  in the  United  States  of  America
requires management to exercise its judgment.  We exercise considerable judgment
with respect to establishing  sound  accounting  polices and in making estimates
and assumptions  that affect the reported amounts of our assets and liabilities,
our  recognition of revenues and expenses,  and  disclosures of commitments  and
contingencies at the date of the financial statements.

On an ongoing basis, we evaluate our estimates and judgments.  Areas in which we
exercise  significant  judgment include, but are not necessarily limited to, our
valuation of accounts  receivable,  recoverability of long-lived assets,  income
taxes,  equity transactions  (compensatory and financing) and contingencies.  We
have also adopted  certain  polices with respect to our  recognition  of revenue
that we believe are consistent with the guidance provided under


                                       11



Securities  and  Exchange  Commission  Staff  Accounting  Bulletin  No.  104 and
estimate values of delivered and undelivered elements.

We base our  estimates  and  judgments  on a variety  of factors  including  our
historical  experience,  knowledge  of our business  and  industry,  current and
expected  economic  conditions,  the  composition  of our  products,  regulatory
environment,  and in  certain  cases,  the  results of  outside  appraisals.  We
constantly  re-evaluate  our  estimates  and  assumptions  with respect to these
judgments and modify our approach when circumstances indicate that modifications
are necessary.

While we believe that the factors we evaluate provide us with a meaningful basis
for  establishing and applying sound  accounting  policies,  we cannot guarantee
that the  results  will always be  accurate.  Since the  determination  of these
estimates  requires the exercise of judgment,  actual  results could differ from
such estimates.

A  description  of  significant  accounting  policies  that  require  us to make
estimates and  assumptions  in the  preparation of our  sconsolidated  financial
statements are as follows:

ACCOUNTS RECEIVABLE AND REVENUE RECOGNITION

We derive  our  revenues  from the  following  sources:  (1)  sales of  computer
software,  which includes new software licenses and software updates and product
support revenues and (2) professional consulting services.

We apply the revenue  recognition  principles set forth under AICPA Statement of
Position ("SOP") 97-2 "Software Revenue Recognition" and Securities and Exchange
Commission Staff  Accounting  Bulletin  ("SAB") 104 "Revenue  Recognition"  with
respect to its  revenue.  Accordingly,  we record  revenue  when (i)  persuasive
evidence  of an  arrangement  exists,  (ii)  delivery  has  occurred,  (iii) the
vendor's fee is fixed or  determinable,  and (iv)  collectability  is reasonably
assured.

We also accrue unbilled revenue under software  licenses and services  delivered
under  contractual  arrangements  which  provide  for  billings  to be  made  at
intervals that may differ from the periods of delivery or performance.

We generate  revenues  through  sales of software  licenses  and annual  support
subscription agreements,  which include access to technical support and software
updates (if and when  available).  Software  license revenues are generated from
licensing  the rights to use products  directly to end-users  and through  third
party service providers.

Revenues from software license agreements are generally recognized upon delivery
of  software to the  customer.  All of our  software  sales are  supported  by a
written  contract  or other  evidence  of sale  transaction  such as a  customer
purchase order.  These forms of evidence  clearly  indicate the selling price to
the  customer,  shipping  terms,  payment  terms  (generally 30 days) and refund
policy,  if any. The selling  prices of these products are fixed at the time the
sale is consummated.

Revenue from post-contract customer support arrangements or undelivered elements
are deferred and  recognized at the time of delivery or over the period in which
the services are performed based on vendor specific  objective  evidence of fair
value for such  undelivered  elements.  Vendor  specific  objective  evidence is
typically  based on the price charged when an element is sold  separately or, if
an element is not sold  separately,  on the price  established  by an authorized
level of management,  if it is probable that the price, once  established,  will
not change before market introduction.  We use the residual method prescribed in
SOP 98-9,  "Modification of SOP 97-2,  Software Revenue Recognition With Respect
to Certain  Transaction" to allocate revenues to delivered  elements once it has
established   vendor-specific   objective   evidence  of  fair  value  for  such
undelivered elements.

Professional  consulting  services  are  billed  based on the number of hours of
consultant  services provided and the hourly billing rates. We recognize revenue
under these arrangements as the service is performed.

We adjust our accounts receivable balances that we deem to be uncollectible. The
allowance  for doubtful  accounts is our best estimate of the amount of probable
credit losses in our existing accounts  receivable.  We review our allowance for
doubtful  accounts on a monthly  basis to determine  the  allowance  based on an
analysis of its past due  accounts.  All past due balances that are over 90 days
are reviewed  individually for collectability.  Account balances are charged off
against the allowance  after all means of collection have been exhausted and the
potential for recovery is considered  remote. An allowance for doubtful accounts
is not provided because in our opinion,  all accounts  recorded are deemed to be
collectible.


                                       12



INCOME TAXES

We are required to determine the aggregate  amount of income tax expense or loss
based upon tax statutes in jurisdictions in which we conduct business. In making
these estimates,  we adjust our results  determined in accordance with generally
accepted  accounting  principles  for items that are treated  differently by the
applicable taxing authorities.  Deferred tax assets and liabilities, as a result
of  these  differences,  are  reflected  on  our  balance  sheet  for  temporary
differences  loss and credit  carry  forwards  that will  reverse in  subsequent
years. We also establish a valuation  allowance against deferred tax assets when
it is more likely than not that some or all of the  deferred tax assets will not
be realized.  Valuation  allowances  are based,  in part,  on  predictions  that
management must make as to our results in future periods.  The outcome of events
could differ over time which would  require us to make changes in our  valuation
allowance.

GOODWILL AND INTANGIBLE ASSETS

We account for Goodwill and  Intangible  Assets in accordance  with Statement of
Financial  Accounting  Standards ("SFAS") No. 141,  "Business  Combinations" and
SFAS No.  142,  "Goodwill  and Other  Intangible  Assets."  Under SFAS No.  142,
goodwill and intangibles  that are deemed to have indefinite lives are no longer
amortized but,  instead,  are to be reviewed at least  annually for  impairment.
Application of the goodwill  impairment  test requires  judgment,  including the
identification of reporting units, assigning assets and liabilities to reporting
units,  assigning  goodwill to reporting  units, and determining the fair value.
Significant  judgments  required to estimate the fair value of  reporting  units
include estimating future cash flows, determining appropriate discount rates and
other  assumptions.  Changes in these estimates and assumptions could materially
affect the  determination  of fair value  and/or  goodwill  impairment  for each
reporting unit. During the year ended December, 31, 2005 we recorded $22,440,212
of  goodwill  in  connection  with  the  acquisitions  of  LucidLine,  CSSI  and
Entelagent.  In  accordance  with SFAS 142, we conducted  our annual  impairment
review of goodwill for the year ended  December 31,  2006,  which  resulted in a
goodwill impairment charge of $210,716.

This 2006 charge,  which  principally  represents  goodwill  remaining  from the
PolicyBridge  business we acquired from Entelagent is classified in discontinued
operations  as a result of our  decision to exit that  business.  The  remaining
amount of goodwill, which amounts to $9,300,000 at December 31, 2006, relates to
our  acquisition  of CSSI in February 2005 from which we acquired the FormStream
software technology, our sole line of business. We engaged an outside specialist
to assist us with performing our annual goodwill  impairment tests.  These tests
were made  using a  discounted  cash  flow  model to value  the  business.  This
approach  requires us to forecast our  expectation of revenues and cash flows in
future  periods  and to  work  with  an  independent  specialist  on  developing
assumptions relating to the risk that such cash flows may or may not materialize
in future periods.

SHARE BASED PAYMENTS AND OTHER EQUITY TRANSACTIONS

Prior to January 1, 2006, we accounted for employee stock based  compensation in
accordance with Accounting  Principles  Board ("APB") Opinion No. 25 "Accounting
for Stock Issued to Employees." We applied the proforma disclosure  requirements
of SFAS No. 123 "Accounting for Stock-Based Compensation."

Effective  January 1, 2006, we adopted SFAS No. 123R "Share Based Payment." This
statement is a revision of SFAS  Statement No. 123, and  supersedes  APB Opinion
No. 25, and its related implementation  guidance.  SFAS 123R addresses all forms
of share based payment  ("SBP")  awards  including  shares issued under employee
stock purchase plans,  stock options,  restricted  stock and stock  appreciation
rights.  Under SFAS 123R,  SBP awards  result in a cost that is measured at fair
value on the awards' grant date,  based on the  estimated  number of awards that
are expected to vest. We adopted the modified prospective method with respect to
accounting  for  our  transition  to  SFAS  123(R)  and  measured   unrecognized
compensation cost. Under this method of accounting,  we are required to estimate
the  fair  value  of  share  based  payments  that we make to our  employees  by
developing  assumptions  regarding  expected  holding  terms of  stock  options,
volatility  rates and  expectation  of  forfeitures  and future vesting that can
significantly  impact the amount of compensation  cost that we recognize in each
reporting period.

We are also  required to apply  complex  accounting  principles  with respect to
accounting  for  financing  transactions  that we have  consummated  in order to
sustain our business. These transactions, which generally consist of convertible
debt and equity instruments,  require us to use significant judgment in order to
assess the fair values of these instruments at their dates of issuance, which is
critical to making a reasonable  presentation  of our financing costs and how we
finance our business.


                                       13



Formulating  estimates  in  any of  the  above  areas  requires  us to  exercise
significant  judgment.  It is at least reasonably possible that the estimates of
the effect on the  financial  statements  of a condition,  situation,  or set of
circumstances  that  existed  at the date of the  financial  statements  that we
considered in formulating our estimates could change in the near term due to one
or more future  confirming  events.  Accordingly,  the actual results  regarding
estimates  of any of the  above  items as they are  presented  in the  financial
statements could differ materially from our estimates.

RESULTS OF OPERATIONS  FOR THE YEAR ENDED DECEMBER 31, 2006 COMPARED TO THE YEAR
ENDED DECEMBER 31, 2005

For the year ended December 31, 2006, our consolidated  revenues from continuing
operations  amounted  to  $1,188,045  compared  to  $178,821  for the year ended
December  31,  2005.  The  increase  is the  result of growth of our  FormStream
product, since the combination was consummated with CSSI in February 2005.

Cost of Sales for the year ended December 31, 2006 amounted to $147,951 compared
to $219,173 for the year ended December 31, 2005.  Cost of sales during the year
ended  December 31, 2006 and December 31, 2005  includes  $38,943 and  $111,670,
respectively,  associated with the amortization of developed  technology that we
acquired from CSSI.

Operating  expenses  amounted to $4,251,799 for the year ended December 31, 2006
as compared to $23,405,761  for the year ended December 31, 2005, a reduction of
$19,153,962.  The  reduction  in  operating  expenses  includes  an  increase of
approximately  $253,000 for salaries  associated with increased  staffing in the
development, support and sales organizations, approximately $361,000 of employee
stock option compensation  expense,  approximately  $252,000 for increased legal
and professional  fees associated with the negotiation and settlement of various
legal matters under the creditor and claimant liabilities restructuring program,
and approximately  $442,000 for increased general and  administrative  expenses.
These increases were partially offset by an approximately  $12,930,000 reduction
associated  with  goodwill  impairment  in 2005,  a reduction  of  approximately
$1,421,000  associated  with  consulting  fees,  a  reduction  of  approximately
$558,000  associated with an acquired  technology  impairment  charge in 2005, a
reduction  in  losses   associated  with  legal   settlements  of  approximately
$4,337,000,  a reduction of $859,000 associated with registration  penalties, an
expense  reduction of approximately  $358,000  associated with penalties under a
collateralized financing arrangement.

Our loss from  operations  for the year ended  December  31,  2006  amounted  to
$3,211,705  compared to a loss of  $23,446,113  for the same period in 2005. Our
loss was reduced as a result of the  reductions  in  operating  expenses and the
increase in revenues discussed above.

Interest  expense during the year ended December 31, 2006 amounted to $1,169,105
as compared to  $17,453,447  for the year ended December 31, 2005. The reduction
is  due  to the  issuance  of  Series  A  Preferred  stock  and  its  associated
amortization of deferred financing costs and the accretion of debt discounts and
the intrinsic value of the conversion option for bridge note holders being lower
in total  during the year  ended  December  31,  2006 than the  amortization  of
deferred financing costs and the accretion of debt discounts incurred during the
year ended  December 31, 2005.  Offsetting  this  reduction  was the increase in
interest  expense due to the increased level of total debt financing  during the
year ended December 31, 2006 when compared to the same period in 2005.  Non-cash
interest  relating  to the  amortization  of  deferred  financing  costs and the
accretion of debt discounts  during the year ended December 31, 2006 amounted to
approximately  $303,039  compared  to  $4,096,297  in same  period in 2005.  The
intrinsic value of the conversion option for bridge note holders, which has been
classified as interest  expense amounted to $192,000 for the year ended December
31, 2006 compared to  $12,393,000 in the same period in 2005.  Interest  income,
was  $10,553  and  $19,250  in the  year  ended  December  31,  2006  and  2005,
respectively.  Interest income represents the interest earned from loans that we
made to Entelagent  prior to our  acquisition of that business on March 30, 2005
and interest on cash balances in the year ended December 31, 2006.

For the year ended  December 31, 2006, the net loss from  continuing  operations
was $4,372,329 or $(0.98) per share on 7,366,088  weighted average common shares
outstanding compared to a net loss from continuing  operations of $40,589,196 or
$(20.80) per share on 1,951,389  weighted average common shares  outstanding for
the year ended December 31, 2005.


                                       14



Our loss from discontinued  operations was reduced to $2,036,660 during the year
ended December 31, 2006 from $3,856,955 during the year ended December 31, 2005.
This reduction is principally due to the sale of the LucidLine business in April
2006 and the resulting  reduction in the losses  incurred in that business.  The
loss from  discontinued  operations  in the year ended  December  31,  2006 also
includes a charge of $781,740  associated  with the write-off of the  intangible
assets  associated  with the  PolicyBridge  business  and a goodwill  impairment
charge in the amount of $210,716 associated with the impairment of the remaining
goodwill associated with the Entelagent acquisition.  Additionally,  we recorded
in 2006 a loss on disposal of the discontinued LucidLine business of $75,920.

For the  year  ended  December  31,  2006,  the net  loss  available  to  common
stockholders  was $9,344,434 or $(1.27) per share on 7,366,088  weighted average
common  shares   outstanding   compared  to  a  net  loss  available  to  common
stockholders of $44,446,151 or $(22.78) per share on 1,951,389  weighted average
common shares outstanding for the year ended December 31, 2005.

LIQUIDITY AND CAPITAL RESOURCES

We incurred a net loss from  continuing  operations of  $4,372,329  for the year
ended December 31, 2006, which includes $1,139,496 of non-cash charges including
depreciation and amortization of $168,068, aggregate stock based compensation of
$523,915,  non-cash  interest expense of $543,438,  loss on sale of property and
equipment  $2,072 and a loss on the  disposition of  discontinued  operations of
$75,920.  The  non-cash  charges  were  offset by non-cash  gains of  $2,452,909
associated  with  the  settlements  of  outstanding   liabilities,   claims  and
litigation  under the creditor and claimant  liabilities  restructuring  program
that  occurred in the year ended  December  31,  2006.  We used  $511,691 of our
restricted   cash  escrowed  to  settle   liabilities   assumed  in  a  business
combination.  Including  the  amounts  above,  we used  net  cash  flows  in our
operating  activities of $5,301,169 during the year ended December 31, 2006. Our
working  capital  deficiency at December 31, 2006 amounted to $2,795,521  and we
are continuing to experience shortages of working capital. We cannot provide any
assurance  that the outcome of these  matters  will not have a material  adverse
affect on our ability to sustain the business.  These matters raise  substantial
doubt about our ability to continue as a going concern. The financial statements
do not include any  adjustments  that might be necessary  should we be unable to
continue as a going concern.

We expect to continue  incurring  losses for the  foreseeable  future due to the
inherent uncertainty that is related to establishing the commercial  feasibility
of  technological  products and developing a presence in new markets.  We raised
$8,773,217  of gross  proceeds  ($7,832,348  net  proceeds  after the payment of
certain  transaction  expenses) in financing  transactions during the year ended
December 31, 2006. We used  $5,301,169 of these  proceeds to fund our operations
and a net of $425,589 in investing activities.

We will  need to raise  additional  capital  and  have  taken  certain  steps to
conserve our liquidity  while we continue to develop our  business.  Although we
believe  that we have  access to  capital  resources,  we have not  secured  any
commitments  for  additional  financing  at this  time  nor can we  provide  any
assurance that we will be successful in our efforts to raise additional  capital
and/or successfully execute our business plan.

OFF-BALANCE SHEET ARRANGEMENTS

At December  31, 2006,  we did not have any  relationships  with  unconsolidated
entities  or  financial  partnerships,  such as  entities  often  referred to as
structured finance,  variable interest or special purpose entities,  which would
have  been  established  for  the  purpose  of  facilitating  off-balance  sheet
arrangements or other contractually narrow or limited purposes.  As such, we are
not exposed to any financing,  liquidity, market or credit risk that could arise
if we had engaged in such relationships.

RISK FACTORS

The risks noted below and  elsewhere  in this report and in other  documents  we
file  with the SEC are risks  and  uncertainties  that  could  cause our  actual
results   to  differ   materially   from  the   results   contemplated   by  the
forward-looking  statements contained in this report and other public statements
we make.

RISKS RELATED TO OUR COMMON STOCK

THERE IS SUBSTANTIAL DOUBT ABOUT OUR ABILITY TO CONTINUE AS A GOING CONCERN.

We  currently  have a number of  obligations  that we are unable to meet without
generating  additional  revenues  or raising  additional  capital.  If we cannot
generate  additional revenues or raise additional capital in the near future, we
may become insolvent. As of December 31, 2006, our cash balance was $541,570 and
we had a working capital deficit of $2,795,521.  This raises  substantial  doubt
about our ability to continue as a going concern.  Historically,  we have funded
our capital  requirements with debt and equity financing.  Our ability to obtain
additional equity or debt


                                       15



financing depends on a number of factors including our financial performance and
the overall  conditions in our industry.  If we are not able to raise additional
financing or if such  financing is not  available on  acceptable  terms,  we may
liquidate assets, seek or be forced into bankruptcy,  and/or continue operations
but suffer  material  harm to our  operations  and  financial  condition.  These
measures  could have a material  adverse  affect on our ability to continue as a
going concern.

We have  restructured  approximately 93% of our previously  outstanding  claims,
liabilities,  demands,  causes of  action,  costs,  expenses,  attorneys'  fees,
damages,  indemnities,  and  obligations  of every kind and nature that  certain
creditors  and  claimants  had with us pursuant  to our  Creditor  and  Claimant
Liabilities  Restructuring  described  elsewhere in this annual  report.  We are
currently  unable to provide  assurance  that the acceptance of the Creditor and
Claimant Liabilities Restructuring will actually improve our ability to fund the
further development of our business plan or improve our operations.  Our failure
to fund the  further  development  of our  business  plan and  operations  would
materially adversely affect our ability to continue as a going concern.

INVESTORS MAY NOT BE ABLE TO ADEQUATELY  EVALUATE OUR BUSINESS AND PROSPECTS DUE
TO OUR  LIMITED  OPERATING  HISTORY,  LACK  OF  REVENUES  AND  LACK  OF  PRODUCT
OFFERINGS.

We are at an early stage of executing  our business  plan and have no history of
offering information security capabilities.  We were incorporated in Delaware in
2002. Significant business operations only began with the acquisitions completed
in  February  and March  2005.  As a result of our  limited  history,  it may be
difficult to plan operating  expenses or forecast our revenues  accurately.  Our
assumptions about customer or network requirements may be wrong. The revenue and
income  potential of these  products is unproven,  and the markets  addressed by
these  products are volatile.  If such products are not  successful,  our actual
operating  results  could be below  our  expectations  and the  expectations  of
investors and market analysts,  which would likely cause the price of our common
stock to decline.

We have generated  limited revenues and have relied on financing  generated from
our capital raising  activities to fund the implementation of our business plan.
We  have  incurred  operating  and net  losses  and  negative  cash  flows  from
operations  since our inception.  As of December 31, 2006, we had an accumulated
deficit of approximately  $93.3 million.  We may continue to incur operating and
net losses, due in part to implementing our acquisitions  strategy,  engaging in
financing activities and expansion of our personnel and our business development
capabilities.  We will continue to seek  financing for the  acquisition of other
acquisition  targets that we may identify in the future.  We continue to believe
that we will secure financing in the near future,  but there can be no assurance
of our  success.  If we are  unable to obtain  the  necessary  funding,  it will
materially  adversely  affect our  ability to execute our  business  plan and to
continue our operations.

In addition, we may not be able to achieve or maintain profitability,  and, even
if we do  achieve  profitability,  the  level  of any  profitability  cannot  be
predicted and may vary significantly from quarter to quarter.

THE  AUTOMATIC  CONVERSION  OF OUR SERIES A-1  PREFERRED  STOCK HAS  RESULTED IN
SIGNIFICANT DILUTION TO OUR EXISTING STOCKHOLDERS AND A CHANGE IN CONTROL OF OUR
COMPANY,  AND COULD ALSO  RESULT IN  ADDITIONAL  VOLATILITY  IN THE PRICE OF OUR
COMMON STOCK.

The  automatic  conversion  of our Series A-1  Preferred  Stock on July 31, 2006
resulted in significant  dilution to our existing  stockholders  and resulted in
our former creditors and claimants owning approximately 85.0% of our outstanding
shares of common stock. These creditors and claimants, to the extent they act in
concert, would be able to determine all actions brought before our stockholders.
As a result of the automatic  conversion of our Series A-1 Preferred Stock, each
of Per  Gustafsson,  Arco van Nieuwland and Sherleigh  Associates,  Inc.  Profit
Sharing Plan became  greater than five percent  beneficial  owners of our common
stock.

Upon the  registration  of the shares of common stock issued upon the conversion
of our Series A-1 Preferred Stock,  there will be a substantial amount of shares
eligible  for sale in the  public  market.  If former  holders of our Series A-1
Preferred  Stock decide to sell their  shares of  registered  stock,  such sales
could result in  significant  volatility in the market price of our common stock
and would likely cause the market price of our common stock to decline.

THERE CAN BE NO GUARANTY  THAT A MARKET WILL  DEVELOP FOR THE PRODUCTS WE INTEND
TO OFFER.

We currently have a limited offering of products.  We intend to acquire products
through the acquisition of existing businesses. There is no guarantee,  however,
that a market will develop for Internet security solutions of the type we


                                       16



intend to offer. We cannot predict the size of the market for Internet  security
solutions,  the rate at which the  market  will  grow,  or  whether  our  target
customers will accept our acquired products.

OUR  OPERATING  RESULTS  MAY  FLUCTUATE  SIGNIFICANTLY,   WHICH  MAY  RESULT  IN
VOLATILITY OR HAVE AN ADVERSE EFFECT ON THE MARKET PRICE OF OUR COMMON STOCK.

The  market  prices  of the  securities  of  technology-related  companies  have
historically  been  volatile and may continue to be volatile.  Thus,  the market
price of our common stock is likely to be subject to wide  fluctuations.  If our
revenues do not grow or grow more slowly than we  anticipate,  if  operating  or
capital   expenditures   exceed   our   expectations   and   cannot  be  reduced
appropriately,  or if some other event adversely affects us, the market price of
our common stock could decline.  Only a small public market currently exists for
our common stock and the number of shares eligible for sale in the public market
is currently  very limited,  but is expected to increase.  Sales of  substantial
shares in the future would depress the price of our common  stock.  In addition,
we currently do not receive any stock market research coverage by any recognized
stock  market  research  or  trading  firm and our  shares are not traded on any
national  securities  exchange.  A larger and more active  market for our common
stock may not develop.

Because of our limited  operations  history  and lack of assets and  revenues to
date, our common stock is believed to be currently  trading on speculation  that
we will be successful in implementing  our  acquisition  and growth  strategies.
There can be no assurance  that such  success  will be achieved.  The failure to
implement our acquisitions  and growth  strategies would likely adversely affect
the  market  price  of  our  common  stock.  In  addition,  if  the  market  for
technology-related stocks or the stock market in general experiences a continued
or greater loss in investor  confidence or otherwise  fails, the market price of
our common stock could decline for reasons unrelated to our business, results of
operations  and financial  condition.  The market price of our common stock also
might decline in reaction to events that affect other  companies in our industry
even if these events do not directly  affect us.  General  political or economic
conditions, such as an outbreak of war, a recession or interest rate or currency
rate  fluctuations,  could also cause the  market  price of our common  stock to
decline.  Our  common  stock  has  experienced,  and is likely  to  continue  to
experience, these fluctuations in price, regardless of our performance.

FUTURE SALES OF SHARES BY EXISTING  STOCKHOLDERS  COULD CAUSE OUR STOCK PRICE TO
DECLINE.

If our  existing  or  future  stockholders  sell,  or  are  perceived  to  sell,
substantial  amounts of our common stock in the public market,  the market price
of our common stock could decline.  As of March 28, 2007,  there were 14,512,260
shares of common stock outstanding,  of which 1,244,012 shares were beneficially
held by directors,  executive  officers and other affiliates,  the sale of which
are subject to volume limitations under Rule 144, various vesting agreements and
our quarterly  and other  "blackout"  periods.  Furthermore,  shares  subject to
outstanding  options and warrants and shares  reserved for future issuance under
our stock option plan will become  eligible for sale in the public market to the
extent  permitted by the provisions of various vesting  agreements,  the lock-up
arrangements and Rule 144 under the Securities Act.

THE  UNPREDICTABILITY  OF AN ACQUIRED COMPANY'S  QUARTERLY RESULTS MAY CAUSE THE
TRADING PRICE OF OUR COMMON STOCK TO DECLINE.

The quarterly  revenues and  operating  results of companies we may acquire will
likely continue to vary in the future due to a number of factors,  many of which
are outside of our control.  Any of these  factors  could cause the price of our
common stock to decline. The primary factors that may affect future revenues and
future operating results include the following:

o        the demand for our  subsidiaries'  current  product  offerings  and our
         future products;

o        the length of sales cycles;

o        the timing of recognizing revenues;

o        new product introductions by us or our competitors;

o        changes  in  our  pricing  policies  or  the  pricing  policies  of our
         competitors;

o        variations in sales channels, product costs or mix of products sold;

o        our  ability  to  develop,  introduce  and ship in a timely  manner new
         products and product enhancements that meet customer requirements;

o        our ability to obtain  sufficient  supplies  of sole or limited  source
         components for our products;

o        variations in the prices of the components we purchase;


                                       17



o        our  ability to attain and  maintain  production  volumes  and  quality
         levels  for  our  products  at  reasonable  prices  at our  third-party
         manufacturers;

o        our ability to manage our customer  base and credit risk and to collect
         our accounts receivable; and

o        the financial strength of our value-added resellers and distributors.

Our  operating  expenses are largely  based on  anticipated  revenues and a high
percentage  of our  expenses  are,  and will  continue to be, fixed in the short
term. As a result,  lower than  anticipated  revenues for any reason could cause
significant  variations  in our  operating  results from quarter to quarter and,
because of our rapidly growing operating  expenses,  could result in substantial
operating losses.

OUR  COMMON  STOCK  IS  SUBJECT  TO THE  SEC'S  PENNY  STOCK  RULES.  THEREFORE,
BROKER-DEALERS MAY EXPERIENCE DIFFICULTY IN COMPLETING CUSTOMER TRANSACTIONS AND
TRADING ACTIVITY IN OUR SECURITIES MAY BE ADVERSELY AFFECTED.

If at any time a company has net tangible  assets of  $5,000,000 or less and the
common  stock has a market price per share of less than $5.00,  transactions  in
the common stock may be subject to the "penny stock" rules promulgated under the
Exchange Act. Under these rules, broker-dealers who recommend such securities to
persons other than institutional accredited investors must:

o        make a special written suitability determination for the purchaser;

o        receive the  purchaser's  written  agreement to a transaction  prior to
         sale;

o        provide the purchaser  with risk  disclosure  documents  which identify
         certain risks  associated  with  investing in "penny  stocks" and which
         describe the market for these "penny  stocks" as well as a  purchaser's
         legal remedies; and

o        obtain  a  signed   and  dated   acknowledgment   from  the   purchaser
         demonstrating  that the  purchaser  has actually  received the required
         risk disclosure document before a transaction in a "penny stock" can be
         completed.

As our common stock is subject to these rules,  broker-dealers  may find it
difficult  to  effectuate  customer  transactions  and  trading  activity in our
securities  may be  adversely  affected.  As a result,  the market  price of our
securities may be depressed, and stockholders may find it more difficult to sell
their shares of our common stock.

RISKS RELATED TO OUR BUSINESS

WE MAY BE UNABLE TO SUCCESSFULLY INTEGRATE ACQUIRED BUSINESSES.

Our business plan is dependent upon the acquisition and integration of companies
that have previously operated independently.  To date we have experienced delays
in  implementing  our business  plan as a result of limited  capital  resources,
which have had a material adverse effect on our business.  Further delays in the
process of integrating  could cause an interruption  of, or loss of momentum in,
the activities of our business and the loss of key  personnel.  The diversion of
management's attention and any delays or difficulties  encountered in connection
with our integration of acquired  operations could have an adverse effect on our
business, results of operations, financial condition or prospects.

WE CURRENTLY DO NOT HAVE SUFFICIENT  REVENUES TO SUPPORT OUR BUSINESS ACTIVITIES
AND IF OPERATING LOSSES CONTINUE,  WILL BE REQUIRED TO OBTAIN ADDITIONAL CAPITAL
THROUGH FINANCINGS WHICH WE MAY NOT BE ABLE TO SECURE.

To achieve our intended growth, we will require substantial  additional capital.
We have  encountered  difficulty  and delays in raising  capital to date and the
market   environment  for  development  stage  companies,   like  ours,  remains
particularly challenging. There can be no assurance that funds will be available
when  needed or on  acceptable  terms.  Technology  companies  in  general  have
experienced  difficulty in recent years in accessing  capital.  Our inability to
obtain  additional  financing  may require us to delay,  scale back or eliminate
certain of our growth  plans which could have a material  and adverse  effect on
our business,  financial condition or results of operations or could cause us to
cease  operations.  Even if we are able to  obtain  additional  financing,  such
financing  could be  structured  as  equity  financing  that  would  dilute  the
ownership percentage of any investor in our securities.


                                       18



DOWNTURNS IN THE INTERNET  INFRASTRUCTURE,  NETWORK SECURITY AND RELATED MARKETS
MAY DECREASE OUR REVENUES AND MARGINS.

The  market  for our  current  products  and other  products  we intend to offer
depends on economic  conditions  affecting the broader Internet  infrastructure,
network  security  and related  markets.  Downturns  in these  markets may cause
enterprises  and  carriers to delay or cancel  security  projects,  reduce their
overall or security-specific  information technology budgets or reduce or cancel
orders for our current  products and other products we intend to offer.  In this
environment, customers such as distributors,  value-added resellers and carriers
may  experience  financial  difficulty,  cease  operations and fail to budget or
reduce  budgets for the  purchase of our current  products or other  products we
intend to offer.  This,  in turn,  may lead to longer  sales  cycles,  delays in
purchase  decisions,  payment  and  collection,  and may  also  result  in price
pressures,  causing us to realize  lower  revenues,  gross margins and operating
margins.  In  addition,   general  economic   uncertainty  caused  by  potential
hostilities involving the United States,  terrorist  activities,  the decline in
specific markets such as the service  provider market in the United States,  and
the general  decline in capital  spending in the information  technology  sector
make it difficult to predict changes in the purchase and network requirements of
our potential  customers and the markets we intend to serve. We believe that, in
light of these events, some businesses may curtail or eliminate capital spending
on  information  technology.  A decline in capital  spending  in the  markets we
intend to serve may  adversely  affect our future  revenues,  gross  margins and
operating margins and make it necessary for us to gain significant  market share
from our future  competitors in order to achieve our financial goals and achieve
profitability.

COMPETITION MAY DECREASE OUR PROJECTED REVENUES, MARKET SHARE AND MARGINS.

The market for network security  products is highly  competitive,  and we expect
competition  to intensify in the future.  Competitors  may gain market share and
introduce new competitive  products for the same markets and customers we intend
to serve with our products.  These products may have better  performance,  lower
prices and broader  acceptance than the products we currently offer or intend to
offer.

Many of our potential competitors have longer operating histories,  greater name
recognition,   large  customer  bases  and  significantly   greater   financial,
technical,  sales, marketing and other resources than we have. In addition, some
of our  potential  competitors  currently  combine  their  products  with  other
companies'  networking and security products.  These potential  competitors also
often combine their sales and marketing  efforts.  Such activities may result in
reduced  prices,  lower gross and operating  margins and longer sales cycles for
the  products  we  currently  offer and  intend to offer.  If any of our  larger
potential  competitors were to commit greater  technical,  sales,  marketing and
other  resources to the markets we intend to serve,  or reduce  prices for their
products over a sustained  period of time, our ability to successfully  sell the
products  we intend to offer,  increase  revenue or meet our or market  analysts
expectations could be adversely affected.

FAILURE TO ADDRESS  EVOLVING  STANDARDS  IN THE NETWORK  SECURITY  INDUSTRY  AND
SUCCESSFULLY  DEVELOP AND INTRODUCE NEW PRODUCTS OR PRODUCT  ENHANCEMENTS  WOULD
CAUSE OUR REVENUES TO DECLINE.

The market for network security products is characterized by rapid technological
change, frequent new product introductions, changes in customer requirements and
evolving   industry   standards.   We  expect  to  introduce  our  products  and
enhancements  to existing  products to address  current  and  evolving  customer
requirements and broader networking trends and  vulnerabilities.  We also expect
to develop products with strategic partners and incorporate third-party advanced
security  capabilities  into  our  intended  product  offerings.  Some of  these
products and enhancements  may require us to develop new hardware  architectures
that involve complex and time consuming processes. In developing and introducing
our  intended  product  offerings,  we have  made,  and will  continue  to make,
assumptions with respect to which features,  security  standards and performance
criteria will be required by our potential customers.  If we implement features,
security  standards  and  performance  criteria  that are  different  from those
required by our potential  customers,  market acceptance of our intended product
offerings may be significantly reduced or delayed,  which would harm our ability
to penetrate existing or new markets.

Furthermore,  we may not be able to develop new products or product enhancements
in a timely  manner,  or at all. Any failure to develop or  introduce  these new
products and product  enhancements  might cause our existing products to be less
competitive, may adversely affect our ability to sell solutions to address large
customer  deployments  and, as a  consequence,  our  revenues  may be  adversely
affected.  In addition,  the introduction of products embodying new technologies
could render existing  products we intend to offer obsolete,  which would have a
direct,  adverse  effect on our market  share and  revenues.  Any failure of our
future products or product enhancements to achieve market


                                       19



acceptance  could cause our revenues to decline and our operating  results to be
below our  expectations  and the  expectations of investors and market analysts,
which would likely cause the price of our common stock to decline.

WE HAVE EXPERIENCED ISSUES WITH OUR FINANCIAL  SYSTEMS,  CONTROLS AND OPERATIONS
THAT COULD HARM OUR FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

Our ability to sell our intended  product  offerings  and implement our business
plan successfully in a volatile and growing market requires effective management
and financial systems and a system of financial processes and controls.  Through
the quarter  ended  December 31,  2006,  our Chief  Executive  Officer and Chief
Financial  Officer  evaluated the  effectiveness of our disclosure  controls and
procedures in accordance with Exchange Act Rules 13a-15 or 15d-15 and identified
material weaknesses in our internal controls.  These material weaknesses related
to the fact that that our  overall  financial  reporting  structure  and current
staffing  levels were not  sufficient to support the complexity of our financial
reporting requirements. We currently lack the expertise we need to apply complex
accounting   principles  relating  to  our  business   combinations  and  equity
transactions and have  experienced  difficulty in applying income tax accounting
principles. Although we have taken steps to correct these previous deficiencies,
including  the  hiring  of a  Chief  Financial  Officer,  and are  currently  in
compliance  with the  SEC's  reporting  requirements,  additional  time is still
required to test and document our internal and disclosure  control  processes to
ensure  their  operating  effectiveness.  In addition,  we have limited  capital
resources  and are still at risk for the loss of key  personnel  in our  finance
department.  The loss of key personnel in our finance  department,  or any other
conditions that could disrupt our operations in this area, could have a material
adverse affect on our ability to communicate  critical information to management
and our  investors,  raise  capital  and/or  maintain  compliance  with  our SEC
reporting obligations. These circumstances, if they arise, could have a material
adverse affect on our business.

We have  limited  management  resources to date and are still  establishing  our
management and financial systems.  Growth, to the extent it occurs, is likely to
place a considerable strain on our management resources,  systems, processes and
controls.  To address  these  issues,  we will need to  continue  to improve our
financial and managerial  controls,  reporting systems and procedures,  and will
need to continue to expand, train and manage our work force worldwide. If we are
unable to maintain an adequate level of financial processes and controls, we may
not be able to accurately report our financial performance on a timely basis and
our business and stock price would be harmed.

WE MAY NOT BE ABLE  TO  IMPLEMENT  SECTION  404 OF THE  SARBANES-OXLEY  ACT ON A
TIMELY BASIS.

The SEC, as directed by Section 404 of the  Sarbanes-Oxley  Act of 2002, adopted
rules generally  requiring each public company to include a report of management
on the company's internal controls over financial reporting in its annual report
on Form 10-KSB that contains an assessment by management of the effectiveness of
the company's internal controls over financial  reporting  beginning in the year
ended  December 31, 2007.  In addition,  the  company's  independent  registered
accounting  firm must  attest to and report on  management's  assessment  of the
effectiveness of the company's internal controls over financial reporting.  This
requirement  will first apply to our annual report on Form 10-KSB for the fiscal
year  ending  December  31,  2008.  We have  not yet  developed  a  Section  404
implementation  plan.  We have in the  past  discovered,  and may in the  future
discover,  areas of our internal controls that need  improvement.  How companies
should be implementing these new requirements including internal control reforms
to comply with Section  404's  requirements  and how  independent  auditors will
apply  these  requirements  and  test  companies'  internal  controls,  is still
reasonably  uncertain.  We  expect  that  we may  need  to  hire  and/or  engage
additional  personnel and incur  incremental costs in order to complete the work
required by Section 404. We can not guarantee that we will be able to complete a
Section 404 plan on a timely basis.  Additionally,  upon completion of a Section
404  plan,  we may  not be able to  conclude  that  our  internal  controls  are
effective,  or in the event that we  conclude  that our  internal  controls  are
effective,  our independent accountants may disagree with our assessment and may
issue a report that is  qualified.  Any  failure to  implement  required  new or
improved controls, or difficulties  encountered in their  implementation,  could
negatively  affect  our  operating  results  or  cause  us to fail  to meet  our
reporting obligations.

IF OUR FUTURE  PRODUCTS DO NOT  INTEROPERATE  WITH OUR END CUSTOMERS'  NETWORKS,
INSTALLATIONS WOULD BE DELAYED OR CANCELLED,  WHICH COULD  SIGNIFICANTLY  REDUCE
OUR ANTICIPATED REVENUES.

Future  products will be designed to interface with our end customers'  existing
networks,  each of which have  different  specifications  and  utilize  multiple
protocol standards. Many end customers' networks contain multiple generations of
products  that  have  been  added  over time as these  networks  have  grown and
evolved.  Our future products must  interoperate with all of the products within
these networks as well as with future products that might


                                       20



be added to these networks in order to meet end customers'  requirements.  If we
find errors in the existing software used in our end customers' networks, we may
elect to  modify  our  software  to fix or  overcome  these  errors  so that our
products will  interoperate and scale with their existing software and hardware.
If our future products do not interoperate  with those within our end customers'
networks,  installations  could be delayed or orders for our  products  could be
cancelled, which could significantly reduce our anticipated revenues.

AS A PUBLIC  COMPANY,  WE MAY  INCUR  INCREASED  COSTS AS A RESULT  OF  RECENTLY
ENACTED AND  PROPOSED  CHANGES IN LAWS AND  REGULATIONS  RELATING  TO  CORPORATE
GOVERNANCE MATTERS AND PUBLIC DISCLOSURE.

Recently  enacted and  proposed  changes in the laws and  regulations  affecting
public companies, including the provisions of the Sarbanes-Oxley Act of 2002 and
rules adopted or proposed by the SEC will result in increased costs for us as we
evaluate the  implications of these laws,  regulations and standards and respond
to their  requirements.  In  addition,  we will become  subject to the  internal
control reporting requirement specified in Section 404 of the Sarbanes-Oxley Act
of 2002 beginning in the year ended December 31, 2007,  which will require us to
expend substantial  financial  resources in order to become compliant with these
requirements.  These laws and  regulations  could make it more difficult or more
costly for us to obtain  certain  types of  insurance,  including  director  and
officer  liability  insurance,  and we may be forced to  accept  reduced  policy
limits and  coverage or incur  substantially  higher costs to obtain the same or
similar  coverage.  The impact of these events could also make it more difficult
for us to  attract  and  retain  qualified  persons  to  serve  on our  board of
directors,  board  committees or as executive  officers.  We cannot estimate the
amount or timing of additional  costs we may incur as a result of these laws and
regulations.

WE DEPEND ON OUR KEY PERSONNEL TO MANAGE OUR BUSINESS  EFFECTIVELY  IN A RAPIDLY
CHANGING  MARKET,  AND IF WE ARE UNABLE TO HIRE  ADDITIONAL  PERSONNEL OR RETAIN
EXISTING  PERSONNEL,  OUR  ABILITY TO EXECUTE  OUR  BUSINESS  STRATEGY  WOULD BE
IMPAIRED.

Our  future  success  depends  upon  the  continued  services  of our  executive
officers. The loss of the services of any of our key employees, the inability to
attract  or  retain  qualified  personnel  in the  future,  or  delays in hiring
required  personnel,  could  delay the  development  and  introduction  of,  and
negatively impact our ability to sell, our intended product offerings.

WE MIGHT HAVE TO DEFEND  LAWSUITS OR PAY DAMAGES IN CONNECTION  WITH ANY ALLEGED
OR ACTUAL FAILURE OF OUR PRODUCTS AND SERVICES.

Because our intended product  offerings and services provide and monitor network
security and may protect valuable information,  we could face claims for product
liability,  tort or breach of  warranty.  Anyone who  circumvents  our  security
measures could misappropriate the confidential  information or other property of
end  customers  using our  products,  or  interrupt  their  operations.  If that
happens,  affected  end  customers  or others may sue us.  Defending  a lawsuit,
regardless of its merit, could be costly and could divert management  attention.
Our business  liability  insurance coverage may be inadequate or future coverage
may be unavailable on acceptable terms or at all.

WE COULD BECOME SUBJECT TO LITIGATION  REGARDING  INTELLECTUAL  PROPERTY  RIGHTS
THAT COULD BE COSTLY AND RESULT IN THE LOSS OF SIGNIFICANT RIGHTS.

In recent  years,  there has been  significant  litigation  in the United States
involving patents and other intellectual  property rights. We may become a party
to litigation in the future to protect our intellectual  property or as a result
of an alleged infringement of another party's intellectual property.  Claims for
alleged infringement and any resulting lawsuit, if successful,  could subject us
to significant liability for damages and invalidation of our proprietary rights.
These lawsuits,  regardless of their success, would likely be time-consuming and
expensive  to  resolve  and would  divert  management  time and  attention.  Any
potential intellectual property litigation could also force us to do one or more
of the following:

o        stop or delay  selling,  incorporating  or using  products that use the
         challenged intellectual property; and/or

o        obtain from the owner of the infringed  intellectual  property  right a
         license to sell or use the relevant technology, which license might not
         be  available on  reasonable  terms or at all; or redesign the products
         that use that technology.


                                       21



If we are forced to take any of these  actions,  our business might be seriously
harmed.  Our insurance may not cover potential claims of this type or may not be
adequate to indemnify us for all liability that could be imposed.

OUR INABILITY TO OBTAIN ANY THIRD-PARTY LICENSE REQUIRED TO DEVELOP NEW PRODUCTS
AND PRODUCT  ENHANCEMENTS  COULD REQUIRE US TO OBTAIN  SUBSTITUTE  TECHNOLOGY OF
LOWER QUALITY OR PERFORMANCE STANDARDS OR AT GREATER COST, WHICH COULD SERIOUSLY
HARM OUR BUSINESS, FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

From time to time, we may be required to license  technology  from third parties
to develop new products or product enhancements. Third-party licenses may not be
available to us on  commercially  reasonable  terms or at all. Our  inability to
obtain any  third-party  license  required  to develop  new  products or product
enhancements  could require us to obtain substitute  technology of lower quality
or  performance  standards or at greater cost,  which could  seriously  harm our
business, financial condition and results of operations.

GOVERNMENTAL  REGULATIONS  AFFECTING  THE  IMPORT OR EXPORT  OF  PRODUCTS  COULD
NEGATIVELY AFFECT OUR REVENUES.

Governmental  regulation  of imports  or  exports or failure to obtain  required
export approval of our encryption  technologies could harm our international and
domestic sales.  The United States and various foreign  governments have imposed
controls,  export license  requirements and restrictions on the import or export
of some technologies,  especially encryption technology.  In addition, from time
to time, governmental agencies have proposed additional regulation of encryption
technology,  such as requiring the escrow and  governmental  recovery of private
encryption keys.

In particular,  in light of recent terrorist  activity,  governments could enact
additional regulation or restrictions on the use, import or export of encryption
technology.  Additional  regulation  of  encryption  technology  could  delay or
prevent the  acceptance and use of encryption  products and public  networks for
secure  communications.  This might  decrease  demand for our  intended  product
offerings and services.  In addition,  some foreign  competitors  are subject to
less stringent controls on exporting their encryption technologies. As a result,
they may be able to compete  more  effectively  than we can in the  domestic and
international network security market.

MANAGEMENT COULD INVEST OR SPEND OUR CASH OR CASH EQUIVALENTS AND INVESTMENTS IN
WAYS THAT MIGHT NOT ENHANCE OUR RESULTS OF OPERATIONS OR MARKET SHARE.

We have  made no  specific  allocations  of our  cash  or cash  equivalents  and
investments.  Consequently,  management  will  retain a  significant  amount  of
discretion over the application of our cash or cash  equivalents and investments
and could spend the proceeds in ways that do not improve our  operating  results
or increase our market share. In addition, these proceeds may not be invested to
yield a favorable rate of return.


                                       22



ITEM 7.  FINANCIAL STATEMENTS

                              PATRON SYSTEMS, INC.
                                DECEMBER 31, 2006



                                    CONTENTS

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM ...................   24

FINANCIAL STATEMENTS

    Balance Sheet as of December 31, 2006 .................................   25

    Statements of Operations for the years ended
       December 31, 2006 and 2005 .........................................   26

    Statements of Stockholders' (Deficiency) Equity for
       the years ended December 31, 2006 and 2005 .........................   27

    Statements of Cash Flows for the years ended
       December 31, 2006 and 2005 .........................................   28

Notes to Financial Statements .............................................   29


                                       23



             REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM


To the Audit Committee of the Board of
Directors and Stockholders of Patron
Systems, Inc.


We have  audited the  accompanying  balance  sheet of Patron  Systems,  Inc (the
"Company") as of December 31, 2006, and the related  consolidated  statements of
operations, changes in stockholders' (deficiency) equity and cash flows for each
of the two  years  in the  period  ended  December  31,  2006.  These  financial
statements   are  the   responsibility   of  the   Company's   management.   Our
responsibility  is to express an opinion on these financial  statements based on
our audit.

We conducted our audits in accordance  with the standards of the Public  Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements  are free of material  misstatement.  The Company is not  required to
have,  nor were we engaged to perform,  an audit of its  internal  control  over
financial reporting.  Our audit included  consideration of internal control over
financial  reporting  as  a  basis  for  designing  audit  procedures  that  are
appropriate  in the  circumstances,  but not for the  purpose of  expressing  an
opinion on the  effectiveness  of the Company's  internal control over financial
reporting.  Accordingly,  we express  no such  opinion.  An audit also  includes
examining,  on a test basis,  evidence supporting the amounts and disclosures in
the  financial   statements,   assessing  the  accounting  principles  used  and
significant  estimates  made by  management,  as well as evaluating  the overall
financial  statement  presentation.   We  believe  that  our  audits  provide  a
reasonable basis for our opinion.

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

The  accompanying  financial  statements  have been  prepared  assuming that the
Company  will  continue  as a  going  concern.  As  discussed  in  Note 2 to the
financial  statements,  the Company has incurred net losses since its inception,
has a working capital deficiency and limited capital resources. These conditions
raise  substantial  doubt  about the  Company's  ability to  continue as a going
concern.  The financial  statements do not include any adjustments that might be
necessary should the company be unable to continue as a going concern.


/s/ Marcum & Kliegman LLP
-------------------------
    Marcum & Kliegman LLP

New York, New York
March 20, 2007


                                       24



                              PATRON SYSTEMS, INC.
                                  BALANCE SHEET


                                                                   DECEMBER 31,
                                                                       2006
                                                                  -------------

ASSETS
Current Assets:
  Cash .....................................................      $     541,570
  Accounts receivable ......................................            828,875
  Other current assets .....................................            133,841
                                                                  -------------
     Total current assets ..................................          1,504,286

Property and equipment, net ................................            174,791
Computer software development costs ........................            414,560
Intangible assets, net .....................................            127,290
Assets held for sale .......................................            210,710
Goodwill ...................................................          9,300,000
                                                                  -------------
     Total assets ..........................................      $  11,731,637
                                                                  =============

LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities
  Accounts payable .........................................      $     535,128
  Other current liabilities ................................          1,858,878
  Demand notes payable .....................................            312,557
  Bridge notes payable .....................................            519,975
  Notes payable (to creditors of acquired
    business, including $554,202 to related
    parties) ...............................................            799,982
  Deferred revenue .........................................            164,295
  Liabilities of discontinued operations ...................            108,992
                                                                  -------------
     Total current liabilities .............................          4,299,807


Commitments and Contingencies

Stockholders' Equity
  Preferred stock, par value $0.01 per share,
    75,000,000 shares authorized,
       Series A convertible: 2,160 shares
         authorized; 964 shares issued and
         outstanding; liquidation preference
         of $6,394,098 .....................................                 10
       Series A-1 convertible: 50,000,000 shares
         authorized; no shares outstanding .................               --
       Series B convertible: 2,000 shares
         authorized; 791 shares issued and
         outstanding; liquidation preference
         of $5,037,705 .....................................                  8
  Common stock, par value $0.01 per share,
    150,000,000 shares authorized, 14,512,260
    shares issued and outstanding ..........................            145,127
  Additional paid-in capital ...............................        100,573,227
  Accumulated deficit ......................................        (93,286,542)
                                                                  -------------
     Total stockholders' equity ............................          7,431,830
                                                                  -------------
     Total liabilities and stockholders' equity ............      $  11,731,637
                                                                  =============

The accompanying notes are an integral part of these financial statements


                                       25




                              PATRON SYSTEMS, INC.
                            STATEMENTS OF OPERATIONS


                                                               FOR THE YEAR ENDED DECEMBER 31,
                                                                ----------------------------
                                                                    2006            2005
                                                                ------------    ------------
                                                                          
Revenue .....................................................   $  1,188,045    $    178,821
                                                                ------------    ------------
Cost of Sales
  Cost of products/services .................................        109,008         107,503
  Amortization of technology ................................         38,943         111,670
                                                                ------------    ------------
    Total cost of sales .....................................        147,951         219,173
                                                                ------------    ------------
  Gross Profit ..............................................      1,040,094         (40,352)
                                                                ------------    ------------

Operating Expenses
  Salaries and related expenses .............................      3,755,130       3,140,219
  Consulting expense ........................................         63,120       1,483,933
  Professional fees .........................................      1,313,754       1,061,831
  General and administrative ................................      1,564,144       1,122,036
  Registration penalties ....................................           --           859,004
  Loss on collateralized financing arrangement ..............          8,560         366,193
  Goodwill impairment charge ................................           --        12,929,696
  Acquired technology impairment charge .....................           --           558,330
  Losses associated with legal and other settlements, net ...     (2,452,909)      1,884,519
                                                                ------------    ------------
     Total operating expenses ...............................      4,251,799      23,405,761

                                                                ------------    ------------
Loss from operations ........................................     (3,211,705)    (23,446,113)
                                                                ------------    ------------

Other Income (Expense)
  Interest income ...........................................         10,553          19,250
  Change in intrinsic value of common stock put right .......           --           300,000
  Loss on sale of property and equipment ....................         (2,072)         (8,886)
  Interest expense ..........................................     (1,169,105)    (17,453,447)
                                                                ------------    ------------
Total Other Expense .........................................     (1,160,624)    (17,143,083)
                                                                ------------    ------------

Loss from continuing operations before income taxes .........     (4,372,329)    (40,589,196)

  Income taxes ..............................................           --              --
                                                                ------------    ------------
Loss from continuing operations .............................     (4,372,329)    (40,589,196)
                                                                ------------    ------------

Loss from discontinued operations ...........................     (2,036,660)     (3,856,955)
Loss on disposal of discontinued operations .................        (75,920)           --
                                                                ------------    ------------
                                                                  (2,112,580)     (3,856,955)
                                                                ------------    ------------

Net loss ....................................................     (6,484,909)    (44,446,151)

Preferred stock deemed dividend .............................     (2,413,606)           --
Preferred stock contractual dividend ........................       (445,919)           --
                                                                ------------    ------------
Net loss available to common stockholders ...................   $ (9,344,434)   $(44,446,151)
                                                                ============    ============


Net Loss Per Share - Basic and Diluted
  - Continuing operations ...................................   $      (0.98)   $     (20.80)
  - Discontinued operations .................................          (0.29)          (1.98)
                                                                ------------    ------------
  - Total Net Loss per share available to common stockholders   $      (1.27)   $     (22.78)
                                                                ============    ============

Weighted Average Number of Shares Outstanding
   - Basic and diluted ......................................      7,366,088       1,951,389
                                                                ============    ============


The accompanying notes are an integral part of these financial statements


                                       26




                              PATRON SYSTEMS, INC.
                 STATEMENTS OF STOCKHOLDERS' (DEFICIENCY) EQUITY
                 FOR THE YEARS ENDED DECEMBER 31, 2005 AND 2006


                                                                                     SHARES OF       PAR VALUE
                                                                                     SERIES A        SERIES A        SHARES OF
                                                                                    CONVERTIBLE     CONVERTIBLE      SERIES A-1
                                                                                     PREFERRED       PREFERRED       PREFERRED
                                                                                       STOCK           STOCK           STOCK
                                                                                   -------------   -------------   -------------
                                                                                                            
BALANCE - JANUARY 1, 2005 ......................................................            --     $        --              --
Common stock issued in purchase business combinations
   Complete Security Solutions, Inc. ...........................................            --              --              --
   LucidLine, Inc. .............................................................            --              --              --
   Entelagent Software Corporation .............................................            --              --              --
Amortization of deferred stock-based compensation ..............................            --              --              --
Issuance of warrants to Bridge Note I Investors ................................            --              --              --
Issuance of warrants issued as purchase consideration ..........................            --              --              --
Issuance of warrants to transaction advisors ...................................            --              --              --
Issuance of warrants to placement agent - Interim Bridge Financing I ...........            --              --              --
Common stock under accommodation agreement as a penalty ........................            --              --              --
Common stock issued under collateralized financing arrangement .................            --              --              --
Common stock issued in lieu of cash for services ...............................            --              --              --
Common stock issued on consulting agreement ....................................            --              --              --
Recission of common stock under consulting agreement ...........................            --              --              --
Issuance of warrants to Bridge Note II investors ...............................            --              --              --
Issuance of warrants to placement agent - Interim Bridge Financing II ..........            --              --              --
Issuance of warrants in connection with bridge loan extension ..................            --              --              --
Issuance of stock options to Chief Executive Officer ...........................            --              --              --
Issuance of warrants to Bridge Note III investors ..............................            --              --              --
Reduction of intrinsic value of put right ......................................            --              --              --
Conversion option penalty incurred upon default of Bridge Financing I ..........            --              --              --
Conversion option penalty incurred upon default of Subordinated Notes ..........            --              --              --
Conversion option penalty incurred upon default of Bridge Financing II .........            --              --              --
Conversion option penalty incurred upon default of Bridge Financing III ........            --              --              --
Issuance of options to non-employee ............................................            --              --              --
Net loss .......................................................................            --              --              --
                                                                                   -------------   -------------   -------------
BALANCE - DECEMBER 31, 2005 ....................................................            --              --              --
Reclassification of deferred compensation upon adoption of FAS 123(R) ..........            --              --              --

Issuance of Series A Convertible Preferred Stock to investors ..................             964              10            --
Conversion of Bridge Notes to Series A Convertible Preferred Stock .............            --              --              --
Fees associated with Series A Convertible Preferred Stock offerings ............            --              --              --
Issuance of warrants in connection with bridge loan extension - extension
   warrants ....................................................................            --              --              --
Conversion option penalty incurred upon default of Bridge Financing III ........            --              --              --
Issuance of Series A-1 Convertible Preferred stock in settlement of debt .......            --              --        36,993,054
Cancellation of stock repurchase obligations to former officer .................            --              --              --
Issuance of shares in connection with anti-dilution provision ..................            --              --              --
Issuance of common stock for services rendered .................................            --              --              --
Stock based compensation - employees ...........................................            --              --              --
Stock based compensation - nonemployees ........................................            --              --              --
Conversion of Preferred Series A-1 to common stock .............................            --              --       (36,993,054)
Issuance of Series B Convertible Preferred Stock to investors ..................            --              --              --
Conversion of Bridge Notes to Series B Convertible Preferred Stock .............            --              --              --
Fees associated with Series B Convertible Preferred Stock offerings ............            --              --              --
Beneficial Conversion Feature under Series B Convertible Preferred stock .......            --              --              --
Beneficial Conversion Feature upon modification of Series A Convertible
   Preferred conversion price ..................................................            --              --              --
Net Loss .......................................................................            --              --              --
                                                                                   -------------   -------------   -------------
BALANCE - DECEMBER 31, 2006 ....................................................             964   $          10            --
                                                                                   =============   =============   =============



                                                                                                                      SHARES OF
                                                                                     PAR VALUE        SERIES B        SERIES B
                                                                                    SERIES A-1       CONVERTIBLE     CONVERTIBLE
                                                                                     PREFERRED        PREFERRED       PREFERRED
                                                                                       STOCK            STOCK           STOCK
                                                                                   -------------    -------------   -------------
                                                                                                           
BALANCE - JANUARY 1, 2005 ......................................................   $        --               --     $        --
Common stock issued in purchase business combinations
   Complete Security Solutions, Inc. ...........................................            --               --              --
   LucidLine, Inc. .............................................................            --               --              --
   Entelagent Software Corporation .............................................            --               --              --
Amortization of deferred stock-based compensation ..............................            --               --              --
Issuance of warrants to Bridge Note I Investors ................................            --               --              --
Issuance of warrants issued as purchase consideration ..........................            --               --              --
Issuance of warrants to transaction advisors ...................................            --               --              --
Issuance of warrants to placement agent - Interim Bridge Financing I ...........            --               --              --
Common stock under accommodation agreement as a penalty ........................            --               --              --
Common stock issued under collateralized financing arrangement .................            --               --              --
Common stock issued in lieu of cash for services ...............................            --               --              --
Common stock issued on consulting agreement ....................................            --               --              --
Recission of common stock under consulting agreement ...........................            --               --              --
Issuance of warrants to Bridge Note II investors ...............................            --               --              --
Issuance of warrants to placement agent - Interim Bridge Financing II ..........            --               --              --
Issuance of warrants in connection with bridge loan extension ..................            --               --              --
Issuance of stock options to Chief Executive Officer ...........................            --               --              --
Issuance of warrants to Bridge Note III investors ..............................            --               --              --
Reduction of intrinsic value of put right ......................................            --               --              --
Conversion option penalty incurred upon default of Bridge Financing I ..........            --               --              --
Conversion option penalty incurred upon default of Subordinated Notes ..........            --               --              --
Conversion option penalty incurred upon default of Bridge Financing II .........            --               --              --
Conversion option penalty incurred upon default of Bridge Financing III ........            --               --              --
Issuance of options to non-employee ............................................            --               --              --
Net loss .......................................................................            --               --              --
                                                                                   -------------    -------------   -------------
BALANCE - DECEMBER 31, 2005 ....................................................            --               --              --
Reclassification of deferred compensation upon adoption of FAS 123(R) ..........            --               --              --

Issuance of Series A Convertible Preferred Stock to investors ..................            --               --              --
Conversion of Bridge Notes to Series A Convertible Preferred Stock .............            --               --              --
Fees associated with Series A Convertible Preferred Stock offerings ............            --               --              --
Issuance of warrants in connection with bridge loan extension - extension
   warrants ....................................................................            --               --              --
Conversion option penalty incurred upon default of Bridge Financing III ........            --               --              --
Issuance of Series A-1 Convertible Preferred stock in settlement of debt .......         369,930             --              --
Cancellation of stock repurchase obligations to former officer .................            --               --              --
Issuance of shares in connection with anti-dilution provision ..................            --               --              --
Issuance of common stock for services rendered .................................            --               --              --
Stock based compensation - employees ...........................................            --               --              --
Stock based compensation - nonemployees ........................................            --               --              --
Conversion of Preferred Series A-1 to common stock .............................        (369,930)            --              --
Issuance of Series B Convertible Preferred Stock to investors ..................            --                791               8
Conversion of Bridge Notes to Series B Convertible Preferred Stock .............            --               --              --
Fees associated with Series B Convertible Preferred Stock offerings ............            --               --              --
Beneficial Conversion Feature under Series B Convertible Preferred stock .......            --               --              --
Beneficial Conversion Feature upon modification of Series A Convertible
   Preferred conversion price ..................................................            --               --              --
Net Loss .......................................................................            --               --              --
                                                                                   -------------    -------------   -------------
BALANCE - DECEMBER 31, 2006 ....................................................   $        --                791   $           8
                                                                                   =============    =============   =============



                                                                                     SHARES OF        PAR VALUE        ADDITIONAL
                                                                                      COMMON           COMMON           PAID IN
                                                                                       STOCK            STOCK           CAPITAL
                                                                                   -------------    -------------    -------------
                                                                                                            
BALANCE - JANUARY 1, 2005 ......................................................       1,382,304    $      67,106    $  33,948,067
Common stock issued in purchase business combinations
   Complete Security Solutions, Inc. ...........................................         250,000           75,000        6,300,000
   LucidLine, Inc. .............................................................         146,667           44,000        3,696,000
   Entelagent Software Corporation .............................................         100,000           30,000        2,520,000
Amortization of deferred stock-based compensation ..............................            --               --               --
Issuance of warrants to Bridge Note I Investors ................................            --               --          1,043,860
Issuance of warrants issued as purchase consideration ..........................            --               --          1,912,500
Issuance of warrants to transaction advisors ...................................            --               --            255,000
Issuance of warrants to placement agent - Interim Bridge Financing I ...........            --               --            297,500
Common stock under accommodation agreement as a penalty ........................          60,000          777,076             --
Common stock issued under collateralized financing arrangement .................          29,684            8,905          397,300
Common stock issued in lieu of cash for services ...............................            --           (939,000)         939,000
Common stock issued on consulting agreement ....................................          13,334           35,600             --
Recission of common stock under consulting agreement ...........................          (3,334)         (78,900)            --
Issuance of warrants to Bridge Note II investors ...............................            --               --            532,723
Issuance of warrants to placement agent - Interim Bridge Financing II ..........            --               --             80,867
Issuance of warrants in connection with bridge loan extension ..................            --               --            946,924
Issuance of stock options to Chief Executive Officer ...........................            --               --             30,000
Issuance of warrants to Bridge Note III investors ..............................            --               --            587,595
Reduction of intrinsic value of put right ......................................            --               --           (300,000)
Conversion option penalty incurred upon default of Bridge Financing I ..........            --               --          3,500,000
Conversion option penalty incurred upon default of Subordinated Notes ..........            --               --          4,500,000
Conversion option penalty incurred upon default of Bridge Financing II .........            --               --          2,543,000
Conversion option penalty incurred upon default of Bridge Financing III ........            --               --          1,850,000
Issuance of options to non-employee ............................................            --               --             20,936
Net loss .......................................................................            --               --               --
                                                                                   -------------    -------------    -------------
BALANCE - DECEMBER 31, 2005 ....................................................       1,978,655           19,787       65,601,272
Reclassification of deferred compensation upon adoption of FAS 123(R) ..........            --               --             (7,500)

Issuance of Series A Convertible Preferred Stock to investors ..................            --               --          3,205,489
Conversion of Bridge Notes to Series A Convertible Preferred Stock .............            --               --          1,615,001
Fees associated with Series A Convertible Preferred Stock offerings ............            --               --           (368,550)
Issuance of warrants in connection with bridge loan extension - extension
   warrants ....................................................................            --               --             48,129
Conversion option penalty incurred upon default of Bridge Financing III ........            --               --            192,000
Issuance of Series A-1 Convertible Preferred stock in settlement of debt .......         (98,626)            (983)      22,245,869
Cancellation of stock repurchase obligations to former officer .................            --               --          1,300,000
Issuance of shares in connection with anti-dilution provision ..................         251,175            2,512           (2,512)
Issuance of common stock for services rendered .................................          50,000              500           99,500
Stock based compensation - employees ...........................................            --               --            360,795
Stock based compensation - nonemployees ........................................            --               --             63,120
Conversion of Preferred Series A-1 to common stock .............................      12,331,056          123,311          246,619
Issuance of Series B Convertible Preferred Stock to investors ..................            --               --          2,952,708
Conversion of Bridge Notes to Series B Convertible Preferred Stock .............            --               --          1,000,000
Fees associated with Series B Convertible Preferred Stock offerings ............            --               --           (392,319)
Beneficial Conversion Feature under Series B Convertible Preferred stock .......            --               --          1,824,431
Beneficial Conversion Feature upon modification of Series A Convertible
   Preferred conversion price ..................................................            --               --            589,175
Net Loss .......................................................................            --               --               --
                                                                                   -------------    -------------    -------------
BALANCE - DECEMBER 31, 2006 ....................................................      14,512,260    $     145,127    $ 100,573,227
                                                                                   =============    =============    =============



                                                                                      COMMON
                                                                                       STOCK
                                                                                    REPURCHASE         DEFERRED       ACCUMULATED
                                                                                    OBLIGATION       COMPENSATION       DEFICIT
                                                                                   -------------    -------------    -------------
                                                                                                            
BALANCE - JANUARY 1, 2005 ......................................................   $  (1,300,000)   $  (1,475,333)   $ (39,941,876)
Common stock issued in purchase business combinations
   Complete Security Solutions, Inc. ...........................................            --               --               --
   LucidLine, Inc. .............................................................            --               --               --
   Entelagent Software Corporation .............................................            --               --               --
Amortization of deferred stock-based compensation ..............................            --          1,467,833             --
Issuance of warrants to Bridge Note I Investors ................................            --               --               --
Issuance of warrants issued as purchase consideration ..........................            --               --               --
Issuance of warrants to transaction advisors ...................................            --               --               --
Issuance of warrants to placement agent - Interim Bridge Financing I ...........            --               --               --
Common stock under accommodation agreement as a penalty ........................            --               --               --
Common stock issued under collateralized financing arrangement .................            --               --               --
Common stock issued in lieu of cash for services ...............................            --               --               --
Common stock issued on consulting agreement ....................................            --               --               --
Recission of common stock under consulting agreement ...........................            --               --               --
Issuance of warrants to Bridge Note II investors ...............................            --               --               --
Issuance of warrants to placement agent - Interim Bridge Financing II ..........            --               --               --
Issuance of warrants in connection with bridge loan extension ..................            --               --               --
Issuance of stock options to Chief Executive Officer ...........................            --               --               --
Issuance of warrants to Bridge Note III investors ..............................            --               --               --
Reduction of intrinsic value of put right ......................................            --               --               --
Conversion option penalty incurred upon default of Bridge Financing I ..........            --               --               --
Conversion option penalty incurred upon default of Subordinated Notes ..........            --               --               --
Conversion option penalty incurred upon default of Bridge Financing II .........            --               --               --
Conversion option penalty incurred upon default of Bridge Financing III ........            --               --               --
Issuance of options to non-employee ............................................            --               --               --
Net loss .......................................................................            --               --        (44,446,151)
                                                                                   -------------    -------------    -------------
BALANCE - DECEMBER 31, 2005 ....................................................      (1,300,000)          (7,500)     (84,388,027)
Reclassification of deferred compensation upon adoption of FAS 123(R) ..........            --              7,500             --

Issuance of Series A Convertible Preferred Stock to investors ..................            --               --               --
Conversion of Bridge Notes to Series A Convertible Preferred Stock .............            --               --               --
Fees associated with Series A Convertible Preferred Stock offerings ............            --               --               --
Issuance of warrants in connection with bridge loan extension - extension
   warrants ....................................................................            --               --               --
Conversion option penalty incurred upon default of Bridge Financing III ........            --               --               --
Issuance of Series A-1 Convertible Preferred stock in settlement of debt .......            --               --               --
Cancellation of stock repurchase obligations to former officer .................       1,300,000             --               --
Issuance of shares in connection with anti-dilution provision ..................            --               --               --
Issuance of common stock for services rendered .................................            --               --               --
Stock based compensation - employees ...........................................            --               --               --
Stock based compensation - nonemployees ........................................            --               --               --
Conversion of Preferred Series A-1 to common stock .............................            --               --               --
Issuance of Series B Convertible Preferred Stock to investors ..................            --               --               --
Conversion of Bridge Notes to Series B Convertible Preferred Stock .............            --               --               --
Fees associated with Series B Convertible Preferred Stock offerings ............            --               --               --
Beneficial Conversion Feature under Series B Convertible Preferred stock .......            --               --         (1,824,431)
Beneficial Conversion Feature upon modification of Series A Convertible
   Preferred conversion price ..................................................            --               --           (589,175)
Net Loss .......................................................................            --               --         (6,484,909)
                                                                                   -------------    -------------    -------------
BALANCE - DECEMBER 31, 2006 ....................................................   $        --      $        --      $ (93,286,542)
                                                                                   =============    =============    =============



                                                                                       TOTAL
                                                                                   -------------
                                                                                
BALANCE - JANUARY 1, 2005 ......................................................   $  (8,702,036)
Common stock issued in purchase business combinations
   Complete Security Solutions, Inc. ...........................................       6,375,000
   LucidLine, Inc. .............................................................       3,740,000
   Entelagent Software Corporation .............................................       2,550,000
Amortization of deferred stock-based compensation ..............................       1,467,833
Issuance of warrants to Bridge Note I Investors ................................       1,043,860
Issuance of warrants issued as purchase consideration ..........................       1,912,500
Issuance of warrants to transaction advisors ...................................         255,000
Issuance of warrants to placement agent - Interim Bridge Financing I ...........         297,500
Common stock under accommodation agreement as a penalty ........................         777,076
Common stock issued under collateralized financing arrangement .................         406,205
Common stock issued in lieu of cash for services ...............................           --
Common stock issued on consulting agreement ....................................          35,600
Recission of common stock under consulting agreement ...........................         (78,900)
Issuance of warrants to Bridge Note II investors ...............................         532,723
Issuance of warrants to placement agent - Interim Bridge Financing II ..........          80,867
Issuance of warrants in connection with bridge loan extension ..................         946,924
Issuance of stock options to Chief Executive Officer ...........................          30,000
Issuance of warrants to Bridge Note III investors ..............................         587,595
Reduction of intrinsic value of put right ......................................        (300,000)
Conversion option penalty incurred upon default of Bridge Financing I ..........       3,500,000
Conversion option penalty incurred upon default of Subordinated Notes ..........       4,500,000
Conversion option penalty incurred upon default of Bridge Financing II .........       2,543,000
Conversion option penalty incurred upon default of Bridge Financing III ........       1,850,000
Issuance of options to non-employee ............................................          20,936
Net loss .......................................................................     (44,446,151)
                                                                                   -------------
BALANCE - DECEMBER 31, 2005 ....................................................     (20,074,468)
Reclassification of deferred compensation upon adoption of FAS 123(R) ..........            --

Issuance of Series A Convertible Preferred Stock to investors ..................       3,205,499
Conversion of Bridge Notes to Series A Convertible Preferred Stock .............       1,615,001
Fees associated with Series A Convertible Preferred Stock offerings ............        (368,550)
Issuance of warrants in connection with bridge loan extension - extension
   warrants ....................................................................          48,129
Conversion option penalty incurred upon default of Bridge Financing III ........         192,000
Issuance of Series A-1 Convertible Preferred stock in settlement of debt .......      22,614,816
Cancellation of stock repurchase obligations to former officer .................       2,600,000
Issuance of shares in connection with anti-dilution provision ..................            --
Issuance of common stock for services rendered .................................         100,000
Stock based compensation - employees ...........................................         360,795
Stock based compensation - nonemployees ........................................          63,120
Conversion of Preferred Series A-1 to common stock .............................            --
Issuance of Series B Convertible Preferred Stock to investors ..................       2,952,716
Conversion of Bridge Notes to Series B Convertible Preferred Stock .............       1,000,000
Fees associated with Series B Convertible Preferred Stock offerings ............        (392,319)
Beneficial Conversion Feature under Series B Convertible Preferred stock .......            --
Beneficial Conversion Feature upon modification of Series A Convertible
   Preferred conversion price ..................................................            --
Net Loss .......................................................................      (6,484,909)
                                                                                   -------------
BALANCE - DECEMBER 31, 2006 ....................................................   $   7,431,830
                                                                                   =============


The accompanying notes are an integral part of these financial statements


                                       27




                              PATRON SYSTEMS, INC.
                            STATEMENTS OF CASH FLOWS

                                                                               FOR THE YEAR ENDED DECEMBER 31,
                                                                                ----------------------------
                                                                                    2006            2005
                                                                                ------------    ------------
                                                                                          
CASH FLOWS FROM CONTINUING OPERATING ACTIVITIES
  Net loss ..................................................................   $ (4,372,329)   $(40,589,196)
                                                                                ------------    ------------
  Adjustments to reconcile net loss to net cash used in operating activities:
    Depreciation and amortization ...........................................        168,068         226,293
    Stock based compensation ................................................        523,915       1,554,369
    Non cash interest expense ...............................................        543,438      16,489,300
    Stock based penalty under accomodation agreement ........................           --           777,076
    Goodwill impairment charge ..............................................           --        12,929,696
    Acquired technology impairment charge ...................................           --           558,330
    Loss/(gain) associated with legal settlements ...........................     (2,452,909)      1,884,519
    Loss on collateralized financing arrangement ............................           --           366,193
    Loss on sale of property and equipment ..................................          2,072           8,886
    Loss on disposition of discontinued operations ..........................         75,920
    Reduction in intrinsic value of put right ...............................           --          (300,000)
    Gain on settlement of consulting agreement payable ......................           --          (228,900)
    Non-cash interest income ................................................           --           (19,250)
    Changes in operating assets and liabilities:
      Restricted cash .......................................................        511,691        (511,691)
      Prepaid expenses ......................................................           --            51,487
      Accounts receivable ...................................................       (707,206)        (93,878)
      Other current assets ..................................................       (107,230)        (57,782)
      Accounts payable ......................................................       (197,641)       (165,464)
      Accrued interest ......................................................        618,289         414,676
      Deferred revenue ......................................................        (80,712)        112,591
      Expense reimbursements payable ........................................        (26,835)        (94,062)
      Accrued payroll and payroll related expenses ..........................         88,709        (758,530)
      Amounts due under settlement with former officer ......................           --           165,298
      Other current liabilities .............................................        103,031         230,096
      Consulting agreements payable .........................................           --           (50,000)
      Accrued registration penalty ..........................................          8,560          81,928
      Other accrued expenses ................................................           --           (16,440)
                                                                                ------------    ------------
  Total adjustments .........................................................       (928,840)     33,554,741
                                                                                ------------    ------------
NET CASH USED IN CONTINUING OPERATING ACTIVITIES ............................     (5,301,169)     (7,034,455)
                                                                                ------------    ------------

CASH FLOWS USED IN CONTINUING INVESTING ACTIVITIES
  Cash payments in purchase business combinations ...........................           --          (857,633)
  Cash acquired in purchase business combinations ...........................           --           416,397
  Computer software development costs .......................................       (281,373)       (163,800)
  Proceeds from sale of property and equipment ..............................          1,704           1,500
  Purchase of fixed assets ..................................................       (145,920)        (73,799)
                                                                                ------------    ------------

NET CASH USED IN CONTINUING INVESTING ACTIVITIES ............................       (425,589)       (677,335)
                                                                                ------------    ------------

CASH FLOWS FROM CONTINUING FINANCING ACTIVITIES
  Expenses (repaid to) officers and stockholders ............................           --          (250,694)
  Payments on settlement of accommodation agreements ........................       (125,000)           --
  Deferred financing costs ..................................................        (54,000)       (627,739)
  Repayments of amounts due under settlement with former officer ............           --          (200,000)
  Proceeds from issuance of bridge notes ....................................           --        11,277,000
  Proceeds from issuances of Series A convertible preferred stock ...........      3,025,500            --
  Proceeds from issuances of Series B convertible preferred stock ...........      2,952,716            --
  Proceeds from bridge notes to Series A convertible preferred stock ........      1,615,001            --
  Proceeds from bridge notes to Series B convertible preferred stock ........      1,000,000            --
  Placement agrent fees for preferred stock issuances .......................       (760,869)           --
  Principal payments on notes payable .......................................         (7,001)           --
  Proceeds from disposition of discontinued operations ......................         50,000            --
  Proceeds received in connection with financing settlement .................        180,000            --
  Repayments of advances from shareholders ..................................           --           (32,774)
                                                                                ------------    ------------
NET CASH PROVIDED BY CONTINUING FINANCING ACTIVITIES ........................      7,876,347      10,165,793
                                                                                ------------    ------------

CASH FLOWS FROM DISCONTINUED OPERATIONS
  Operating cash flows ......................................................     (1,373,703)     (2,201,044)
  Investing cash flows ......................................................       (234,330)       (205,050)
  Financing cash flows ......................................................           --           (93,796)
                                                                                ------------    ------------
NET CASH USED IN DISCONTINUED OPERATIONS ....................................     (1,608,033)     (2,499,890)
                                                                                ------------    ------------

NET INCREASE (DECREASE) IN CASH .............................................        541,556         (45,887)

CASH, beginning of year .....................................................             14          45,901
                                                                                ------------    ------------
CASH, end of year ...........................................................   $    541,570    $         14
                                                                                ============    ============

Supplemental Disclosures of Cash Flow Information:
  Conversion of outstanding notes into Series A Preferred Convertible Stock .      1,615,001            --
  Conversion of outstanding notes into Series A-1 Preferred Convertible Stock     18,032,167            --
  Conversion of outstanding notes into Series B Preferred Convertible Stock .      1,000,000            --
Cash paid during the period for:
  Interest ..................................................................          7,241         527,715
Supplemental non-cash investing and finanical activity:
Acquisition of businesses:
    Current tangible assets acquired ........................................                        328,411
    Non-current tangible assets acquired ....................................                      2,809,689
    Current liabilities assumed with acquisitions ...........................                     (8,457,986)
    Non-current liabilities assumed with acquisitions .......................                       (447,790)
    Intangible assets acquired ..............................................                      3,101,000
    Goodwill recognized on purchase business combinations ...................                     22,440,412
    Non-cash consideration ..................................................                    (19,332,500)
    Cash acquired in purchase business combinations .........................                        416,397
                                                                                                ------------
    Cash paid to acquire businesses .........................................                        857,633
                                                                                                ============


The accompanying notes are an integral part of these financial statements


                                       28



                              PATRON SYSTEMS, INC.
                      NOTES TO AUDITED FINANCIAL STATEMENTS
                                DECEMBER 31, 2006

NOTE 1 - THE COMPANY

ORGANIZATION AND DESCRIPTION OF BUSINESS

Patron Systems,  Inc. (the "Company") is a Delaware  corporation formed in April
2002. The Company provides application software and services focused on business
process  management  (BPM) in the public sector.  Patron's  current  application
software offering,  FormStream,  is an open standards  information  sharing tool
that addresses the need for law  enforcement and public safety agencies to share
information  between  local,  state and federal  law  enforcement  and  homeland
security agencies.

On July 31, 2006, the Company  effectuated a 1-for-30 reverse stock split of its
common stock following the  effectiveness of the amendment to its Second Amended
and Restated  Certificate of Incorporation which was approved by stockholders at
the 2006 Annual  Meeting of  Stockholders  on July 20,  2006.  The  accompanying
financial  statements  give  retroactive  effect  to the  reverse  split for all
periods presented.

Effective  September 19, 2006, the Company merged its wholly-owned  subsidiaries
Entelagent,  CSSI and PILEC  Distribution  Company into the Company  through the
filing with the Secretary of State of the States of Delaware and  California,  a
Certificate  of Ownership  and Merger  merging  Entelagent  Software  Corp.,  (a
California  corporation),   Complete  Security  Solutions,   Inc.,  (a  Delaware
corporation)  and PILEC  Disbursement  Company,  (a Delaware  corporation)  into
Patron Systems, Inc., (a Delaware corporation).

NOTE 2 - LIQUIDITY AND FINANCIAL CONDITION

The Company incurred a net loss from continuing operations of $4,372,329 for the
year ended  December 31, 2006,  which  includes  $1,139,496 of non-cash  charges
including  depreciation  and  amortization  of $168,068,  aggregate  stock based
compensation of $523,915, non-cash interest expense of $543,438, loss on sale of
property and  equipment  $2,072 and a loss on the  disposition  of  discontinued
operations  of $75,920.  The non-cash  charges were offset by non-cash  gains of
$2,452,909  associated with the settlements of outstanding  liabilities,  claims
and litigation under the creditor and claimant liabilities restructuring program
that  occurred  during the year ended  December  31, 2006 (Note 17). The Company
used $511,691 of its restricted cash escrowed to settle liabilities assumed in a
business  combination.  Including the amounts  above,  the Company used net cash
flows in its operating  activities of $5,301,169  during the year ended December
31, 2006. The Company's working capital deficiency at December 31, 2006 amounted
to  $2,795,521  and the Company  continues  to  experience  shortages of working
capital.

The Company expects to continue  incurring losses for the foreseeable future due
to the  inherent  uncertainty  that is related to  establishing  the  commercial
feasibility of technological  products and developing a presence in new markets.
The Company raised  $8,773,217 of gross proceeds  ($7,832,348 net proceeds after
the payment of certain  transaction  expenses) in financing  transactions during
the year ended December 31, 2006. The Company used  $5,301,169 of these proceeds
to fund its  operations  and a net of  $425,589  in  investing  activities.  The
Company  also  settled  $24,467,871  of  outstanding  liabilities,   claims  and
litigation  under the creditor and claimant  liabilities  restructuring  program
that  occurred  during the year ended  December  31, 2006 (Note 17). The Company
believes  that its  completion  of this  program  has  enabled it to improve its
financial  condition by  eliminating  substantial  requirements  to settle these
obligations  for  cash;  however,  the  Company's  capital  resources  are still
significantly  limited and there can be no assurance that the completion of this
program  will enable the  Company to actually  attain  positive  operating  cash
flows.

The Company has taken certain steps to conserve its liquidity while it continues
to  develop  its  business;  however,  the  Company  will  still  need to  raise
additional  capital to sustain the  business  until such time that it is able to
generate  sufficient  revenue and operating cash flows.  The Company believes it
has access to capital  resources,  however,  the  Company  has not  secured  any
commitments  for  additional  financing  at this  time  nor can it  provide  any
assurance that it will be successful in its efforts to raise additional  capital
or that if capital is raised,  the proceeds  will be  sufficient  to sustain the
business until it is able to generate  operating cash flow.  These matters raise
substantial  doubt about the Company's  ability to continue as a going  concern.
The financial  statements do not include any adjustments that might be necessary
should the Company be unable to continue as a going concern.


                                       29



NOTE 3 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

CASH

The Company  considers  all highly  liquid  securities  purchased  with original
maturities of three months or less to be cash.

CONCENTRATION OF CREDIT RISK

The Company maintains cash with major financial institutions. Cash is insured by
the  Federal  Deposit  Insurance  Corporation  ("FDIC")  up to  $100,000 at each
institution.  From time to time amounts may exceed the FDIC limits.  At December
31, 2006 the uninsured  bank cash balances  were  $441,570.  The Company has not
experienced any losses on these accounts.

REVENUE RECOGNITION

The Company derives revenues from the following  sources:  (1) sales of computer
software,  which includes new software licenses and software updates and product
support revenues and (2) professional consulting services.

The Company  applies the revenue  recognition  principles  set forth under AICPA
Statement of Position ("SOP") 97-2 "Software Revenue Recognition" and Securities
and  Exchange   Commission  Staff  Accounting   Bulletin  ("SAB")  104  "Revenue
Recognition"  with  respect to its  revenue.  Accordingly,  the Company  records
revenue when (i) persuasive evidence of an arrangement exists, (ii) delivery has
occurred,   (iii)  the  vendor's  fee  is  fixed  or   determinable,   and  (iv)
collectability is reasonably assured.

The Company  generates  revenues  through sales of software  licenses and annual
support subscription  agreements,  which include access to technical support and
software  updates  (if  and  when  available).  Software  license  revenues  are
generated  from  licensing the rights to use products  directly to end-users and
through third party service providers.

Revenues from software license agreements are generally recognized upon delivery
of software to the customer.  All of the Company's  software sales are supported
by a written  contract or other evidence of sale  transaction such as a customer
purchase order.  These forms of evidence  clearly  indicate the selling price to
the  customer,  shipping  terms,  payment  terms  (generally 30 days) and refund
policy,  if any. The selling  prices of these products are fixed at the time the
sale is consummated.

Revenue from post-contract customer support arrangements or undelivered elements
are deferred and  recognized at the time of delivery or over the period in which
the services are performed based on vendor specific  objective  evidence of fair
value for such  undelivered  elements.  Vendor  specific  objective  evidence is
typically  based on the price charged when an element is sold  separately or, if
an element is not sold  separately,  on the price  established  by an authorized
level of management,  if it is probable that the price, once  established,  will
not change  before  market  introduction.  The Company uses the residual  method
prescribed in SOP 98-9,  "Modification of SOP 97-2, Software Revenue Recognition
With Respect to Certain  Transaction" to allocate revenues to delivered elements
once it has  established  vendor-specific  objective  evidence of fair value for
such undelivered elements.

Professional  consulting  services  are  billed  based on the number of hours of
consultant   services  provided  and  the  hourly  billing  rates.  The  Company
recognizes revenue under these arrangements as the service is performed.


                                       30



ACCOUNTS RECEIVABLE

The  Company  adjusts  its  accounts  receivable  balances  that it  deems to be
uncollectible.  The  allowance  for  doubtful  accounts  is the  Company's  best
estimate  of the amount of  probable  credit  losses in the  Company's  existing
accounts receivable.  The Company reviews its allowance for doubtful accounts on
a monthly basis to determine the allowance  based on an analysis of its past due
accounts.  All past due balances that are over 90 days are reviewed individually
for collectability. Account balances are charged off against the allowance after
all means of  collection  have been  exhausted and the potential for recovery is
considered remote.  Accounts receivable includes $577,000 of accrued revenue for
software  licenses and services  delivered under  contractual  arrangements that
were billed,  pursuant to contracts subsequent to December 31, 2006. The Company
has  determined  that an allowance for doubtful  accounts is not necessary  with
respect to the balance due from customers as of December 31, 2006.

SOFTWARE DEVELOPMENT COSTS

Capitalization   of  computer   software   development  costs  begins  upon  the
establishment of technological  feasibility.  Technological  feasibility for the
Company's  computer  software  products is generally based upon achievement of a
detail  program  design  free of  high  risk  development  issues.  The  Company
capitalizes  only those costs directly  attributable  to the  development of the
software.  The  establishment  of  technological  feasibility  and  the  ongoing
assessment of recoverability of capitalized  computer software development costs
require  considerable  judgment by management  with respect to certain  external
factors,  including, but not limited to, technological feasibility,  anticipated
future  gross  revenue,  estimated  economic  life and changes in  software  and
hardware technology.

Prior to reaching  technological  feasibility the Company's policy is to expense
these  costs  as  incurred  and  include  them in  general  and  administrative.
Activities  undertaken  after the products are available for general  release to
customers to correct errors or keep the product updated are expensed as incurred
and included in general and administrative. The Company has incurred no research
and development costs in the years ended December 31, 2005 and 2006. The Company
currently has only one core product  (FormStream) for which it is in the process
of  developing  certain  functionalities  that  are  expected  to  increase  its
potential to generate revenue.

Amortization of capitalized  computer software  development costs commences when
the  related  products  become  available  for  general  release  to  customers.
Amortization  is provided  on a product by product  basis and is included in the
applicable  cost of  revenue.  Amortization  is being  provided  for  using  the
straight-line  method over the estimated economic life of the product,  which is
five years.

The  Company  periodically  performs  reviews  of  the  recoverability  of  such
capitalized software costs. At the time a determination is made that capitalized
amounts are not  recoverable  based on the estimated  cash flows to be generated
from the applicable software, any remaining capitalized amounts are written off.

PROPERTY AND EQUIPMENT

Property and  equipment is stated at cost.  Depreciation  is computed  using the
straight-line  method over the estimated  useful lives of the assets  (generally
three to five  years).  Maintenance  and  repairs  are  charged  to  expense  as
incurred; cost of major additions and betterments are capitalized. When property
and equipment is sold or otherwise disposed of, the cost and related accumulated
depreciation  are eliminated from the accounts and any resulting gains or losses
are reflected in the statement of operations in the period of disposal.

GOODWILL AND INTANGIBLE ASSETS

The Company  accounts for  Goodwill and  Intangible  Assets in  accordance  with
Statement  of  Financial   Accounting  Standards  ("SFAS")  No.  141,  "Business
Combinations"  and SFAS No. 142,  "Goodwill and Other Intangible  Assets." Under
SFAS No. 142,  goodwill and intangibles that are deemed to have indefinite lives
are no longer amortized but,  instead,  are to be reviewed at least annually for
impairment.  Application  of the goodwill  impairment  test  requires  judgment,
including  the   identification   of  reporting  units,   assigning  assets  and
liabilities  to reporting  units,  assigning  goodwill to reporting  units,  and
determining the fair value.  Significant judgments required to estimate the fair
value of  reporting  units  include  estimating  future cash flows,  determining
appropriate discount rates and other assumptions. Changes in these estimates and
assumptions  could materially  affect the  determination of fair value of and/or
goodwill  impairment for each reporting unit. During the year ended December 31,
2005,  the  Company  recorded  goodwill  in  connection  with  the  acquisitions
described in Note 4. The Company's annual impairment review of goodwill resulted
in a goodwill impairment charge of $210,716 for the year ended December 31, 2006
(Note 5) resulting  in  $9,300,000  in goodwill at December  31, 2006.  The 2006
charge,  which principally  represents  goodwill remaining from the PolicyBridge
business the Company  acquired from  Entelagent,  is classified in  discontinued
operations as a result of its decision to exit that  business in November  2006.
The  remaining  amount of goodwill,  which amounts to $9,300,000 at December 31,
2006, relates to the Company's acquisition of CSSI in February 2005 in which the
Company acquired FormStream.


                                       31



LONG LIVED ASSETS

The Company  periodically  reviews the carrying  values of its long lived assets
(which  include  property and equipment and  amortizable  intangible  assets) in
accordance  with SFAS 144,  "Long  Lived  Assets"  when  events  or  changes  in
circumstances would indicate that it is more likely than not that their carrying
values may exceed their  realizable  value and records  impairment  charges when
necessary.  The Company's review of the carrying values of its long lived assets
used in continuing  operations has resulted in no impairment charge for the year
ended December 31, 2006 (Note 8). The Company has  classified  its  PolicyBridge
software business as a discontinued operation at December 31, 2006 (Note 7, Note
8 and Note 20). This business had $931,470 of intangible  assets associated with
acquired software  technology in which the recovery of only portion of its value
is considered likely. A substantial portion of the carrying value, in the amount
of $781,470,  has been  expensed as a loss from  discontinued  operations in the
year ended  December 31, 2006. The remaining  carrying value of $150,000,  which
represents  the  Company's  best  estimate  of  the  recoverable  value  of  the
PolicyBridge  intangible  assets at December 31, 2006 is included in assets held
for sale in the accompanying balance sheet.

Making  estimates  about the  carrying  values  of  intangible  assets  requires
management to exercise significant  judgment. It is at least reasonably possible
that the  estimate of the effect on the  financial  statements  of a  condition,
situation,  or set of  circumstances  that existed at the date of the  financial
statements which management  considered in formulating its estimate could change
in the near term due to one or more future confirming events.  Accordingly,  the
actual results regarding  estimates of carrying value of these intangibles could
differ materially from the Company's estimate.

RECLASSIFICATION

Certain amounts included in the financial statements for the year ended December
31, 2005 have been  reclassified to the presentation  used by the Company in the
year ended December 31, 2006.

USE OF ESTIMATES IN PREPARING FINANCIAL STATEMENTS

In preparing  financial  statements in  conformity  with  accounting  principles
generally  accepted in the United  States of America,  management is required to
make estimates and  assumptions  that affect the reported  amounts of assets and
liabilities and the disclosure of contingent  assets and liabilities at the date
of the  financial  statements  and revenue  and  expenses  during the  reporting
period.  Critical accounting policies requiring the use of estimates are revenue
recognition  for software  products  with multiple  deliverables,  allowance for
doubtful  accounts,  goodwill,   intangibles  other  than  goodwill,  which  are
associated  with its  continuing  operations,  impairment  charges,  convertible
instruments, freestanding derivatives, and share based payments.

FAIR VALUE OF FINANCIAL INSTRUMENTS

The  carrying  amounts  reported  in  the  balance  sheet  for  cash,   accounts
receivable,  accounts payable accrued  expenses,  advances from stockholders and
all note obligations  classified as current  liabilities  approximate their fair
values based on the short-term maturity of these instruments.

PREFERRED STOCK

The Company  applies the guidance  enumerated  in SFAS No. 150  "Accounting  for
Certain  Financial  Instruments  with  Characteristics  of both  Liabilities and
Equity"  and EITF Topic  D-98  "Classification  and  Measurement  of  Redeemable
Securities,"  when determining the  classification  and measurement of preferred
stock.  Preferred shares subject to mandatory redemption (if any) are classified
as liability  instruments and are measured at fair value in accordance with SFAS
150. All other  issuances of preferred  stock are subject to the  classification
and  measurement   principles  of  EITF  Topic  D-98.  Accordingly  the  Company
classifies  conditionally  redeemable  preferred shares (if any), which includes
preferred  shares that  feature  redemption  rights  that are either  within the
control of the holder or subject to redemption  upon the occurrence of uncertain
events not solely  within the Company's  control,  as temporary  equity.  At all
other  times,  the Company  classifies  its  preferred  shares in  stockholders'
equity.


                                       32



The Company's  preferred shares do not feature any redemption  rights within the
holders  control or  conditional  redemption  features not within the  Company's
control as of December 31, 2006.  Accordingly  all issuances of preferred  stock
are presented as a component of stockholders equity.

CONVERTIBLE INSTRUMENTS

The Company  evaluates  and  accounts  for  conversion  options  embedded in its
convertible  instruments  in  accordance  with  SFAS  No.  133  "Accounting  for
Derivative  Instruments  and  Hedging  Activities"  ("SFAS  133") and EITF 00-19
"Accounting  for Derivative  Financial  Instruments  Indexed to, and Potentially
Settled in, a Company's Own Stock" ("EITF 00-19").

SFAS 133 generally  provides three criteria that, if met,  require  companies to
bifurcate conversion options from their host instruments and account for them as
free standing  derivative  financial  instruments in accordance with EITF 00-19.
These  three  criteria   include   circumstances   in  which  (a)  the  economic
characteristics and risks of the embedded derivative  instrument are not clearly
and  closely  related  to the  economic  characteristics  and  risks of the host
contract,  (b) the hybrid instrument that embodies both the embedded  derivative
instrument and the host contract is not remeasured at fair value under otherwise
applicable  generally accepted accounting  principles with changes in fair value
reported in earnings as they occur and (c) a separate  instrument  with the same
terms as the embedded  derivative  instrument  would be  considered a derivative
instrument subject to the requirements of SFAS 133. SFAS 133 and EITF 00-19 also
provide  an  exception  to this  rule when the host  instrument  is deemed to be
conventional (as that term is described in the  implementation  guidance to SFAS
133 and further clarified in EITF 05-2 "The Meaning of "Conventional Convertible
Debt Instrument" in Issue No. 00-19).

The Company  accounts for convertible  instruments  (when it has determined that
the  embedded  conversion  options  should  not be  bifurcated  from  their host
instruments)  in accordance  with the  provisions of EITF 98-5  "Accounting  for
Convertible  Securities with Beneficial  Conversion Features," ("EITF 98-5") and
EITF  00-27  "Application  of EITF  98-5 to  Certain  Convertible  Instruments."
Accordingly,  the Company records when necessary  discounts to convertible notes
for the intrinsic value of conversion options embedded in debt instruments based
upon the  differences  between the fair value of the underlying  common stock at
the commitment date of the note  transaction and the effective  conversion price
embedded in the note. Debt discounts under these arrangements are amortized over
the term of the related debt to their earliest date of  redemption.  The Company
also  records  when  necessary  deemed  dividends  for the  intrinsic  value  of
conversion  options  embedded in  preferred  shares  based upon the  differences
between the fair value of the underlying  common stock at the commitment date of
the note transaction and the effective conversion price embedded in the note.

The  Company  evaluated  the  conversion  option  embedded  in  its  convertible
instruments  during each of the reporting  periods presented and has determined,
in accordance with the provisions of these statements, that it does not meet the
criteria requiring bifurcation of these instruments.

The  Company  determined  that the  conversion  option  embedded in its Series A
Convertible  Preferred  Stock, par value $0.01 per share ("Series A Preferred"),
is not a free standing derivative in accordance with the implementation guidance
provided in paragraph 61 (l) of Appendix A to SFAS 133.

The  Company  determined  that the  conversion  option  embedded in its Series B
Convertible  Preferred  Stock, par value $0.01 per share ("Series B Preferred"),
is not a free standing derivative in accordance with the implementation guidance
provided in paragraph 61 (l) of Appendix A to SFAS 133.

The characteristics of common stock that is issuable upon a holder's exercise of
conversion  options embedded in the Company's  preferred shares are deemed to be
clearly and closely related to the  characteristics  of the preferred shares (as
that  term is  clarified  in  paragraph  61 (l) of the  implementation  guidance
included in Appendix A of SFAS 133). The Company  recorded  $2,413,606 of deemed
dividends  during  the year  ended  December  31,  2006  because  the  effective
conversion  price of the preferred shares exceeded the fair value of the Company
common stock at the respective dates of issuance and/or modification.

COMMON STOCK PURCHASE WARRANTS AND OTHER DERIVATIVE FINANCIAL INSTRUMENTS

The Company  accounts  for the issuance of common  stock  purchase  warrants and
other free standing  derivative  financial  instruments  in accordance  with the
provisions of EITF 00-19. The Company performs classification assessments of its
derivative  financial  instruments  at each balance sheet date as required under
EITF 00-19.  Based on the  provisions of EITF 00-19,  the Company  classifies as
equity any contracts that (i) require physical settlement


                                       33



or  net-share  settlement  or (ii)  gives  the  Company  a  choice  of  net-cash
settlement  or settlement  in its own shares  (physical  settlement or net-share
settlement).  The Company classifies as assets or liabilities any contracts that
(i) require net-cash settlement  (including a requirement to net cash settle the
contract  if an event  occurs and if that event is  outside  the  control of the
Company)  or (ii) gives the  counterparty  a choice of  net-cash  settlement  or
settlement in shares (physical settlement or net-share settlement).  The Company
has  determined  that its  derivative  financial  instruments,  which consist of
common stock purchase warrants, are equity instruments since they do not provide
any cash settlement alternatives outside of the Company's control.

STOCK BASED COMPENSATION

Prior to January  1, 2006,  the  Company  accounted  for  employee  stock  based
compensation in accordance with Accounting  Principles Board ("APB") Opinion No.
25 "Accounting  for Stock Issued to Employees." The Company applied the proforma
disclosure   requirements   of  SFAS  No.  123   "Accounting   for   Stock-Based
Compensation."

Effective  January 1, 2006,  the Company  adopted  SFAS No.  123R  "Share  Based
Payment." This statement is a revision of SFAS Statement No. 123, and supersedes
APB Opinion No. 25, and its related implementation guidance. SFAS 123R addresses
all forms of share based payment  ("SBP") awards  including  shares issued under
employee  stock  purchase  plans,  stock  options,  restricted  stock  and stock
appreciation  rights.  Under  SFAS  123R,  SBP  awards  result in a cost that is
measured at fair value on the awards' grant date,  based on the estimated number
of  awards  that  are  expected  to  vest.  The  Company  adopted  the  modified
prospective  method with respect to accounting for its transition to SFAS 123(R)
and  measured   unrecognized   compensation   cost  as  described  in  Note  18.
Accordingly,  the  Company  recognized  in salaries  and related  expense in the
statement of  operations,  $360,795 for the fair value of employee stock options
expected to vest during the year ended December 31, 2006.

The Company has  reclassified  certain  components of its  stockholders'  equity
section to  reflect  the  elimination  of  deferred  compensation  arising  from
unvested  share-based   compensation  pursuant  to  the  requirements  of  Staff
Accounting  Bulletin  No.  107,  regarding  Statement  of  Financial  Accounting
Standards No.  123(R),  "Share-Based  Payment." This deferred  compensation  was
previously  recorded  as an  increase  to  additional  paid-in  capital  with  a
corresponding  reduction to stockholders' equity for such deferred compensation.
This  reclassification has no effect on net income or total stockholders' equity
as  previously  reported.  The Company  will  record an  increase to  additional
paid-in  capital with  corresponding  charges to operations  as the  share-based
payments vest.

For the year ended  December 31, 2005,  the Company  applied APB Opinion No. 25,
"Accounting  for Stock  Issued to  Employees."  As required  under SFAS No. 148,
"Accounting  for  Stock-based  Compensation  - Transition and  Disclosure,"  the
following table presents pro-forma net income and basic and diluted earnings per
share as if the fair  value-based  method had been applied to all awards  during
that period.

                                                                     YEAR ENDED
                                                                    DECEMBER 31,
                                                                        2005
                                                                   ------------
Net Loss, as reported ........................................     $(44,446,151)
(+) Stock-based compensation cost reflected in the
    financial statements .....................................           22,500
(-) Stock-based employee compensation cost, under fair
    value accounting .........................................         (440,753)
                                                                   ------------
Pro-forma net loss under fair value method ...................     $(44,864,404)
                                                                   ============

Net loss per share - basic and diluted, as reported ..........     $     (22.78)

Net loss per share - basic and diluted, proforma .............     $     (22.99)

The fair  value of all  awards  was  estimated  at the date of grant  using  the
Black-Scholes   option  pricing  model  with  the  following   weighted  average
assumptions:  risk free interest rate: 3.10% to 3.83%;  expected dividend yield:
0%; expected option life: 9 months to 4 years; volatility: 125%.


                                       34



NON-EMPLOYEE STOCK BASED COMPENSATION

The  Company  accounts  for  equity   instruments  issued  to  non-employees  in
accordance  with the  provisions of SFAS No. 123 and Emerging  Issues Task Force
(EITF) Issue No. 96-18,  "Accounting for Equity  Instruments  That Are Issued to
Other Than Employees for Acquiring,  or in  Conjunction  with Selling,  Goods or
Services,"  which  requires that such equity  instruments  are recorded at their
fair value on the measurement date. The measurement of stock-based  compensation
is subject to periodic  adjustment as the underlying  equity  instrument  vests.
Non-employee  stock-based  compensation  charges are amortized  over the vesting
period.  Stock based compensation expense to non employees for service amount to
$163,120  for the year ended  December 31, 2006  including  $63,120 for the fair
value of 50,000 stock  options  with an exercise  price of $2.40 per share which
were fully  vested  upon  grant and have a life of 3 years and 50,000  shares of
common stock with a an aggregate fair value of $100,000.

INCOME TAXES

The Company accounts for income taxes under SFAS No. 109, "Accounting for Income
Taxes."  SFAS No.  109  requires  the  recognition  of  deferred  tax assets and
liabilities  for both the expected  impact of differences  between the financial
statements and tax basis of assets and  liabilities  and for the expected future
tax benefit to be derived from tax loss and tax credit carry forwards.  SFAS No.
109  additionally  requires a valuation  allowance to be established  when it is
more likely  than not that all or a portion of  deferred  tax assets will not be
realized.  Furthermore,  SFAS No. 109 provides  that it is difficult to conclude
that a valuation allowance is not needed when there is negative evidence such as
cumulative losses in recent years. Therefore, cumulative losses weigh heavily in
the overall  assessment.  Accordingly  the Company has recorded a full valuation
allowance against its net deferred tax assets. In addition,  the Company expects
to  provide a full  valuation  allowance  on future  tax  benefits  until it can
sustain a level of  profitability  that  demonstrates its ability to utilize the
assets, or other significant  positive evidence arises that suggests its ability
to utilize  such  assets.  The future  realization  of a portion of the reserved
deferred  tax assets  related to tax  benefits  associated  with the exercise of
stock  options,  if and when  realized,  will not result in a tax benefit in the
consolidated  statement of operations,  but rather will result in an increase in
additional paid in capital.  The Company will continue to re-assess its reserves
on deferred income tax assets in future periods on a quarterly basis.

NET LOSS PER SHARE

Basic  net loss  per  common  share  is  computed  by  dividing  net loss by the
weighted-average  number of common shares outstanding during the period. Diluted
net loss per common share also  includes  common stock  equivalents  outstanding
during the period if dilutive.  Diluted net loss per common share,  if required,
would be computed by dividing net loss by the weighted-average  number of common
shares outstanding  without an assumed increase in common shares outstanding for
common stock equivalents; as such common stock equivalents are anti-dilutive.

Net loss per  common  share  excludes  the  following  outstanding  options  and
warrants as their effect would be anti-dilutive:

                                                             December 31,
                                                     ---------------------------
                                                        2006             2005
                                                     ----------       ----------
Options ......................................          492,635          388,000
Warrants .....................................        4,472,590          993,779
Series A Convertible Preferred stock .........        5,356,138             --
Series B Convertible Preferred stock .........        4,820,417             --
Convertible Notes ............................           66,557             --
                                                     ----------       ----------
                                                     15,208,337        1,381,779
                                                     ==========       ==========


RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

In February 2006, the FASB issued SFAS No. 155,  "Accounting  for Certain Hybrid
Financial  Instruments - an amendment of FASB  Statements No. 133 and 150." SFAS
No. 155 (a) permits fair value remeasurement for any hybrid financial instrument
that contains an embedded  derivative that otherwise would require  bifurcation,
(b) clarifies that certain  instruments  are not subject to the  requirements of
SFAS 133, (c)  establishes a requirement  to evaluate  interests in  securitized
financial assets to identify  interests that may contain an embedded  derivative
requiring  bifurcation,  (d) clarifies  what may be an embedded  derivative  for
certain  concentrations  of credit  risk and (e)  amends  SFAS 140 to  eliminate
certain  prohibitions  related to  derivatives  on a qualifying  special-purpose
entity.


                                       35



SFAS 155 is applicable to new or modified financial  instruments in fiscal years
beginning after September 15, 2006, though the provisions  related to fair value
accounting  for hybrid  financial  instruments  can also be applied to  existing
instruments.  Early adoption, as of the beginning of an entity's fiscal year, is
also permitted,  provided interim financial statements have not yet been issued.
The Company is currently  evaluating  the  potential  impact,  if any,  that the
adoption of SFAS 155 will have on its consolidated financial statements.

In March 2006,  the FASB issued  Statement  of  Financial  Accounting  Standards
("SFAS") No. 156,  Accounting for Servicing of Financial  Assets (SFAS No. 156).
SFAS No. 156 amends SFAS No. 140  "Accounting  for  Transfers  and  Servicing of
Financial Assets and  Extinguishments of Liabilities," to require all separately
recognized  servicing assets and servicing  liabilities to be initially measured
at  fair  value,  if  practicable.  SFAS  No.  156  also  permits  servicers  to
subsequently  measure each separate class of servicing assets and liabilities at
fair value rather than at the lower of cost or market.  For those companies that
elect to measure their servicing assets and liabilities at fair value,  SFAS No.
156 requires  the  difference  between the carrying  value and fair value at the
date of adoption to be recognized as a cumulative  effect adjustment to retained
earnings as of the  beginning  of the fiscal year in which the election is made.
SFAS No. 156 is effective for the first fiscal year  beginning  after  September
15, 2006. The Company is currently evaluating the potential impact, if any, that
the adoption of SFAS 156 will have on its consolidated financial statements.

In  June  2006,   the   Financial   Accounting   Standards   Board  issued  FASB
Interpretation  No.  48,  Accounting  for  Uncertainty  in  Income  Taxes.  This
Interpretation  prescribes a recognition threshold and measurement attribute for
the financial  statement  recognition and measurement of a tax position taken or
expected to be taken in a tax return. This Interpretation also provides guidance
on derecognition,  classification, interest and penalties, accounting in interim
periods,  disclosure, and transition. The Interpretation is effective for fiscal
years  beginning  after December 15, 2006. The Company has not yet completed its
analysis of the impact this Interpretation will have on its financial condition,
results of operations, cash flows or disclosures.

In September 2006, the FASB issued Statement of Financial  Accounting  Standards
No. 157, Fair Value Measurements ("SFAS 157"). This Standard defines fair value,
establishes  a  framework  for  measuring  fair  value  in  generally   accepted
accounting  principles and expands  disclosures  about fair value  measurements.
SFAS 157 is effective for financial statements issued for fiscal years beginning
after  November 15, 2007 and interim  periods  within those  fiscal  years.  The
adoption of SFAS 157 is not expected to have a material  impact on the Company's
financial position, results of operations or cash flows.

In  September  2006,  the  Securities  and  Exchange   Commission  issued  Staff
Accounting  Bulletin  ("SAB")  108,  "Considering  the  Effects  of  Prior  Year
Misstatements   when   Quantifying   Misstatements  in  Current  Year  Financial
Statements"   ("SAB  108").  SAB  108  provides   guidance  on  how  prior  year
misstatements should be taken into consideration when quantifying  misstatements
in current year financial  statements  for purposes of  determining  whether the
current  year's  financial  statements  are  materially  misstated.  SAB  108 is
effective for the first fiscal year ending after November 15, 2006. The adoption
of SAB 108 did not impact the Company's financial statements.

In  November  2006,  the EITF  reached  a final  consensus  in EITF  Issue  06-6
"Debtor's  Accounting  for a  Modification  (or  Exchange) of  Convertible  Debt
Instruments"   ("EITF  06-6").   EITF  06-6  addresses  the  modification  of  a
convertible  debt  instrument  that  changes  the  fair  value  of  an  embedded
conversion  option and the subsequent  recognition  of interest  expense for the
associated  debt  instrument  when the  modification  does not  result in a debt
extinguishment  pursuant to EITF 96-19,  "Debtor's Accounting for a Modification
or  Exchange  of  Debt   Instruments."   The  consensus  should  be  applied  to
modifications  or exchanges of debt  instruments  occurring in interim or annual
periods  beginning  after  November  29,  2006.  The  Company doe not expect the
adoption of EITF 06-6 to have a material  impact on its  consolidated  financial
position, results of operations or cash flows.

In November 2006, the FASB ratified EITF Issue No. 06-7, Issuer's Accounting for
a Previously  Bifurcated Conversion Option in a Convertible Debt Instrument When
the Conversion Option No Longer Meets the Bifurcation Criteria in FASB Statement
No. 133,  Accounting for Derivative  Instruments and Hedging  Activities  ("EITF
06-7"). At the time of issuance,  an embedded conversion option in a convertible
debt  instrument may be required to be bifurcated  from the debt  instrument and
accounted for  separately by the issuer as a derivative  under FAS 133, based on
the  application  of EITF 00-19.  Subsequent to the issuance of the  convertible
debt,  facts may change and cause the  embedded  conversion  option to no longer
meet the conditions for separate accounting as a derivative instrument,  such as
when the  bifurcated  instrument  meets  the  conditions  of  Issue  00-19 to be
classified in stockholders' equity. Under EITF 06-7, when an embedded conversion
option  previously  accounted for as a derivative  under FAS 133 no longer meets
the  bifurcation  criteria  under  that  standard,  an issuer  shall  disclose a
description of the principal  changes causing the embedded  conversion option to
no longer require bifurcation under FAS 133 and the amount of


                                       36



the liability for the conversion  option  reclassified to stockholders'  equity.
EITF 06-7 should be applied to all previously  bifurcated  conversion options in
convertible debt instruments that no longer meet the bifurcation criteria in FAS
133 in interim or annual periods  beginning after December 15, 2006,  regardless
of whether the debt  instrument  was  entered  into prior or  subsequent  to the
effective  date of EITF 06-7.  Earlier  application of EITF 06-7 is permitted in
periods for which financial  statements have not yet been issued. The Company is
currently  evaluating the impact of this guidance on its consolidated  financial
position, results of operations or cash flows.

In December 2006, the FASB issued FSP EITF 00-19-2, "Accounting for Registration
Payment  Arrangements."  FSP EITF 00-19-2  addresses an issuer's  accounting for
registration  payment  arrangements.   This  pronouncement  specifies  that  the
contingent   obligation   to  make  future   payments  or   otherwise   transfer
consideration  under a  registration  payment  arrangement,  whether issued as a
separate agreement or included as a provision of a financial instrument,  should
be separately  recognized and accounted for as a contingency in accordance  with
SFAS 5  "Accounting  for  Contingencies."  FSP EITF  00-19-2  amending  previous
standards  relating to rights  agreements  became effective on December 21, 2006
with respect to arrangements entered into or modified beginning on such date and
for the first  fiscal year  beginning  after  December  15, 2006 with respect to
those  arrangements  entered into prior to December 21, 2006.  The Company is in
the process of  evaluating  the impact of the adoption of this  statement on the
Company's results of operations and financial condition.

In February 2007, the FASB issued SFAS 159, "The Fair Value Option for Financial
Assets and Financial Liabilities" ("SFAS 159"). SFAS 159 provides companies with
an option to report selected  financial assets and liabilities at fair value and
establishes  presentation  and  disclosure  requirements  designed to facilitate
comparisons between companies that choose different  measurement  attributes for
similar types of assets and liabilities.  SFAS 159 is effective for fiscal years
beginning  after  November 15, 2007. The Company is in the process of evaluating
the  impact of the  adoption  of this  statement  on the  Company's  results  of
operations and financial condition.

Other  accounting  standards  that have been  issued or  proposed by the FASB or
other standards-setting  bodies that do not require adoption until a future date
are not  expected  to  have a  material  impact  on the  consolidated  financial
statements upon adoption.

NOTE 4 - BUSINESS COMBINATIONS

MERGER WITH COMPLETE SECURITY SOLUTIONS, INC.

On February 25, 2005, pursuant to the filing of an Agreement and Plan of Merger,
the Company's  merger with Complete  Security  Solutions,  Inc.  ("CSSI") became
effective. In connection with the CSSI merger, the Company issued 250,000 shares
of common  stock in exchange for the  outstanding  shares of the common stock of
CSSI, and  subordinated  promissory  notes in the aggregate  principal amount of
$4,500,000 (the "Subordinated  Notes") and warrants to purchase 75,000 shares of
common stock ("Purchase Warrants") in exchange for the outstanding shares of the
preferred  stock of CSSI.  The Purchase  Warrants  have a term of 5 years and an
exercise price of $0.70 per share. The Subordinated  Notes and Purchase Warrants
were issued to Apex Investment Fund V, L.P.  ("Apex"),  The Northwestern  Mutual
Life Insurance Company ("Northwestern"),  and Advanced Equities Venture Partners
I, L.P. ("Advanced Equities").

The Company did not redeem the Subordinated  Notes on their extended due date of
August 24, 2005 and, as a result,  the notes  became  automatically  convertible
into 0.128 shares of common stock for each $1 of principal  then  outstanding in
accordance with the original note agreement. Accordingly, the Company recorded a
charge of  $4,500,000  during the year ended  December  31,  2005 based upon the
intrinsic value of this conversion option measured at the original issuance date
of the note. The Subordinated Notes remained outstanding  subsequent to the date
of their  maturity  but were  ultimately  surrendered  as payment for  5,625,000
shares of Series A-1 Preferred Stock under the creditor and claimant liabilities
restructuring  program in March 2006 (Note 17).  The  Company has agreed to file
with the SEC, a registration  statement for the resale of the restricted  shares
of the Company's  common stock issuable upon exercise of the  conversion  option
that would be issued in this transaction, on a best efforts basis.

The Company has agreed to  register  the resale of the 250,000  shares of common
stock  issued to the  holders of the  outstanding  common  stock of CSSI and the
75,000 shares of common stock issuable upon the exercise of the warrants  issued
to the holders of the  outstanding  preferred  stock of CSSI at such time as the
Company next files a  registration  statement  with the  Securities and Exchange
Commission ("SEC") on a best efforts basis.


                                       37



MERGER WITH LUCIDLINE, INC.

On February 25, 2005, pursuant to the filing of an Agreement and Plan of Merger,
the Company's merger with LucidLine,  Inc.  ("LucidLine")  became effective.  In
connection  with the LucidLine  merger,  the Company  issued  146,667  shares of
common stock and $200,000 of cash, in exchange for all of the outstanding shares
of  LucidLine's  common stock.  The Company has agreed to register the resale of
the shares of common stock issued to the holders of the outstanding common stock
of  LucidLine at such time as the Company  next files a  registration  statement
with the SEC on a best efforts basis.

MERGER WITH ENTELAGENT SOFTWARE CORP.

On February 24, 2005, the Company entered into a definitive Amended and Restated
Supplemental  Agreement  pursuant to which ESC  Acquisition,  Inc., a California
corporation and wholly-owned  subsidiary of Patron ("Entelagent Mergerco") would
merge  with  and  into  Entelagent  Software  Corp.,  a  California  corporation
("Entelagent"),   with  Entelagent   surviving  the  merger  as  a  wholly-owned
subsidiary  of the  Company.  On March 30,  2005,  pursuant  to the filing of an
Amended and Restated  Agreement and Plan of Merger,  the  Company's  merger with
Entelagent became effective.

In connection with the Entelagent  Merger,  the Company issued 100,000 shares of
the Company's common stock in exchange for all of the outstanding  shares of the
capital stock of Entelagent.  In addition,  pursuant to the terms of the Amended
and  Restated  Supplemental  Agreement,  the Company also agreed to (i) issue to
certain  officers,  directors,  stockholders  and  creditors of  Entelagent,  in
consideration of amounts owed by Entelagent to such parties, promissory notes in
the aggregate principal amount of $2,640,000, with interest payable thereon at a
rate of 8% per annum and  maturing one year after the  completion  of the merger
and (ii) pay and satisfy  $1,388,000 in  outstanding  liabilities of Entelagent.
The Company  placed  $1,388,000  of the  proceeds  it received  from the Interim
Bridge  Financing I financing  transaction  completed  on February 28, 2005 in a
reserve  account  established  to assist  the  Company  in the  payment  of such
liabilities.

BUSINESS COMBINATION ACCOUNTING

The Company  accounted for its  acquisitions  of CSSI,  LucidLine and Entelagent
using the purchase  method of  accounting  prescribed  under SFAS 141  "Business
Combinations."

The following  table  provides a breakdown of the purchase  price  including the
fair value of  purchase  consideration  issued to the  sellers  of the  acquired
business and direct  transaction  expenses incurred by the Company in connection
with consummating these transactions:




                                   CSSI        LUCIDLINE    ENTELAGENT       TOTAL
                                -----------   -----------   -----------   -----------
                                                              
Cash ........................   $      --     $   200,000   $      --     $   200,000
Common Stock ................     6,375,000     3,740,000     2,550,000    12,665,000
Subordinated promissory notes     4,500,000          --            --       4,500,000
Common stock warrants .......     1,912,500          --            --       1,912,500
Transaction expenses ........       398,128       154,611       359,894       912,633
                                -----------   -----------   -----------   -----------
   Total Purchase Price .....   $13,185,628   $ 4,094,611   $ 2,909,894   $20,190,133
                                ===========   ===========   ===========   ===========



The fair value of common stock  issued to the sellers as purchase  consideration
was determined in accordance with the provisions of EITF 99-12 "Determination of
the  Measurement  Date for the Market Price of Acquirer  Securities  Issued in a
Purchase Business  Combination." The fair value of subordinated  notes issued to
the  sellers  as  purchase  consideration  is  considered  to be  equal to their
principal  amounts  due to the  short-term  maturity of those  instruments.  The
Company  calculated the fair value of common stock purchase  warrants  issued to
the sellers as purchase  consideration  using the  Black-Scholes  option-pricing
model  with the  following  assumptions:  fair  value of  common  stock  $25.50;
risk-free  interest  rate of 3.55%;  expected  dividend  yield of zero  percent;
expected warrant life of five years; and current volatility of 125%.


                                       38



Transaction expenses, which include legal fees and transaction advisory services
directly  related to the  acquisitions  amount to  $912,633.  Such fees  include
$657,633  paid in cash and $255,000  for the fair value of 300,000  common stock
purchase  warrants  issued  to  Laidlaw  & Company  UK Ltd.  ("Laidlaw")  in its
capacity as a transaction advisor.

PURCHASE PRICE ALLOCATION

Under business combination accounting, the total purchase price was allocated to
CSSI's and LucidLine's net tangible and identifiable  intangible assets based on
their  estimated  fair values as of February 25, 2005.  The total purchase price
allocation for Entelagent's net tangible and identifiable  intangible assets was
based on their estimated fair values as of March 30, 2005. The allocation of the
purchase price for these three  acquisitions  is set forth below.  The excess of
the purchase price over the net tangible and identifiable  intangible assets was
recorded as goodwill.



                                             CSSI          LUCIDLINE      ENTELAGENT        TOTAL
                                         ------------    ------------    ------------    ------------
                                                                             
Fair value of tangible assets:
   Total current assets ..............   $    584,377    $     34,825    $    125,606    $    744,808
   Total  tangible assets ............      3,321,066          95,825         137,606       3,554,497
Liabilities assumed:
   Total current liabilities .........       (533,022)       (861,505)     (7,063,459)     (8,457,986)
   Total liabilities assumed .........       (533,022)       (963,965)     (7,408,789)     (8,905,776)
                                         ------------    ------------    ------------    ------------
Net tangible assets acquired .........      2,788,044        (868,140)     (7,271,183)     (5,351,279)

Value of excess allocated to:
   Developed technology ..............        670,000            --         1,900,000       2,570,000
   Customer relationships ............        180,000            --              --           180,000
   Trademarks and tradenames .........         55,000            --           106,000         161,000
   In-process research and development        190,000            --              --           190,000
   Goodwill ..........................      9,302,584       4,962,751       8,175,077      22,440,412
                                         ------------    ------------    ------------    ------------
Purchase Price .......................   $ 13,185,628    $  4,094,611    $  2,909,894    $ 20,190,133
                                         ============    ============    ============    ============


The purchase price  allocation was based upon a valuation  study performed by an
independent  outside appraisal firm. The Company, in formulating the allocation,
considered its intention for future use of the acquired assets,  analyses of the
historical  financial  performance  of  each  of  the  acquired  businesses  and
estimates  of future  performance  of each  acquired  businesses'  products  and
services.  The Company made certain  adjustments  during the year ended December
31, 2005 to its original  purchase  price  allocation  as a result of (a) having
negotiated  settlements of certain  liabilities  that it assumed in its business
combination  with  Entelagent,  (b) having  completed the audits of the acquired
businesses and (c) the  reevaluation of the carrying amounts of certain accounts
receivable balances recorded in purchase accounting.

PROFORMA FINANCIAL INFORMATION

The unaudited  financial  information in the table below summarizes the combined
results of operations of the Company and CSSI,  LucidLine and  Entelagent,  on a
proforma  basis,  as if the  companies  had been combined as of January 1, 2005.

The unaudited  proforma  financial  information  for the year ended December 31,
2005 combines the historical results for the Company for the year ended December
31, 2005 and the  historical  results for CSSI and LucidLine for the period from
January 1, 2005 to February 24, 2005 and the  historical  results for Entelagent
for the period from January 1, 2005 to March 30, 2005.

                                                                       2005
                                                                   ------------
Total revenues ...............................................     $    800,710
Net loss .....................................................      (46,152,799)
Weighted average shares outstanding on a proforma basis ......        2,034,098
Proforma net loss per share, basic and diluted ...............     $     (22.69)


                                       39



The proforma financial information is presented for informational  purposes only
and is not indicative of the results of operations that would have been achieved
if the acquisitions of these three companies had taken place at the beginning of
each of the periods presented.

Additionally,  the  Company  sold  LucidLine  in  April  2006  for  $50,000  and
discontinued the operations of the PolicyBridge  software  application  business
acquired from Entelagent Software Corp. in December 2006.

NOTE 5 - IMPAIRMENT OF GOODWILL

The Company recorded $22,440,412 of goodwill in connection with its acquisitions
of CSSI,  LucidLine  and  Entelagent  (Note 4). The amount of goodwill  that the
Company  recorded  in  connection  with these  acquisitions  was  determined  by
comparing the aggregate  amounts of the respective  purchase prices plus related
transaction  costs to the  fair  values  of the net  tangible  and  identifiable
intangible assets acquired for each of the businesses described in Note 4.

The Company  performed its annual  impairment test of goodwill at its designated
valuation date of December 31, 2005 in accordance  with SFAS 142. As a result of
these tests, the Company determined that the recoverable amount of goodwill with
respect  to its  business  amounted  to  $9,510,716.  Accordingly,  the  Company
recorded a goodwill  impairment charge in the amount of $12,929,696 for the year
ended  December 31, 2005.  The valuation was performed by an outside  specialist
using a weighted average discounted cash flows modeling approach.

The Company  performed its annual  impairment test of goodwill at its designated
valuation date of December 31, 2006 in accordance  with SFAS 142. As a result of
these tests, the Company determined that the recoverable amount of goodwill with
respect  to its  business  amounted  to  $9,300,000.  Accordingly,  the  Company
recorded a goodwill  impairment  charge in the amount of  $210,716  for the year
ended December 31, 2006.

The valuation was performed by an outside  specialist  using a weighted  average
discounted  cash flows modeling  approach.  Making  estimates about the carrying
value of goodwill requires management to exercise significant judgment. It is at
least  reasonably  possible  that the  estimate  of the effect on the  financial
statements of a condition,  situation,  or set of circumstances  that existed at
the date of the financial statements, which management considered in formulating
its estimate could change in the near term due to one or more future  confirming
events.  Accordingly,  the actual  results  regarding  estimates of the carrying
value of these intangibles could differ materially from the Company's estimates.

NOTE 6 - PROPERTY AND EQUIPMENT

                                                                   DECEMBER 31,
                                         USEFUL LIFE                   2006
                                         ------------              -------------
Computers                                2 to 3 years              $    239,029
Furniture and fixtures                   3 to 5 years                    31,962
Leasehold improvements                     5 years                        4,490
                                                                   ------------
     sub-total                                                          275,481
less: accumulated depreciation                                         (100,690)
                                                                   ------------
     Property and equipment, net                                   $     174,791
                                                                   ============


Depreciation  expense  amounted  to  $70,375  and  $33,993  for the years  ended
December 31, 2006 and 2005, respectively.

NOTE 7 - CAPITALIZED SOFTWARE

In December  2006,  the Company  made the  decision to focus its business on its
FormStream software products and to place its PolicyBridge business up for sale.
Because of this decision,  $596,636 of capitalized  software identified with the
PolicyBridge business have been expensed as a loss from discontinued  operations
in the year ended December 31, 2006.

Capitalized software development costs are as follows:


                                       40



Beginning of the year ......................     $   172,130
Capitalized ................................         281,372
Amortization ...............................         (38,942)
                                                 -----------
   Balance at December 31, 2006                  $   414,560

The Company  classifies  amortization of developed  technology as a component of
cost of sales.  Amortization  expense  amounted to $97,693 and  $192,300 for the
years ended December 31, 2006 and 2005, respectively.

AMORTIZATION OF CAPITALIZED SOFTWARE

The amortization of capitalized software will result in the following additional
expense by year:

                                     SOFTWARE
YEARS ENDED DECEMBER 31:           AMORTIZATION
------------------------           ------------
         2007                      $     79,877
         2008                            97,035
         2009                            97,035
         2010                            65,365
         2011                            58,092
         2012                            17,156
                                   ------------
                                   $    414,560
                                   ============

NOTE 8 - AMORTIZABLE INTANGIBLE ASSETS

In December  2006,  the Company  made the  decision to focus its business on its
FormStream software products and to place its PolicyBridge business up for sale.
Because of this  decision,  $61,834 of  intangible  assets  identified  with the
PolicyBridge business have been expensed as a loss from discontinued  operations
in the year ended December 31, 2006.

The Company  performed an analysis  for the  recoverability  of its  amortizable
intangible assets used in its continuing operations in accordance with SFAS 144.
The Company performed this analysis by estimating the future cash flows expected
to result  from the use of these  assets,  which  principally  include  software
products.  Since the  estimated  undiscounted  cash flows were  greater than the
carrying  value of the related  assets,  it was  determined  that no  impairment
charge should be recognized.

The components of intangible assets as of December 31, 2006 are set forth in the
following table:

                                                                   DECEMBER 31,
                                                                       2006
                                                                   ------------
Customer relationships ........................................    $    180,000
Trademarks and tradenames .....................................          55,000
                                                                   ------------
                                                                        235,000
less: accumulated amortization ................................        (107,710)
                                                                   ------------
     Amortizable intangible assets, net .......................    $    127,290
                                                                   ============

AMORTIZATION OF INTANGIBLE ASSETS

The  amortization of intangible  assets will result in the following  additional
expense by year:


                                       41



                                    INTANGIBLE
YEARS ENDED DECEMBER 31:           AMORTIZATION
------------------------           ------------
         2007                      $     58,750
         2008                            58,750
         2009                             9,790
                                   ------------
                                   $    127,290
                                   ============

NOTE 9 - ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES

Accrued expenses and other current liabilities consist of the following:

                                                                    DECEMBER 31,
                                                                        2006
                                                                    ------------
Payroll and payroll related expenses ...........................    $    582,224
Accrued interest ...............................................         629,331
Reserve for  preacquisition tax contingencies ..................         336,828
Other current liabilities ......................................         210,049
Accrued registration penalty ...................................          90,488
Expense reimbursement payable ..................................           9,958
                                                                    ------------
                                                                    $  1,858,878
                                                                    ============

NOTE 10 - DEMAND NOTES PAYABLE

Through  December 31, 2004, the Company borrowed an aggregate amount of $695,000
from several  unrelated  parties.  At December  31, 2006,  all of the notes were
settled in the creditor and claimant liabilities restructuring. Interest expense
on the notes  amounted to $22,462 and  $69,500 for the year ended  December  31,
2006 and 2005, respectively.

The remaining  demand note at December 31, 2006,  which amounts to $312,557,  is
payable to Lok Technology and is secured by  Entelagent's  accounts  receivable.
Accounts  receivable  of former  Entelagent  customers  amounted  to  $43,430 at
December 31, 2006 and is included in Assets of Discontinued Operations. The note
bears  interest  at 15% per annum.  Interest  on this  demand  note  amounted to
$46,884 for the year ended December 31, 2006 and $35,163 for year ended December
31, 2005. As described in Note 16, on May 4, 2006, the Company became aware of a
complaint  that  Lok  Technologies,  Inc.  had  filed in the  Superior  Court of
California,  County  of Santa  Clara on or about  March  30,  2006  against  the
Company, Entelagent Software Corp. and unnamed defendants.

NOTE 11 - BRIDGE NOTES PAYABLE

INTERIM BRIDGE FINANCING I

On February 28, 2005, the Company completed a $3,500,000 financing (the "Interim
Bridge Financing I") through the issuance of 10% Senior  Convertible  Promissory
Notes (the "Bridge I Notes") and warrants to purchase up to 58,348 shares of the
Company's  common stock  ("Bridge I  Warrants").  The warrants  have a term of 5
years and an exercise price of $1.62 per share.  The aggregate fair value of the
Bridge I Warrants amounts to $1,487,500.  Prior to final maturity,  the Bridge I
Notes would have been  convertible into securities that would be issuable at the
first  closing of a  subsequent  financing  by the  Company,  for such number of
offered  securities  that could be  purchased  for the  principal  amount  being
converted.  The Company did not  complete a financing  transaction  prior to the
final  maturity  date of these notes.  The Bridge I Notes had an initial term of
120 days (due on June 28, 2005) with interest at a  contractual  rate of 10% per
annum  and  featured  an  option  for the  Company  to  extend  the  term for an
additional 60 days to August 27, 2005.


                                       42



In accordance with APB 14, "Accounting for Convertible Debt and Debt Issued with
Stock Purchase  Warrants," the Company  allocated  $2,456,140 of the proceeds to
the Bridge I Notes and  $1,043,860  of proceeds  to the Bridge I  Warrants.  The
difference  between  the  carrying  amount  of the  Bridge  I  Notes  and  their
contractual redemption amount was accreted as interest expense to June 28, 2005,
their earliest date of redemption.

On June 28, 2005, the Company elected to extend the contractual maturity date of
the Bridge I Notes for an  additional  60 days to August 27, 2005,  which caused
the  contractual  interest rate to increase to 12% per annum.  In addition,  the
Company was  required to issue the 58,348  additional  warrants  (the  "Bridge I
Extension  Warrants") to purchase such number of shares of common stock equal to
1/60 of a share for each $1.00 of  principal  amount  outstanding.  The Bridge I
Extension  Warrants  have a term of 5 years and an  exercise  price of $1.62 per
share.  The  Bridge  I  Extension  Warrants  have  a  fair  value  of  $822,500.
Assumptions  relating  to the  estimated  fair  value of these  warrants  are as
follows: fair value of common stock of $19.50; risk-free interest rate of 4.25%;
expected dividend yield zero percent;  expected warrant life of three years; and
current volatility of 125%.

The  Company  did not redeem the  Bridge I Notes on August  27,  2005 and,  as a
result, the notes  automatically  became convertible into 0.128 shares of common
stock for each $1 of principal then  outstanding in accordance with the original
note agreement.  The Bridge I Notes remained outstanding  subsequent to the date
of their  maturity  but were  ultimately  surrendered  as payment for Series A-1
Preferred stock as described below.  Accordingly,  the Company recorded a charge
of $3,500,000 in 2005 based upon the intrinsic value of this  conversion  option
measured  at the  original  issuance  date of the note in  accordance  with EITF
00-27, which is included in interest in the accompanying statement of operations
for the year ended December 31, 2005.

Contractual  interest  expense on the Bridge I Notes  amounted to  $133,238  and
$326,164  for the year ended  December 31, 2006 and 2005,  respectively,  and is
included as a component  of interest  expense in the  accompanying  statement of
operations.

As of December 31, 2006,  $3,180,025 of the Bridge I Notes were  surrendered  as
payment  for  3,975,031  shares of  Series  A-1  Preferred  stock as part of the
creditor and claimant liabilities restructuring (Note 17). With the surrender of
the Bridge I Notes in payment for Series A-1 Preferred  stock under the creditor
and claimant liabilities  restructuring,  conversion options associated with the
surrendered Bridge I Notes are no longer exercisable and have been cancelled. As
of December 31, 2006, $319,975 of Bridge I notes remain outstanding.

INTERIM BRIDGE FINANCING II

On June 6, 2005,  the Company  completed a $2,543,000  financing  (the  "Interim
Bridge  Financing  II")  through  the  issuance  of (i) 10%  Junior  Convertible
Promissory  Notes (the  "Bridge II Notes")  and (ii)  warrants to purchase up to
42,388  shares of common stock (the "Bridge II  Warrants").  The warrants have a
term of 5 years and an exercise  price of $1.74 per share.  The  aggregate  fair
value of the Bridge II Warrants  amounts to  $673,895.  Prior to  maturity,  the
Junior  Convertible  Promissory  Notes  would  have  been  convertible  into the
securities offered by the Company at the first closing of a subsequent financing
for the Company, for such number of offered securities as could be purchased for
the principal amount being  converted.  The Company did not complete a financing
transaction  prior to the final maturity date of the notes.  The Bridge II Notes
had an initial  term of 120 days (due on October 4, 2005) with  interest  at 10%
per annum and  featured  an option  for the  Company  to extend  the term for an
additional 60 days to December 2, 2005.

In accordance with APB 14, the Company  allocated  $2,010,277 of the proceeds to
the Bridge II Notes and  $532,723  of proceeds  to the Bridge II  Warrants.  The
difference  between  the  carrying  amount  of the  Bridge  II Notes  and  their
contractual  redemption  amount is being accreted as interest expense to October
3, 2005, their earliest date of redemption.

On October 4,  2005,  the  Company  elected to extend the  maturity  date of the
Bridge II Notes for an  additional  60 days to December 2, 2005 which caused the
contractual  interest  rate would  increase to 12% per annum.  In addition,  the
Company  was  required  to issue  42,388  additional  warrants  (the  "Bridge II
Extension  Warrants").  The Bridge II  Extension  Warrants,  feature a term of 5
years and an exercise price of $1.74 per share. The Bridge II Extension Warrants
have a fair value of $65,388.  Assumptions  relating to the estimated fair value
of these  warrants are as follows:  fair value of common stock $2.40;  risk-free
interest rate of 3.10%;  expected dividend yield zero percent;  expected warrant
life of five years; and current volatility of 125%.

The  Company  did not redeem the Bridge II Notes on  December  2, 2005 and, as a
result, the notes  automatically  became convertible into 0.128 shares of common
stock for each $1 of principal then outstanding in accordance with


                                       43



the original note agreement. The Bridge II Notes remained outstanding subsequent
to the date of their  maturity but were  ultimately  surrendered  as payment for
Series A-1 Preferred stock as described below. Accordingly, the Company recorded
a charge of $2,543,000 based upon the intrinsic value of this conversion  option
measured  at the  original  issuance  date of the note in  accordance  with EITF
00-27, which is included in interest in the accompanying statement of operations
for the year ended December 31, 2005.

Contractual  interest  expense on the Bridge II Notes  amounted to $123,244  and
$171,434  for the year ended  December  31, 2006 and 2005,  respectively  and is
included as a component  of interest  expense in the  accompanying  statement of
operations.

As of December 31, 2006,  $2,343,000 of the Bridge II Notes were  surrendered as
payment  for  2,928,750  shares of  Series  A-1  Preferred  stock as part of the
creditor and claimant liabilities restructuring (Note 17). With the surrender of
the Bridge II Notes in payment for Series A-1 Preferred stock under the creditor
and claimant liabilities  restructuring,  the conversion options associated with
the  surrendered  Bridge  II Notes  are no  longer  exercisable  and  have  been
cancelled.  As of December  31,  2006,  $200,000  of the Bridge II Notes  remain
outstanding.

INTERIM BRIDGE FINANCING III

Beginning on July 1, 2005, and continuing through December 31, 2005, the Company
completed,  through 12 separate fundings,  a $5,234,000  financing (the "Interim
Bridge  Financing  III")  through  the  issuance  of (i) 10% Junior  Convertible
Promissory  Notes (the  "Bridge III Notes") and (ii)  warrants to purchase up to
87,235 shares of common stock (the "Bridge III  Warrants").  The warrants have a
term of 5 years and an exercise price of $1.74 per share. Prior to maturity, the
Junior  Convertible  Promissory  Notes  would  have  been  convertible  into the
securities offered by the Company at the first closing of a subsequent financing
for the Company, for such number of offered securities as could be purchased for
the principal amount being  converted.  The Company did not complete a financing
transaction prior to the final maturity date of the notes.

In accordance with APB 14, the Company  allocated  $4,646,405 of the proceeds to
the Bridge III Notes and  $587,595 of proceeds to the Bridge III  Warrants.  The
difference  between  the  carrying  amount  of the  Bridge  III  Notes and their
contractual  redemption amount was being accreted as interest expense to various
dates from November 1, 2005, their earliest date of redemption. Accretion of the
aforementioned  discount  amounted to $20,909 and  $566,686  for the years ended
December  31, 2006 and 2005,  respectively,  and are  included as a component of
interest expense in the accompanying statements of operations.

The  Bridge  III Notes had an  initial  term of 120 days (due on  various  dates
beginning October 28, 2005) with interest at 10% per annum and feature an option
for the Company to extend the term for an  additional  60 days to various  dates
beginning  December 28,  2005.  Upon the  extension of the maturity  date of the
Bridge III Notes, the contractual  interest rate increased to 12% per annum, and
the Company was required to issue warrants (the "Bridge III Extension Warrants")
to purchase such number of shares of the Company's  common stock equal to 1/60th
of a share  for  each  $1.00 of  principal  then  outstanding.  The  Bridge  III
Extension  Warrants,  issued upon  extension of the maturity  date of the Junior
Convertible Promissory Notes, feature a term of 5 years and an exercise price of
$1.74 per share. In addition, any Bridge III Notes not paid in full on or before
their extended maturity date, become automatically convertible into 0.128 shares
of the Company's common stock for each $1.00 of principal then outstanding.

Beginning on October 29,  2005,  the Company  elected to extend the  contractual
maturity  date of  $2,400,000  of Bridge III Notes for an  additional 60 days to
various dates beginning December 28, 2005, which caused the contractual interest
rate to increase  to 12% per annum.  Accordingly,  the  Company was  required to
issue 40,000  additional  warrants with a fair value of $67,537  during the year
ended December 31, 2005 and an additional 39,917 warrants (together,  the Bridge
III  Extension  Warrants")  with a fair value of  $48,149  during the year ended
December 31, 2006.  The Bridge III Extension  Warrants have a term of five years
and an exercise price of $1.74 per share.  Assumptions relating to the estimated
fair value of these warrants are as follows: fair value of common stock $1.95 to
$2.40;  risk-free interest rate of 3.10% to 3.44%;  expected dividend yield zero
percent; expected warrant life of three years; and current volatility of 125%.

The aggregate fair value of the warrants was recorded as interest expense in the
accompanying  statement of operations  for the year ended December 31, 2006. The
fair  value  of the  Bridge  III  Extension  Warrants  was  amortized  over  the
respective 60 day extension periods.  Amortization of the aforementioned  values
amount to $59,106 and $56,860 for the years ended December 31, 2005 and December
31, 2006, respectively and is included as a component of interest expense in the
accompanying statements of operations.


                                       44



During the year ended December 31, 2005,  the Company did not redeem  $1,850,000
of Bridge III Notes with contractual  maturity dates occurring  through December
31, 2005. As a result, these notes became  automatically  convertible into 0.128
shares of common stock for each $1 of principal  then  outstanding in accordance
with the original note  agreement.  These Bridge III Notes remained  outstanding
subsequent  to the date of their  maturity but were  ultimately  surrendered  as
payment for Series A-1  Preferred  Stock as described  below.  Accordingly,  the
Company recorded a charge of $1,850,000  during the year ended December 31, 2005
based  upon  the  intrinsic  value of this  conversion  option  measured  at the
original  issuance date of the notes in accordance  with EITF 00-27.  The charge
was recorded as interest expense in the accompanying statement of operations for
the year ended December 31, 2005.

The Company  also did not redeem  $550,000 of Bridge III Notes with  contractual
maturity dates that occurred  through March 27, 2006. As a result,  these Bridge
III Notes became automatically convertible into 0.128 shares of common stock for
each $1 of principal  then  outstanding  in  accordance  with the original  note
agreement. These Bridge III Notes remained outstanding subsequent to the date of
their maturity but were surrendered as payment for Series A-1 Preferred stock as
described below. Accordingly,  the Company recorded a charge of $192,000, in the
three  months  ended  March 31,  2006,  based upon the  intrinsic  value of this
conversion  option  measured  at the  original  issuance  date of the  notes  in
accordance with EITF 00-27.  The charge was recorded as interest  expense in the
accompanying statement of operations for the year ended December 31,2006.

As of December 31, 2006, all of the Bridge III Notes were surrendered as payment
for 6,542,500  shares of Series A-1 Preferred  stock as part of the creditor and
claimant liabilities restructuring (Note 17).

Contractual  interest  expense on the Bridge III Notes  amounted to $153,036 and
$172,816 for the years ended  December 31, 2006 and 2005,  respectively,  and is
included as a component  of interest  expense in the  accompanying  statement of
operations.

The Company sold these securities to Apex, Northwestern,  and Advanced Equities.
Funding  for the Bridge III Notes  included  the  conversion  of  $1,650,000  of
stockholder advances made during the period March 30, 2005 to June 30, 2005 into
Bridge III Notes.

2006 BRIDGE NOTES

On January 18, 2006, the Company completed a financing of approximately $540,000
in  additional  gross  funds (the "2006  Bridge  Note  Financing")  through  the
issuance of Subordinated  Convertible Promissory Notes (the "2006 Bridge Notes")
in the amount of  $720,001.  The 2006 Bridge Note  agreement  provided for these
notes to automatically convert into the same securities (consisting of shares of
Series A Preferred Stock and warrants to purchase shares of the Company's common
stock)  offered  by the  Company  in  connection  with its  Series  A  Preferred
Financing  (Note 17).  On March 27,  2006 (the date of the first  closing of the
Series A Preferred  Financing),  the 2006 Bridge Notes were  converted  into 7.2
Units  in the  Series  A  Preferred  Financing  described  below.  The  $180,000
difference between the gross proceeds received upon the original issuance of the
notes and the redemption amount was recorded as interest expense during the year
ended December 31, 2006.

Additionally,  the  Company  paid  Laidlaw & Company  (UK)  Ltd.  (Laidlaw),  as
placement  agent in the  transaction,  a fee of $54,000 in conjunction  with the
2006 Bridge Note  Financing.  This fee was fully  amortized  and  recognized  as
interest expense during the year ended December 31, 2006.

INTERIM BRIDGE FINANCING IV

Beginning  on July 18, 2006 and  continuing  through  September  15,  2006,  the
Company  obtained  interim  financing  ("Interim  Bridge Financing IV") totaling
$1,000,000 from Apex. This Interim Bridge Financing IV  automatically  converted
into  securities  (consisting of shares of Series B Preferred Stock and warrants
to purchase  shares of the  Company's  common  stock)  offered by the Company in
connection  with its Series B Preferred  Financing (see Note 18). On October 13,
2006, (the date of the first closing of the Series B Preferred  Financing),  the
Interim  Bridge  Financing  IV was  converted  into 10  Units  in the  Series  B
Preferred Financing described in Note 18 below.


                                       45



NOTE 12 - RELATED PARTY TRANSACTIONS

LIABILITIES DUE TO FORMER CHAIRMAN AND OFFICERS/STOCKHOLDERS

The Company's former non-executive  chairman surrendered $254,152 of liabilities
due to him by the Company for expense  reimbursements  and other working capital
advances made to the Company as payment for Series A-1  Preferred  stock as part
of the creditor and claimant liabilities restructuring (Note 17).

A former officer of the Company  surrendered  $1,180,991 of liabilities  due for
expense reimbursements, payroll and various other loans and advances made to the
Company as payment for Series A-1  Preferred  stock as part of the  creditor and
claimant  liabilities  restructuring  (Note 17). A portion of these  liabilities
were previously classified as notes payable to creditors of acquired business.

CONSULTING AGREEMENT PAYABLE

On June 8, 2005,  the Company  negotiated  a  settlement  regarding a consulting
agreement  payable with a related party.  The terms of the settlement  agreement
terminated the prior agreement and reduced the remaining  payments due under the
contract  to  $150,000  including  a  $50,000  payment  that was  made  upon the
execution of the agreement and two additional  $50,000 payments including one to
be made upon the completion of a follow-on-financing  by the Company and one not
later than September 30, 2005.  The $150,000  reduction in payments was recorded
as a  reduction  of general  and  administrative  expense  during the year ended
December  31,  2005.  Additionally,   the  settlement  agreement  terminated  an
obligation  for the Company to issue 3,334  shares of  unrestricted  stock.  The
stock issuable under this commitment was recorded in 2004 as common stock issued
in lieu of cash for  services in the amount of $78,900.  The  rescission  of the
stock issuable  under this  arrangement  resulted in an additional  reduction of
$78,900 in general and  administrative  expenses during the year ended December,
31, 2005.

The payment due on September 30, 2005 was not made by the Company.  The $100,000
balance due under this  arrangement  has been  surrendered as payment for Series
A-1 Preferred  stock under the creditor and claimant  liabilities  restructuring
described in Note 17.

NOTES PAYABLE (TO CREDITORS OF ACQUIRED BUSINESS)

The notes issued to creditors of Entelagent (in connection  with the acquisition
described  in Note 4) include  $554,202  that is payable to related  parties for
settlements  of accrued  payroll,  notes payable and other  payables that remain
outstanding at December 31, 2006. The original amount of these notes amounted to
$2,602,913.  Aggregate  interest  expense on these notes amounted to $90,184 and
$155,959 for the years ended December 31, 2006 and 2005, respectively.

During the year ended  December 31,  2006,  $1,795,930  of the notes  payable to
creditors  of  acquired  business  were  surrendered  as payment  for Series A-1
Preferred stock under the creditor and claimant liabilities  restructuring (Note
17). As of December 31, 2006, $799,982 of the notes payable remain outstanding.

NOTE 13 - DEFERRED REVENUE

Deferred revenue at December 31, 2006 includes (1) $59,674 for the fair value of
remaining  service  obligations  on  maintenance  and support  contracts and (2)
$104,621  for  contracts  on which the revenue  recognition  is  deferred  until
contract deliverables have been completed.

NOTE 14 - SETTLEMENT WITH PATRICK J. ALLIN, FORMER CHIEF EXECUTIVE OFFICER

On June 6, 2005, the Company entered into a settlement of certain employment and
indemnification  related claims brought by Patrick J. Allin,  ("Mr.  Allin") the
Company's  former  Chief  Executive  Officer  and former  member of its Board of
Directors,  against the Company  during the year ended  December 31,  2004.  The
Settlement  Agreement and Mutual Release dated June 2, 2005,  among the Company,
Mr.  Allin and The Allin  Dynastic  Trust,  called for the Company to pay to Mr.
Allin, in settlement of all claims, an aggregate  payment of $1,150,000  payable
in an initial installment upon execution of the Settlement  Agreement and Mutual
Release  and (ii)  $950,000  payable in cash and/or a  promissory  note upon the
consummation  of a  follow-on-financing  by the Company.  The Company accrued an
aggregate  of $933,493 in amounts  repayable to Mr. Allin up through the date of
his termination in February 2004.


                                       46



The  difference  between the  amounts  accrued  and the cash  settlement,  which
difference  amounts to  $216,507,  was  recorded in general  and  administrative
expense in the quarter  ended March 31,  2004.  The amount  payable to Mr. Allin
under this provision of the settlement,  totaling $1,130,022,  was presented net
of the $200,000  payment that was made upon the  execution of the  agreement and
includes  $48,522 of interest and $130,500 of penalties  accrued during the year
ended December 31, 2005.

Pursuant to the Settlement Agreement and Mutual Release, the Company also agreed
to purchase from Mr. Allin and The Allin  Dynastic Trust an aggregate of 133,334
shares of the Company's common stock as follows: (i) 66,667 shares (the "Initial
Shares") through the issuance of 8% promissory notes in the aggregate  principal
amount of One Million Six Hundred Thousand Dollars  ($1,600,000) and (ii) 66,667
shares (the  "Remainder  Shares")  through a cash payment from the proceeds of a
follow-on-financing  by the Company, at a price per share equal to the lesser of
(a) $15.00 per share or (b) 90% of the issue price or conversion  price,  as the
case may be, of the security issued in a  follow-on-financing,  provided however
that in the event that 90% of the issue price or conversion  price,  as the case
may be, of the security  issued in the  follow-on-financing  is less than $15.00
per share,  Mr.  Allin  and/or The Allin  Dynastic  Trust may, at their  option,
decline to sell any or all of the Remainder Shares to the Company.

As of December 31, 2005, the fair value of the Company's  common stock was $1.50
per share,  which resulted in a reduction of the charge for the intrinsic  value
of the put right associated with the Remainder Shares granted on June 6, 2005 to
$0. Such reduction is presented as a change in the intrinsic  value of put right
in the  accompanying  statement of  operations  for the year ended  December 31,
2005.

Effective  January 1, 2006,  the  Company and Mr.  Allin and the Allin  Dynastic
Trust entered into Stock  Subscription  Agreement and Mutual Release  agreements
(the  "Series  A-1  Agreements")  to settle all claims  under the  creditor  and
claimant  liabilities  restructuring  (Note 17). The settlement  resulted in the
release of all claims and the reversal of $2,600,000 of  obligations to purchase
common stock from Mr. Allin and the Allin Dynastic Trust. These liabilities were
reclassified  to  stockholders'  equity since Mr.  Allin and the Allin  Dynastic
Trust  retained  the  shares  that  were  subject  to the  Company's  repurchase
obligation.  In addition, the Company issued an aggregate of 2,500,000 Shares of
Series A-1 Preferred  stock with a fair value of $1,500,000 to Mr. Allin and the
Allin  Dynastic  Trust in  settlement of  $1,317,089  of  liabilities  that were
payable in cash.  Accordingly,  the  Company  recorded  a $182,911  loss on this
settlement  based on the  difference  between  the fair  value of the Series A-1
Preferred shares and the liabilities payable in cash.

NOTE 15 - ACCOMMODATION AGREEMENT

In November 2002, the Company entered into a financing  arrangement with a third
party financial institution (the "Lender"),  pursuant to which the Company would
borrow $950,000 under a note to be collateralized by the pledge of 31,667 shares
of registered  stock from five different  stockholders.  In connection with this
arrangement,  the Company  executed a series of  Accommodation  Agreements  with
these stockholders  wherein each stockholder  pledged their shares in return for
the right to the return of the  pledged  shares,  or  replacement  shares in the
event of  foreclosure,  and one additional  share of common stock for every four
shares pledged as compensation.  The Company received  approximately $450,000 of
proceeds  under  the note  and  provided  the  Lender  the  pledged  shares.  No
additional  proceeds were provided by the Lender.  The Company accounted for the
Lender's  failure  to fund the  facility  and  return  the  pledged  shares as a
foreclosure  on the loan  collateral  and recorded a $1,047,728  loss during the
year ended  December 31, 2002. In 2003,  the Company  issued 40,000  replacement
shares to the five  stockholders  for which the Company  recorded an  additional
loss of $2,210,272  during the year ended  December 31, 2003 for the  difference
between the loss the  Company  recorded  upon the  Lender's  foreclosure  of the
collateral and the aggregate fair value of the replacement shares.

The  Accommodation  Agreements  provided for the Company to pay a penalty in the
event of its  failure to cause the  replacement  shares to be  registered  on or
before March 31, 2003. As a result,  the Company  recorded stock based penalties
for the fair value of 15,000 shares per quarter  through  December 31, 2005. The
total stock-based  penalties  associated with the Accommodation  Agreements from
April 2003 to December 31, 2005 amounted to $3,318,975.  An aggregate of 165,000
shares were issuable through  December 31, 2005 under the stock-based  penalties
associated with the Accommodation Agreements.

Additionally,  the  accommodating  stockholders  had filed,  in October  2005, a
complaint  against the Company in the Circuit  Court of the  Fifteenth  Judicial
Circuit  in and for Palm  Beach  County,  Florida,  alleging  breach of  certain
accommodation agreements between the plaintiffs and the Company and were seeking
damages in an amount not


                                       47



less than $14,000,000,  plus interest and reasonable  attorneys' fees and costs.
In November 2005, a default was entered  against the Company in this matter.  On
March 27, 2006,  the Company  judgment  entered into an agreement to release and
resolve all outstanding claims between itself and the accommodating stockholders
as part of the creditor and claimant liabilities restructuring (Note 17).

Under the terms of the settlement agreement, the Company issued 3,000,000 shares
of its  Series  A-1  Preferred  stock to the  accommodating  stockholders,  plus
$125,090 in cash for legal fees,  in lieu of the 165,000  shares of common stock
that were issuable to the stockholders under the penalty agreement.  The Company
recorded a  $2,228,090  loss  reserve at December  31, 2005 with respect to this
settlement,  which  represents  the difference  between  $2,400,000 for the fair
value of 3,000,000  Series A-1 shares issued in the settlement  plus $125,090 in
cash less the  settlement  date fair of the common stock that was issuable under
the penalty  arrangement.  The Company  reclassified  the  $2,400,000  liability
payable in stock to  stockholders  equity  upon the  issuance  of the Series A-1
shares on March 27, 2006.

STOCK PLEDGE ARRANGEMENT

In April 2004, a stockholder  of the Company  entered into a one-year stock loan
financing  arrangement ("Stock Financing Facility") with a third party financial
institution (the "Lender I"),  pursuant to which such  stockholder  committed to
obtain financing for the Company under a credit facility  collateralized  by the
pledge of 22,834  shares of  registered  stock (the  "Pledged  Stock")  that was
pledged by a second stockholder (the "Pledging Stockholder"). In connection with
this  arrangement,  the Company  executed an  accommodation  agreement  with the
Pledging Stockholder  committing to issue 22,834 shares of restricted stock (the
"Replacement Stock") on April 2, 2005 (the "Termination Date") in the event of a
loss of the Pledged Stock, plus a premium of 6,850 shares (the "Premium Shares")
for entering  into the  agreement.  The Company  also agreed to register  10,000
shares of restricted  stock held by the Pledging  Stockholder (the "Held Stock")
within thirty days of the agreement and to use its best efforts to register with
the SEC,  both the  Replacement  Stock and Premium  Stock  within 12 months from
their date of issue.

The  Company  received  $40,012 of funds but was unable to recover  the  Pledged
Stock on the Termination Date. In addition, due to a delay in registering all of
the  shares  under  this  arrangement,  the  Company  entered  into a  secondary
agreement  with  the  Pledging  Stockholder  providing  for:  (1) the  immediate
issuance of the Replacement  Shares and Premium Shares;  (2) registration of the
Replacement  Shares,  Premium Shares and Held Stock; (3) the retroactive accrual
of a penalty  from May 2, 2004  through the date the  registration  statement is
filed  payable in such  number of shares  that is equal to 15% of the Held Stock
(prorated  for each  fraction of a year);  and (4) the accrual of an  additional
penalty from April 2, 2005 through the date the registration  statement is filed
equal to 15% of the  Replacement  Stock and  Premium  Stock  (prorated  for each
fraction of a year).

The Company  recorded a charge of $406,205 for the fair value of the Replacement
Stock and Premium Stock (29,684 shares) issued to the Pledging Stockholder under
this arrangement. Such charge, net of $40,012 of advances received, is presented
as a loss on collateralized  financing arrangement in the accompanying statement
of  operations.  The Company also recorded  charges of $8,560 and $81,928 during
the year ended  December 31, 2006 and 2005,  respectively  for the fair value of
4,452 and 4,353  shares  issuable  during the year ended  December  31, 2006 and
2005,  respectively  to the Pledging  Stockholder as penalties for the delays in
registering the stock. The charges associated with the penalties are included in
stock based penalties under loss on collateralized  financing arrangement in the
accompanying statements of operations.

NOTE 16 - COMMITMENTS AND CONTINGENCIES

LEGAL PROCEEDINGS

Effective  January 1, 2006,  the Company and Mr.  Allin,  former  Company  Chief
Executive Officer,  and the Allin Dynastic Trust entered into Stock Subscription
Agreement and Mutual Release  agreements (the "Series A-1 Agreements") to settle
all claims, including claims related to the settlement agreement entered into in
2005 which settled certain employment and indemnification related claims brought
against  the  Company  in 2004,  under the  creditor  and  claimant  liabilities
restructuring  (Note 17). The  settlement  resulted in the release of all claims
and the reversal of $2,600,000 of obligations to purchase  common stock from Mr.
Allin and the Allin Dynastic  Trust.  These  liabilities  were  reclassified  to
stockholders'  equity since Mr. Allin and the Allin  Dynastic Trust retained the
shares that were subject to the Company's  repurchase  obligation.  In addition,
the Company  issued an  aggregate of  2,500,000  Shares of Series A-1  Preferred
stock with a fair value of $1,500,000 to Mr. Allin and the Allin  Dynastic Trust
in settlement


                                       48



of $1,317,089 of liabilities that were payable in cash. Accordingly, the Company
recorded a $182,911 loss on this settlement based on the difference  between the
fair value of the Series A-1  Preferred  shares and the  liabilities  payable in
cash.

Sherleigh  Associates Inc. Profit Sharing Plan  ("Sherleigh")  filed a complaint
against the Company,  Mr. Allin,  former Chief Executive Officer of the Company,
and Robert E. Yaw, the Company's non-executive Chairman, on February 3, 2004, in
the United  States  District  Court for the  Southern  District of New York (the
"Court") alleging common law fraud. On April 24, 2006, the Company and Sherleigh
Associates Inc. Profit Sharing Plan entered into a final and binding  settlement
of all claims as part of the  creditor and  claimant  liabilities  restructuring
(Note 17).

On January 5, 2006,  Mark P. Gertz,  Trustee in  bankruptcy  for Arter & Hadden,
LLP,  filed an Adversary  Complaint  for Recovery of Assets of the Estate in the
United  States  Bankruptcy  Court  Northern  District of Ohio Eastern  Division,
against  the  Company as  successor  in merger to  Entelagent.  Mr.  Gertz seeks
$32,278 plus  interest  accruing at the  statutory  rate since July 15, 2003 for
services rendered by Arter & Hadden,  LLP to Entelagent.  On September 11, 2006,
the Company entered into a settlement and release  agreement with Mark P. Gertz,
Trustee in  bankruptcy  for Arter & Hadden,  LLP which  calls for the payment of
$32,500 in 13 installments of $2,500.

On May 4, 2006,  Patron  became  aware that Lok  Technologies,  Inc. had filed a
complaint on or about March 30, 2006 against the  Company,  Entelagent  Software
Corp.  and unnamed  defendants in the Superior  Court of  California,  County of
Santa Clara alleging  breach of contract,  breach of duty of good faith and fair
dealing and unjust enrichment and seeking damages, interest, disgorgement of any
unjust  enrichment,  attorneys fees and cost. Prior to receipt of this notice of
litigation,  the Company had recorded a note payable of  approximately  $320,000
plus  accrued  interest of $159,432.  The trial date is  currently  set for June
2007.  The Company  believes that it has defenses to these  claims.  The Company
cannot provide any assurance that the ultimate settlement of this claim will not
have a material adverse affect on its financial condition.

The Company,  from time to time, is involved in disputes arising in the ordinary
course of its business.  The Company does not believe that any such disputes are
likely to have any  material  impact on the  Company's  financial  position  and
results of operations.

The Company was previously  subject to an  investigation by the SEC. On February
1, 2007, the Securities and Exchange  Commission  issued a letter to the Company
indicating that the SEC's  investigation  of the Company has been terminated and
that no enforcement action has been recommended to the Commission.

LEASE AGREEMENT

On August 24, 2005, the Company entered into an office lease agreement for 4,876
square feet of space for its office in Boulder, Colorado. The lease commences on
October 1, 2005 and has a term of fifty-four  months including a six-month lease
abatement.  The minimum rental payments,  beginning April 2006, amount to $4,063
per month.  In  addition,  the Company was  required to make a $19,995  security
deposit at the inception of the lease.

Future  minimum  rental  payments,  excluding  the  Company  pro-rata  share  of
maintenance and operating charges under this arrangement are as follows:

         For the year ended December 31,
         -------------------------------
                      2007                      $   48,760
                      2008                          48,760
                      2009                          48,760
                      2010                          12,190
                                                ----------
                      Total                     $  158,470
                                                ==========

BRADEN WAVERLEY, CHIEF EXECUTIVE OFFICER - EMPLOYMENT AGREEMENT

On February 17, 2006,  the Company  entered into an  employment  agreement  (the
"Waverley  Agreement")  with  Braden  Waverley  ("Waverley"),  to  serve  as the
Company's  Chief  Operating  Officer.  Mr.  Waverley  became the Company's Chief
Executive  Officer on January 18, 2007 and the terms of the  Waverley  Agreement
remain in force.  The term of the Waverley  Agreement is one year with automatic
one-year  renewal  unless  Mr.  Waverley  is  provided  with  written  notice of
non-renewal  90 days prior to  expiration  of the current  term of the  Waverley
Agreement. The Waverley Agreement provides for a


                                       49



base  salary of  $200,000  per  year.  The  Waverley  Agreement  provides  for a
performance bonus determined in accordance with revenue  milestones  established
by the Board of  Directors  on a quarterly  basis.  Mr.  Waverley is eligible to
receive a bonus of up to 75% of base  salary for each  quarter  that the Company
achieves the agreed upon revenue  milestones.  The bonus milestones were not met
during the year ended December 31, 2006.  Additionally,  the Waverley  Agreement
provides for the grant of stock options in an amount  representing  an aggregate
3.5% of the  outstanding  shares of  Company  common  stock on the date of grant
("Waverley  Initial Grant").  The Waverley Initial Grant is for 73,371 shares at
an exercise price of $1.65 per share.  These options have a term of 10 years and
vest 20% on the date of grant and 1/48th of the  balance on the last day of each
month for the next 48 months  following  the  effective  date of this  agreement
(Note 19).

BRETT NEWBOLD, PRESIDENT AND CHIEF TECHNOLOGY OFFICER - EMPLOYMENT AGREEMENT

On February 28, 2005,  the Company  entered into an  employment  agreement  with
Brett Newbold ("Mr.  Newbold") in connection with Mr. Newbold's employment for a
one-year term, subject to automatic renewal, commencing on February 28, 2005, as
President  and Chief  Technology  Officer.  Mr.  Newbold  will receive a minimum
annual base salary of $190,000 during each fiscal year of the agreement, subject
to adjustment on an annual basis by the Board.  In the event that his employment
is  terminated,  Mr. Newbold shall continue to receive his base salary and shall
be entitled to continued  participation  in our  executive  benefit  plans for a
period of six (6) months. Mr. Newbold is eligible to receive (i) an annual bonus
of 50% of his annual base salary if certain financial  performance  measures are
attained and (ii) such  discretionary  bonuses as may be authorized by the Board
from time to time for executive  employees.  The bonus  milestones  were not met
during the year ended  December  31,  2006.  Mr.  Newbold  also is  eligible  to
participate in stock option and other employee benefit plans of the Company that
may be in effect from time to time.

Mr.  Newbold's  employment  agreement  will  terminate on the  expiration of the
agreement's term, his death, or delivery of written notice of termination by the
Company to Mr. Newbold if he were to suffer a permanent disability rendering him
unable to perform his duties and obligations  under the agreement for 90 days in
any 12-month  period.  The Company can  terminate  Mr.  Newbold's  employment by
delivery of written notice of such  termination  "for cause" or "without  cause"
(as such terms are  defined in his  employment  agreement  to Mr.  Newbold.  Mr.
Newbold  can  terminate  his   employment  by  delivery  of  written  notice  of
termination  "for good reason" (as defined in his  employment  agreement) to the
Company.  Mr. Newbold agrees not to compete with the Company or solicit  certain
of its employees or clients for a period of two years after the  termination  of
his employment.

MARTIN T. JOHNSON, CHIEF FINANCIAL OFFICER - EMPLOYMENT AGREEMENT

On February 17, 2006,  the Company  entered into an  employment  agreement  (the
"Johnson  Agreement")  with Martin T. Johnson  ("Johnson"),  the Company's Chief
Financial Officer.  The term of the Johnson Agreement is one year with automatic
one-year  renewal  unless  Mr.  Johnson  is  provided  with  written  notice  of
non-renewal  90 days prior to  expiration  of the  current  term of the  Johnson
Agreement.  The Johnson  Agreement  provides  for a base salary of $180,000  per
year.  The Johnson  Agreement  provides for a  performance  bonus  determined in
accordance  with revenue  milestones  established by the board of directors on a
quarterly basis. Mr. Johnson is eligible to receive a bonus of up to 50% of base
salary for each  quarter  that the  Company  achieves  the agreed  upon  revenue
milestones. The bonus milestones were not met during the year ended December 31,
2006.  Additionally,  the  Johnson  Agreement  provides  for the  grant of stock
options in an amount  representing an aggregate 1.25% of the outstanding  shares
of the Company's  common stock on the date of grant ("Johnson  Initial  Grant").
The Johnson Initial Grant is for 26,204 shares at an exercise price of $1.65 per
share.  These  options have a term of 10 years and vest 20% on the date of grant
and  1/48th of the  balance on the last day of each month for the next 48 months
following the effective date of this agreement (Note 19).

ROBERT CROSS - BONUS ARRANGEMENT

On March 7, 2006,  the board of  directors,  in  executive  session  without Mr.
Robert Cross ("Mr.  Cross"),  the Company's then Chief Executive Officer,  being
present,  approved a bonus arrangement ("Bonus  Arrangement") for Mr. Cross. The
Bonus  Arrangement  provided for (i) a cash bonus equal to $200,000,  grossed up
for taxes (the "Cash  Bonus"),  (ii) the Cash Bonus would be payable  only after
agreement has been reached with creditors  holding the applicable  percentage of
the Company's creditor  obligations agree to convert their obligations under the
creditor and claimant  liabilities  restructuring (Note 17) and when the funding
escrow established by Laidlaw under the Series A Preferred Financing transaction
has been  released  (the  "Eligibility  Date"),  and (iii) 50% of the Cash Bonus
would be paid on the  Eligibility  Date,  and the other 50% would be paid in ten
equal monthly  installments  beginning one month following the Eligibility Date.
Mr. Cross would be granted a stock option in


                                       50



an amount  representing an aggregate 2.5% of the  outstanding  shares of Company
common stock  following the completion of the Company's  recapitalization  under
the creditor  and claimant  liabilities  restructuring.  The service  conditions
associated  with Mr.  Cross'  employment  as a result of this  arrangement  were
modified to ensure that his employment with the Company would be extended beyond
June  30,  2006  for an  additional  period  of time  sufficient  for him to (i)
complete  the  creditor  and  claimant  liabilities  restructuring,  (ii)  raise
additional  working  capital and (iii)  transition  his  position to a new Chief
Executive  Officer.  The  Company  accrued  the  unpaid  balance of the bonus at
December 31, 2006,  Mr.  Cross' last date of payroll as CEO of the Company.  The
total amount of Mr. Cross' bonus is $278,558 of which $107,293  remained  unpaid
at December  31, 2006 and is  included in accrued  expenses in the  accompanying
balance sheet.

NOTE 17 - CREDITOR AND CLAIMANT LIABILITIES RESTRUCTURING

On January 12, 2006, the Company issued a Stock Subscription  Agreement & Mutual
Release ("the Original Release") to each creditor and claimant ("Subscriber") of
the Company for purposes of entering  into a final and binding  settlement  with
respect to any and all claims,  liabilities,  demands,  causes of action, costs,
expenses,  attorneys fees, damages,  indemnities,  and obligations of every kind
and  nature  that  the  creditor  and/or  claimant  may have  with  the  Company
("Subscriber  Claims").  Under terms of this agreement,  the Company sold to the
Subscriber and the Subscriber purchased from the Company shares ("Stock") of its
Series A-1 Preferred stock at a price of $0.80 per share. The aggregate purchase
price was equivalent to the value of the Subscriber Claims being settled through
this  settlement  and release.  Subscriber was deemed to have paid for the Stock
through the settlement and release of Subscriber Claims. Each share of Stock was
automatically  convertible into 1/3 share of the Company's common stock upon the
effectiveness  of an amendment to the  Company's  certificate  of  incorporation
which provided for a sufficient number of authorized but unissued and unreserved
shares of the Company's  common stock to permit the conversion of all issued and
outstanding  shares of Series A-1  Preferred.  The Company issued the Series A-1
Preferred shares following the final  determination of the claims and acceptance
by the Company of each  claimant  submitted  Stock  Subscription  Agreement  and
Mutual Release through countersignature thereof.

The Original  Release also  provided that in the event that (a) a bona fide sale
or (series of related  sales) by the Company of equity  interests in the Company
in  an  amount  equal  to  or  in  excess  of  $3,000,000  or  (b)  any  merger,
consolidation,     recapitalization,      reclassification,     reincorporation,
reorganization,  share exchange,  sale of all or substantially all of the assets
of the Company or comparable transaction, was not consummated on or before March
31, 2006 (the "Termination  Date"),  the Stock  Subscription  Agreement & Mutual
Release would terminate and be null and void, the Series A-1 Preferred issued to
Subscriber  would be cancelled  and the  Subscriber  Claims would remain in full
force and effect on their terms.  Each Subscriber agreed not to transfer or sell
any portion of the Stock until the next business day after the Termination Date,
subject  to (i) an  effective  registration  under  the  Securities  Act or in a
transaction  which is otherwise in compliance  with the Securities  Act, (ii) an
effective  registration  under any applicable state  securities  statute or in a
transaction otherwise in compliance with any applicable state securities statue,
and (iii) evidence of compliance  with the applicable  securities  laws of other
jurisdictions.  As  described  below,  the  Company  completed  the sale of $4.8
million in equity securities under the Series A Preferred Financing on March 27,
2006  thereby  eliminating  the  provision  for  automatic  termination  of this
arrangement.

The Company has filed with the  Securities  and Exchange  Commission on July 24,
2006 a registration statement ("Registration  Statement") covering the resale of
the  underlying  Stock and has  agreed  to use its best  efforts  to cause  such
Registration Statement to become effective as soon as practicable thereafter and
in any event no later than 180 days from the date that the Company  countersigns
each Stock Subscription Agreement and Mutual Release. The Company shall keep the
Registration Statement continuously effective under the Securities Act until the
earlier of (i) the date when all shares of the Stock have been sold  pursuant to
the Registration Statement or an exemption from the registration requirements of
the  Securities  Act,  and  (ii)  two  years  from  the  effective  date  of the
Registration Statement.

Through  July  21,  2006,  the  Company  issued  additional  Stock  Subscription
Agreements & Mutual  Releases ("the  Additional  Release") to several  creditors
that had not signed the January 12, 2006 Original Release by April 30, 2006. The
terms of the  Additional  Release  were  predominantly  the same as the Original
Release  with  the  exception  of  the  120  day   requirement  for  filing  the
Registration Statement.


                                       51



On July 21,  2006,  the Board of  Directors  authorized  the  completion  of the
Creditor and Claimant  Liabilities  Restructuring  program.  Under this program,
claims  totaling  $24,467,871  were settled for 36,993,054  shares of Series A-1
Preferred  Stock.  The Company recorded net gains with respect to all claims and
liabilities  settled under this program in the aggregate  amount of  $1,853,055.
The Series A-1 Preferred  shares were  automatically  converted into  12,331,056
shares of the  Company's  common stock on July 31, 2006  following the Company's
effectuation of a 1-for-30 reverse stock split.

The following  table  provides a summary of all claims  settled by category with
the (gain) loss recognized on the settlement:



                                              Series A-1     Fair Value
           Settlement Category               Stock Issued     of Stock      Claim Amount     (Gain)/Loss
------------------------------------------   ------------   ------------    ------------    ------------
                                                                                
General Creditors ........................     22,246,601   $ 13,283,857    $(18,072,357)   $ (4,788,500)
Former Officer/Stockholder ...............      1,549,526        929,716      (1,180,991)       (251,275)
Former Non-Executive Chairman ............        315,438        252,350        (254,152)         (1,802)
Stockholders under Accommodation Agreement      3,000,000      2,400,000      (2,400,000)           --
Mr. Allin and the Allin Dynastic Trust ...      2,500,000      1,500,000      (1,317,089)        182,911
Other Claimants ..........................      7,381,489      4,248,893      (1,243,282)      3,005,611
                                             ------------   ------------    ------------    ------------
                                               36,993,054   $ 22,614,816    $(24,467,871)   $ (1,853,055)
                                             ============   ============    ============    ============


The fair value of the Series A-1 shares issued in  settlements  reached prior to
June 30, 2006 amounted to $.60 per share,  based on a comparison of the features
of these  shares to similar  shares sold in private  placement  transactions  to
unrelated  parties for cash and the trading price of the Company's shares at the
time of the settlements. Series A-1 shares issued in settlements reached in July
2006, which principally  includes the Company's former  non-executive  chairman,
were  valued at $0.80 per share  commensurate  with an  increase  in the trading
price of the Company's  common stock.  These  agreements  effectuated a complete
settlement of these debts,  claims and liabilities and the mutual release of the
parties with respect thereto.

The Company accounted for the  extinguishment of liabilities  payable to general
creditors in accordance  with SFAS 15  "Accounting  by Debtors and Creditors for
Troubled Debt  Restructurings,"  due to the fact that the holders of these notes
granted to Company  concessions  intended to alleviate its  immediate  liquidity
constraints. These concessions that the creditors granted to the Company enabled
it to (a) effectuate their settlement through an exchange of equity instead of a
use of cash and (b) consummate a private  placement of equity  securities  (Note
18) that resulted in an infusion of cash that was needed to sustain operations.

Claimants other than Mr. Allin and the Allin Dynastic Trust that participated in
the  settlement   include  certain  parties  that  were  previously  engaged  in
litigation with the Company  including the Sherleigh  Associates  Profit Sharing
Plan to which the  Company  issued  2,312,500  shares for a  settlement  loss of
$1,387,500,  Richard Linting to whom the Company issued  1,777,261  shares for a
settlement  loss of  approximately  $773,000  and the holders of the Marie Graul
claim to whom the  Company  issued  1,164,461  shares for a  settlement  loss of
approximately $698,000.

OTHER LIABILITIES SETTLEMENTS

The Company also settled $660,494 of other liabilities for $28,140 in cash and a
$32,500  note during the year ended  December 31, 2006 for which it recorded net
gains in the amount of $599,854.

NOTE 18 - STOCKHOLDERS' EQUITY

AMENDMENT TO CERTIFICATE OF INCORPORATION AND AUTHORIZED SHARE CAPITAL

On March 1, 2006,  the  Company  filed with the  Delaware  Secretary  of State a
Certificate of Designation of  Preferences,  Rights and  Limitations of Series A
Convertible Preferred Stock and Series A-1 Convertible Preferred


                                       52



Stock  designating  the rights,  preferences  and  privileges of 2,160 shares of
Series A  Convertible  Preferred  Stock and  50,000,000  shares  of  Series  A-1
Convertible Preferred Stock.

On October 12, 2006,  the Company  filed with the Delaware  Secretary of State a
Certificate of Designation of  Preferences,  Rights and  Limitations of Series B
Convertible  Preferred Stock designating the rights,  preferences and privileges
of 2,000 shares of Series B Convertible  Preferred  Stock.  The  Certificate  of
Designation  of  Preferences,  Rights and  Limitations  of Series B  Convertible
Preferred Stock was amended on January 24, 2007.

A description of each class of the Company's  authorized capital stock following
the most recent amendment to its Certificate of Incorporation is as follows:

SERIES A PREFERRED STOCK

The Series A Preferred  Stock has a stated value of $5,000 per share and carries
a dividend of 10% per annum with such dividend  accruing on a cumulative  basis.
The dividend is payable  only (i) at such time as declared  payable by the Board
of Directors of the Company or (ii) in the event of liquidation,  as part of the
liquidation  preference amount  ("Liquidation  Preference  Amount").  Cumulative
dividends on the Series A Preferred,  which have not been  declared by the board
of directors, amount to $368,471 at December 31, 2006.

The Series A Preferred is convertible,  at the option of the holder, into shares
of the Company's  common stock  ("Conversion  Shares") at an initial  conversion
price ("Initial  Conversion Price") of $2.40 per share based on the stated value
of the Series A Preferred,  subject to adjustment  for stock splits,  dividends,
recapitalizations,  reclassifications, payments made to Common Stock holders and
other similar  events and for issuances of additional  securities at prices more
favorable than the conversion price at the date of such issuance.

The Series A Preferred is mandatorily  convertible  into shares of the Company's
common stock at the Initial  Conversion Price, which is subject to adjustment as
described above, on the date that: (i) there shall be an effective  registration
statement covering the resale of the Conversion Shares, (ii) the average closing
price of the Company's common stock, for a period of 20 consecutive trading days
is at least 250% of the then applicable  Conversion Price, and (iii) the average
daily  trading  volume of the  Company's  common stock for the same period is at
least 8,334 shares.

The Series A Preferred Liquidation Preference Amount is equal to 125% of the sum
of: (i) the stated  value of any then  unconverted  shares of Series A Preferred
and (ii) any accrued and unpaid dividends thereon. An event of liquidation means
any liquidation,  dissolution or winding up of the Company, whether voluntary or
involuntary,  as well as any change of control of the Company which includes the
sale by the  Company  of  either  (x)  substantially  all its  assets or (y) the
portion of its assets which comprises its core business technology,  products or
services.

SERIES A-1 PREFERRED STOCK

The Series A-1 Preferred Stock has a stated value of $0.80 per share and carries
a non-cumulative  dividend of 5% per annum,  with such dividend payable only (i)
at such time as  declared  payable by the Board of  Directors  of the Company or
(ii) in the event of liquidation,  as part of the liquidation  preference amount
("Series  A-1  Liquidation  Preference  Amount").  The  Series  A-1  Liquidation
Preference  Amount  is equal  to the sum of:  (i) the  stated  value of any then
unconverted  shares of Series  A-1  Preferred  and (ii) any  accrued  and unpaid
dividends thereon. An event of liquidation means any liquidation, dissolution or
winding up of the  Company,  whether  voluntary or  involuntary,  as well as any
change of control  of the  Company  which  includes  the sale by the  Company of
either (x)  substantially  all its assets or (y) the portion of its assets which
comprises its core business technology, products or services.

The Series A-1 Preferred is not  convertible  at the option of the holder.  Each
share of Series A-1 Preferred  automatically converted into the Company's common
stock, at a conversion price of $2.40 per share based on the stated value of the
Series A-1 Preferred,  upon the  effectiveness of the amendment to the Company's
certificate  of  incorporation   which  provided  for  a  sufficient  number  of
authorized  shares to permit  the  exercise  or  conversion  of all  issued  and
outstanding shares of Series A Preferred,  Series A-1 Preferred and all options,
warrants and other rights to acquire shares of the Company's common stock.

Through  December 31, 2006, the Company has issued  36,993,054  shares of Series
A-1 Preferred Stock which converted on July 31, 2006 upon the  effectiveness  of
the amendment to the Company's Second Amended and


                                       53



Restated  Certificate of Incorporation to affect a 1-for-30 reverse stock split,
into 12,331,056 shares of the Company's newly split common stock.

SERIES B PREFERRED STOCK

We have designated  2,000 shares of preferred stock as Series B Preferred Stock.
The Series B  Preferred  Stock has a stated  value of $5,000  per share,  has no
maturity date,  carries a dividend of 10% per annum, with such dividend accruing
on a cumulative  basis and is payable only (i) at such time as declared  payable
by the board of  directors or (ii) in the event of  liquidation,  as part of the
liquidation preference amount ("Liquidation Preference Amount"). The Liquidation
Preference  Amount is equal to 125% of the sum of: (i) the  stated  value of any
then  unconverted  shares of Series B  Preferred  Stock and (ii) any accrued and
unpaid  dividends  thereon.  An  event of  liquidation  means  any  liquidation,
dissolution or winding up of the Company,  whether voluntary or involuntary,  as
well as any change of  control of the  Company  which  includes  the sale by the
Company of either  (x)  substantially  all its assets or (y) the  portion of its
assets which comprises its core business technology,  products or services.  The
Series B Preferred  Stock is junior to the Series A Preferred Stock with respect
to  liquidation  and  dividend  rights.  Cumulative  dividends  on the  Series B
Preferred,  which have not been  declared by the board of  directors,  amount to
$77,448 at December 31, 2006.

The Series B Preferred Stock is convertible,  at the option of the holder,  into
shares of Common  Stock  ("Conversion  Shares") at an initial  conversion  price
("Initial  Conversion  Price) of $0.82 based on the stated value of the Series B
Preferred   Stock,   subject  to  adjustment   for  stock   splits,   dividends,
recapitalizations,  reclassifications, payments made to Common Stock holders and
other similar  events and for issuances of additional  securities at prices more
favorable  than  the  conversion  price  at the  date of such  issuance.  We are
obligated to register the Conversion  Shares within 90 days of completion of the
issuance of the Series B Preferred Stock.

The Series B Preferred  Stock is mandatorily  convertible at the then applicable
conversion  price  ("Conversion  Price") into shares of Common Stock at the then
applicable  Conversion  Price on the date that:  (i) there shall be an effective
registration  statement covering the resale of the Conversion  Shares,  (ii) the
average  closing price of Common Stock,  for a period of 20 consecutive  trading
days is at least 250% of the then  applicable  Conversion  Price,  and (iii) the
average  daily  trading  volume of Common  Stock for the same period is at least
8,334 shares.

The Series B Preferred Liquidation Preference Amount is equal to 125% of the sum
of: (i) the stated  value of any then  unconverted  shares of Series A Preferred
and (ii) any accrued and unpaid dividends thereon. An event of liquidation means
any liquidation,  dissolution or winding up of the Company, whether voluntary or
involuntary,  as well as any change of control of the Company which includes the
sale by the  Company  of  either  (x)  substantially  all its  assets or (y) the
portion of its assets which comprises its core business technology,  products or
services.

PRIVATE PLACEMENTS OF CONVERTIBLE PREFERRED STOCKS

PRIVATE PLACEMENT OF SERIES A CONVERTIBLE PREFERRED STOCK AND WARRANTS

In  January  2006,  the  Company  initiated  a  proposed  $5,400,000   financing
transaction (the "Series A Preferred  Financing") which would, for each $100,000
Unit  purchased,  result in the  issuance of (i) 20 shares of Series A Preferred
Stock and (ii) warrants ("Investor Warrants") to purchase 13,888.9 shares of the
Company's common stock.  The minimum amount of the Series A Preferred  Financing
was $3,000,000  ("Minimum  Amount") and the maximum amount was $5,400,000.  Apex
agreed to purchase up to  $1,500,000  which would all be  available  to fund the
Minimum  Amount,  provided  however,  in the event that the  Series A  Preferred
Financing was  over-subscribed as to the Minimum Amount,  then for each $1.00 of
such over  subscription  up to $250,000,  the Apex funding  commitment  would be
reduced on a dollar for dollar basis,  down to a minimum  amount of  $1,250,000.
Additionally,  holders of the 2006 Bridge  Notes were  mandatorily  obligated to
exchange  their 2006 Bridge Notes for Units in the Series A Preferred  Financing
upon consummation of the Series A Preferred Financing at the face value of their
2006 Bridge  Notes.  The  issuance of Units to the holders of 2006 Bridge  Notes
counted toward satisfying the Minimum Amount.

The Investor  Warrants have a term of 5 years and an exercise price of $1.85 per
share.  Each Investor Warrant  entitles the holder thereof to purchase  13,888.9
shares  of the  Company's  common  stock  (the  "Warrant  Shares"),  subject  to
anti-dilution provisions similar to those of the conversion rights of the Series
A Preferred.  The Company was obligated to include the Conversion Shares and the
Warrant Shares in the Registration  Statement originally filed on July 24, 2006.
The Conversion Shares and the Warrant Shares have piggyback registration rights.


                                       54



In  connection  with the Series A  Preferred  Financing,  the  Company  retained
Laidlaw as its  non-exclusive  placement  agent  ("Series A Preferred  Placement
Agent").  Laidlaw received,  in its role as Series A Preferred  Placement Agent,
(i) a cash fee equal to 10% of all gross proceeds,  excluding the Apex proceeds,
delivered at each Closing and (ii) a warrant (the "Agent  Warrants") to purchase
the  Company's  common  stock  equal to 10% times the sum of (x) the  Conversion
Shares to be issued upon  conversion of the shares of Series A Preferred  issued
at each  Closing  and (y) the  number of shares of the  Company's  common  stock
reserved for issuance upon the exercise of the Investor  Warrants issued at each
closing.  The Agent  Warrants  have a term of 5 years and an  exercise  price of
$1.85 per share. Additionally, the Company paid the Series A Preferred Placement
Agent a non-accountable  expense allowance of $25,000. The Agent Warrants have a
fair value of  $274,393.  Assumptions  relating to the  estimated  fair value of
these  warrants are as follows:  fair value of common stock of $0.80;  risk-free
interest rate of 4.52%;  expected dividend yield zero percent;  expected warrant
life of five years; and current volatility of 125%.

On March 3, 2006, the investors in the Series A Preferred  Financing agreed to a
modification of the terms of this financing arrangement to waive the requirement
for 100% completion of the creditor and claimant  liabilities  restructuring for
release of the net  proceeds  of the Series A  Preferred  Financing  in order to
allow the Company to proceed with its business plan and to protect the investors
in the Series A Preferred  Financing.  The  modifications  provided  for the net
proceeds  of the Series A Preferred  Financing  to be  deposited  with an escrow
agent whereby funds would be released to the Company to cover payroll,  rent and
other operating costs,  including eligible payables not otherwise subject to the
creditor and claimant liabilities restructuring, on a bi-monthly basis.

On March 27, 2006, the Company consummated the Series A Preferred Financing with
the  closing of funds  totaling  $4,465,501,  resulting  in the  issuance of 893
shares of Series A Preferred Stock and 620,233 common stock purchase warrants to
the  purchasers  of the Series A Preferred  Stock.  This amount was comprised of
$720,001  associated with the conversion of the Bridge Notes,  $895,000 provided
by Apex and  $2,850,500  from parties  made  available by the Series A Preferred
Placement Agent.  The Company also issued Agent Warrants to Laidlaw  exercisable
for 198,375 shares of common stock.  The Investor  Warrants have a fair value of
$857,908. Assumptions relating to the estimated fair value of these warrants are
as follows:  fair value of common  stock of $1.71;  risk-free  interest  rate of
4.52%;  expected  dividend  yield zero  percent;  expected  warrant life of five
years; and current volatility of 125%.

On April 3, 2006, the Company  consummated an additional closing of the Series A
Preferred  Financing with the closing of funds totaling  $355,000,  resulting in
the  issuance of 71 shares of Series A Preferred  Stock and 49,306  common stock
purchase warrants.  The Investor Warrants issued in this additional closing have
a fair value of $95,102.  Assumptions  relating to the  estimated  fair value of
these  warrants  are as  follows:  risk-free  interest  rate of 4.52%;  expected
dividend yield zero percent;  expected  warrant life of five years;  and current
volatility of 125%.

The completion of the Series A Preferred  Financing was conditioned  upon, among
other things, the Company's  completion of the creditor and claimant liabilities
restructuring in an amount and on terms  satisfactory to the Placement Agent. In
order to make  these  funds  available  to the  Company in  connection  with the
completion of the creditor and claimant liabilities restructuring,  the Company,
on March 27, 2006, entered into a post-closing  restricted cash escrow agreement
("Post-Closing  Escrow Agreement") with an escrow agent ("Escrow Agent").  As of
March 27,  2006,  the  Escrow  Agent was  provided  $2,183,026  in net  offering
proceeds. The escrow agent held the funds and made periodic disbursements to the
Company on or after the 15th of each calendar month and on or after the last day
of each calendar month. The Company was required to provide a detailed  schedule
of  the  mid-month,  month-end  and  maximum  monthly  disbursement  amounts  to
substantiate its requests for a release of any funds. All funds were released to
the Company from the escrow account as of June 15, 2006.

Pursuant to the Certificate of Designation for the Series A Preferred  Stock, in
the event  that  additional  shares of common  stock are  issued or deemed to be
issued at an  effective  price  that is lower than the  conversion  price of the
Series A Preferred  Stock, the conversion price for the Series A Preferred Stock
shall be reduced to the effective price of such issuance.  On November 16, 2006,
the Series B Preferred  Financing was  completed at a conversion  price of $0.82
per share as compared to the $2.40 per share  conversion  price for the Series A
Preferred Stock. Pursuant to the terms of the Certificate of Designation for the
Series A Preferred  Stock the conversion  price of the Series A Preferred  Stock
has been  adjusted  to $0.90 per share.  This change  resulted in an  additional
3,347,571 shares of Common Stock being reserved for issuance upon the conversion
of the  Series A  Preferred  Stock.  The  Company  recorded  $589,175  of deemed
dividends  because  the  effective  adjusted  conversion  price of the  Series A
Preferred shares exceeded the fair value of the Company common stock at the time
of the completion of the Series B Financing.


                                       55



As of December 31, 2006, the 964 shares of Series A Preferred Stock  outstanding
are convertible, as described above, into 5,356,138 shares of Common Stock.

PRIVATE PLACEMENT OF SERIES B CONVERTIBLE PREFERRED STOCK AND WARRANTS

On August 29,  2006,  the  Company  initiated  a proposed  $5,000,000  financing
transaction (the "Series B Preferred  Financing") which would, for each $100,000
Unit  purchased,  result in the  issuance of (i) 20 shares of Series B Preferred
Stock and (ii)  warrants  ("Series B Investor  Warrants")  to  purchase  Company
common stock in an amount  equal to 50% of the  Conversion  Shares.  The minimum
amount of the Series B  Preferred  Financing  is  $3,000,000  ("Series B Minimum
Amount")  and the maximum  amount is  $5,000,000.  Apex agreed to purchase up to
$1,000,000 all of which would be available to fund the Series B Minimum  Amount,
provided  however,  in the  event  that the  Series B  Preferred  Financing  was
over-subscribed  as to the Series B Minimum Amount,  then for each $1.00 of such
over  subscription  up to  $2,000,000,  the  Apex  funding  commitment  would be
increased by $0.333 to a maximum amount of $1,666,667.

The Series B Investor  Warrants have a term of 5 years and an exercise  price of
$1.03 per share.  Each Series B Investor  Warrant entitles the holder thereof to
purchase  up to 50% of the  Conversion  Shares in  Company's  common  stock (the
"Series B Warrant Shares"), subject to anti-dilution provisions similar to those
of the conversion  rights of the Series B Preferred.  The Conversion  Shares and
the Series B Warrant Shares have piggyback registration rights.

In  connection  with the Series B  Preferred  Financing,  the  Company  retained
Laidlaw as its  non-exclusive  placement  agent  ("Series B Preferred  Placement
Agent").  Laidlaw received,  in its role as Series B Preferred  Placement Agent,
(i) a cash fee equal to 13% of all gross proceeds,  excluding the Apex proceeds,
delivered at each Closing and (ii) a warrant (the "Series B Agent  Warrants") to
purchase  the  Company's  common  stock  equal to 10%  times  the sum of (x) the
Conversion  Shares  to be  issued  upon  conversion  of the  shares  of Series B
Preferred  issued at each Closing and (y) the number of shares of the  Company's
common stock  reserved  for issuance  upon the exercise of the Series B Investor
Warrants  issued at each closing.  The Series B Agent  Warrants have a term of 5
years and an exercise price of $1.03 per share.  Additionally,  the Company paid
$32,750 of  Laidlaw's  legal  expenses  associated  with the Series B  Preferred
Financing.

On October 13, 2006, the Company  consummated  the first closing of the Series B
Preferred  Financing through the sale of Units, at a per Unit price of $100,000,
consisting  of (i) 20  shares  of Series B  Preferred  Stock  and (ii)  Series B
Investor  Warrants to purchase  shares of Common Stock in an amount equal to 50%
of the shares issuable upon  conversion of the Series B Preferred  Stock, in the
aggregate amount of $3,082,716. This amount was comprised of $1,027,572 provided
by Apex and $2,055,144 provided by parties made available by Laidlaw, the Series
B  Preferred  Placement  Agent.  The first  closing  of the  Series B  Preferred
Financing  resulted in the issuance of 616.54 shares of Series B Preferred Stock
with a  conversion  price of $1.80 and Series B Investor  Warrants  to  purchase
855,801  shares of Common  Stock at an  exercise  price of $2.40 per share.  The
Company  paid  Laidlaw a fee of  $280,484  and issued to Laidlaw  Series B Agent
Warrants  to purchase  256,737  shares of Common  Stock for its  services as the
Series B Preferred Placement Agent.

The  Investor  Warrants  issued in the  first  closing  of the  Series B have an
aggregate  fair value of $1,441,620.  The Series B Agent Warrants  issued in the
first  closing  of the  Series  B have an  aggregate  fair  value  of  $432,787.
Assumptions  relating  to the  estimated  fair  value of these  warrants  are as
follows:  fair value of common stock $2.00;  risk-free  interest  rate of 4.77%;
expected  dividend yield zero percent;  expected warrant life of five years; and
current volatility of 125%.

The Company  determined,  based upon an  allocation  of the proceeds to the fair
values of the Series B Preferred Stock and Series B Investor  Warrants issued to
the investors in this closing,  that the effective  conversion price embedded in
the Series A Convertible Preferred Shares amounts $1.23 per share.  Accordingly,
the Company  recorded a deemed  dividend in the amount of $1,322,623  based upon
the effective conversion price embedded in the preferred shares times the number
of shares issuable upon conversion.

On November 16, 2006, the Company consummated the second closing of the Series B
Preferred  Financing  through  the  sale of  Units in the  aggregate  amount  of
$870,000.  This amount was  comprised of $290,000  provided by Apex and $580,000
provided by parties made available by Laidlaw,  the Series B Preferred Placement
Agent.  The second closing of the Series B Preferred  Financing  resulted in the
issuance of 174 shares of Series B Preferred  Stock with a  conversion  price of
$0.82 and Series B Investor  Warrants to purchase 530,497 shares of Common Stock
at an  exercise  price of $1.03 per share.  The  Company  paid  Laidlaw a fee of
$72,085 and issued to Laidlaw Series B Agent Warrants to purchase 159,149 shares
of Common Stock at an exercise price of $1.03 per share for its services


                                       56



as the Series B Preferred  Placement Agent. The Investor Warrants issued in this
second  closing of the Series B have an aggregate  fair value of  $454,414.  The
Series B Agent  Warrants  issued in this second  closing of the Series B have an
aggregate  fair value of $137,524.  Assumptions  relating to the estimated  fair
value of these  warrants  are as  follows:  fair  value of common  stock  $1.01;
risk-free interest rate of 4.96%; expected dividend yield zero percent; expected
warrant life of five years; and current volatility of 125%.

The Company  determined,  based upon an  allocation  of the proceeds to the fair
values of the Series B Preferred Stock and Series B Investor  Warrants issued to
the investors in this closing,  that the effective  conversion price embedded in
the Series B Convertible Preferred Shares amounts $0.54 per share.  Accordingly,
the Company  recorded a deemed dividend in the amount of $501,808 based upon the
effective  conversion price embedded in the preferred shares times the number of
shares issuable upon conversion.

On November 16, 2006,  in  conjunction  with the second  closing of the Series B
Preferred  Financing at a per share  conversion price of $0.82 and an associated
Series B Investor  Warrant  exercise  price of $1.03 per share,  the  conversion
price of the Series B Preferred  Stock issued in the first  closing was adjusted
to the $0.82 per share value  associated with the second closing and the warrant
exercise price of the Series B Investor  Warrants issued in conjunction with the
first closing was adjusted to $1.03 per share. An additional  1,023,924 Series B
Investor  Warrants were issued in conjunction with this change.  Because of this
change,  the Company also issued to Laidlaw  Series B Agent Warrants to purchase
an additional  307,179  shares of Common Stock at an exercise price of $1.03 for
its services as the Series B Preferred  Placement  Agent.  The Series B Investor
Warrants  issued in the first closing along with the additional  warrants issued
to the  investors in the first  Series B Preferred  closing upon the revision of
the conversion price of the Series B Preferred  offering and the revision of the
warrant  exercise  price  have a fair  value of  $1,209,596.  The Series B Agent
Warrants  issued in the first closing along with the additional  warrants issued
because of the second closing  revision of the conversion  price of the Series B
Preferred  offering and the revision of the warrant  exercise  price have a fair
value of $387,177.  Assumptions  relating to the  estimated  fair value of these
warrants are as follows:  fair value of common stock $1.01;  risk-free  interest
rate of 4.96%;  expected  dividend yield zero percent;  expected warrant life of
five years; and current volatility of 125%.

The Company  determined,  based upon an  allocation  of the proceeds to the fair
values of the Series B Preferred Stock and Series B Investor  Warrants issued to
the investors in this closing,  that the effective  conversion price embedded in
the Series A Convertible Preferred Shares amounts $0.90 per share.  Accordingly,
the Company  recorded a deemed dividend in the amount of $589,175 based upon the
effective  conversion price embedded in the preferred shares times the number of
shares issuable upon conversion.

The Company is obligated to register  the shares of Common Stock  issuable  upon
exercise of the Series B Investor  Warrants and the Series B Agent  Warrants and
conversion of the Series B Preferred  Stock within 90 days after the  completion
of the Series B Preferred Financing.

As of  November  16,  2006,  the  790.54  shares  of  Series B  Preferred  Stock
outstanding are convertible into 4,820,417 shares of Common Stock.

ADDITIONAL SHARES ISSUED UNDER ANTI-DILUTION PROVISION

Effective April 1, 2006, the Company issued 251,175 shares of common stock under
the provisions of an anti-dilution  agreement associated with private placements
of common stock that occurred in March, August and September 2004.

ISSUANCE OF COMMON STOCK PURCHASE WARRANTS

On January 28, 2006 the Company issued warrants for 20,000 shares at an adjusted
exercise price of $1.74 per share to Apex in connection  with the Interim Bridge
Financing III financing  (Note 11). The aggregate  fair value of these  warrants
amounted to $20,316.

On February 13, 2006 the Company issued warrants for 6,000 shares at an adjusted
exercise price of $1.74 per share to Apex in connection  with the Interim Bridge
Financing III financing  (Note 11). The aggregate  fair value of these  warrants
amounted to $6,634.

On February 21, 2006 the Company issued warrants for 1,250 shares at an adjusted
exercise price of $1.74 per share to Apex in connection  with the Interim Bridge
Financing III financing  (Note 11). The aggregate  fair value of these  warrants
amounted to $1,382.


                                       57



On March 1, 2006 the Company  issued  warrants  for 6,417  shares at an adjusted
exercise price of $1.74 per share to Apex in connection  with the Interim Bridge
Financing III financing  (Note 11). The aggregate  fair value of these  warrants
amounted to $10,029.

On March 17, 2006 the Company  issued  warrants  for 3,750 shares at an adjusted
exercise price of $1.74 per share to Apex in connection  with the Interim Bridge
Financing III financing  (Note 11). The aggregate  fair value of these  warrants
amounted to $5,861.

On March 22, 2006 the Company  issued  warrants  for 2,500 shares at an adjusted
exercise price of $1.74 per share to Apex in connection  with the Interim Bridge
Financing III financing  (Note 11). The aggregate  fair value of these  warrants
amounted to $3,907.

On March 27, 2006 the Company issued  warrants for 620,233 shares at a $1.85 per
share  exercise  price to the  investors  in the Series A  Preferred  Financing.
Additionally,  the Company issued  198,375  common stock purchase  warrants at a
$1.85 per share  exercise  price to Laidlaw as  placement  agent in the Series A
Preferred Financing.

On April 3, 2006 the Company  issued  warrants for 49,306  shares at a $1.85 per
share exercise price to Apex in connection with their investment in the Series A
Preferred Financing.

On October 13, 2006 and November 16, 2006, the Company issued warrants  totaling
1,879,725  shares at a $1.03 per share  exercise  price to the  investors in the
Series B Preferred  Financing in connection with the first closing of the Series
B Preferred Financing.

On October 13, 2006 and November 16, 2006,  the Company  issued  563,913  common
stock  purchase  warrants  at a $1.03 per share  exercise  price to  Laidlaw  as
placement agent for the first closing in the Series B Preferred Financing.

On November 16, 2006, the Company issued  warrants for 530,497 shares at a $1.03
per share exercise price to the investors in the Series B Preferred Financing in
connection with the second closing of the Series B Preferred Financing.

On November 16, 2006, the Company issued 159,147 common stock purchase  warrants
at a $1.03 per share exercise price to Laidlaw as placement agent for the second
closing in the Series B Preferred Financing.

NOTE 19 - SHARE-BASED PAYMENTS

ISSUANCE OF EMPLOYEE STOCK OPTIONS

During the year ended  December 31, 2006,  the Company  issued stock  options to
employees to purchase 139,914 shares.  These options include a grant on February
17, 2006,  to purchase  73,371  shares at $1.65 per share,  with a fair value of
$96,850,  to the Chief Operating  Officer of the Company  Mr. Braden  Waverley,
upon the signing of his employment agreement with the Company.  Additionally, on
February 17, 2006,  the Company  granted  options to purchase  26,204  shares at
$1.65 per share,  with a fair value of $34,589,  to Mr. Martin T.  Johnson,  the
Company's Chief Financial Officer,  upon the signing of his employment agreement
with the Company.

These  options  have a term of 10 years  and  vest 20% on the date of grant  and
1/48th  of the  balance  on the last day of each  month  for the next 48  months
following  the  effective  date of the  agreement.  Assumptions  relating to the
estimated fair value of these stock options, which the Company is accounting for
in accordance with SFAS 123(R) are as follows: fair value of common stock $1.65;
risk-free interest rate of 4.45%; expected dividend yield zero percent; expected
option life of four years; and current volatility of 125%. On July 12, 2006, the
Board of Directors approved the grant of 40,339  non-qualified  stock options to
11  individuals.  The exercise  price for these  options was $1.35,  the closing
price for the Company's common stock on the date of grant, July 12, 2006.

The fair value of the unvested  portion of stock options at December 31, 2006 is
$531,132 with a weighted-average remaining vesting period of 2.9 years.


                                       58



SHARE-BASED COMPENSATION ARRANGEMENTS

The Company,  since its  inception  has granted  non-qualified  stock options to
various employees and non-employees at the discretion of the board of directors.
Substantially all options granted to date have exercise prices equal to the fair
value of underlying  stock at the date of grant and terms of ten years.  Vesting
periods range from fully vested at the date of grant to four years.

2006 PATRON SYSTEMS, INC. STOCK INCENTIVE PLAN

On July 21,  2006,  the  stockholders  of the Company  approved  the 2006 Patron
Systems,  Inc. Stock Incentive Plan (the "2006 Stock Plan"). The 2006 Stock Plan
provides  for the  granting of  incentive  stock  options to  employees  and the
granting of  nonstatutory  stock options to employees,  non-employee  directors,
advisors,  and  consultants.  The 2006  Stock Plan also  provides  for grants of
restricted stock, stock appreciation  rights and stock unit awards to employees,
non-employee directors, advisors and consultants. The 2006 Stock Plan authorizes
and reserves  5,600,000 shares for issuance of options that may be granted under
plan.

In accordance  with the 2006 Stock Plan, the stated  exercise price shall not be
less than 100% and 85% of the estimated fair market value of common stock on the
date of grant for ISO's and NSO's,  respectively,  as determined by the board of
directors  at the  date of  grant.  With  respect  to any 10%  stockholder,  the
exercise  price of an ISO or NSO shall  not be less  than 110% of the  estimated
fair market value per share on the date of grant.

Options  issued  under  the 2006  Stock  Plan  have a term up to  ten-years  and
generally become exercisable over a four-year period.

Shares subject to awards that expire  unexercised or are forfeited or terminated
will  again  become  available  for  issuance  under  the 2006  Stock  Plan.  No
participant in the 2006 Stock Plan can receive option grants, restricted shares,
stock  appreciation  rights or stock units for more than 1,500,000 shares in the
aggregate in any calendar year.

As of December 31, 2006, no options have been granted from the 2006 Stock Plan.

NON-PLAN STOCK OPTION GRANTS

As described  in Note 3, the fair value of all awards was  estimated at the date
of grant using the Black-Scholes  option pricing model.  Assumptions relating to
the  estimated  fair value of stock  options that the Company  granted  prior to
January 1, 2006 that were accounted for and recorded  under the intrinsic  value
method prescribed under APB 25 are also described in Note 3.

The risk-free  rate is based on the U.S.  Treasury  yield curve in effect at the
time of grant. The Company has not paid dividends to date and does not expect to
pay  dividends  in the  foreseeable  future due to its  substantial  accumulated
deficit and limited capital  resources.  Accordingly,  expected dividends yields
are currently zero.  Historical  cancellations  and forfeitures of stock options
granted  through  December  31,  2004  have  been  insignificant.  However,  the
Company's operations and the nature of its business changed substantially during
2005 with the  acquisition  of  businesses  and the  recruitment  of a new Chief
Operating Officer in 2006.  Accordingly,  the Company considers more recent data
relating to employee turnover rates to be indicative of future vesting. Based on
available  data, the Company has assumed that  approximately  84% of outstanding
options will vest annually.  Unearned  compensation  relating to options granted
through  December  31, 2005 has been  adjusted to reflect this  assumption.  The
Company will prospectively  monitor employee  terminations,  exercises and other
factors that could affect its expectations relating to the vesting of options in
future  periods.  The  Company  will  adjust  its  assumptions  relating  to its
expectations  of future  vesting  and the terms of  options  at such  times that
additional  data  indicates  that changes in these  assumptions  are  necessary.
Expected  volatility is principally  based on the  historical  volatility of the
Company's stock.

A summary of option activity for the year ended December 31, 2006 is as follows:


                                       59





                                                                               WEIGHTED-
                                                              WEIGHTED-         AVERAGE
                                                               AVERAGE         REMAINING
                                                              EXERCISE        CONTRACTUAL
               OPTIONS                        SHARES            PRICE             TERM
---------------------------------------   --------------    --------------   --------------
                                                                         
Outstanding at January 1, 2006 ........          428,022    $        21.09        7.7 years
Granted ...............................          189,914    $         1.78             --
Exercised .............................             --                --               --
Forfeited or expired ..................          (85,300)   $         7,74             --
Outstanding at December 31, 2006 ......          532,636    $        16.34        6.5 years
Exercisable at December 31, 2006 ......          400,312    $        20.08        5.4 years



At December 31, 2006, the aggregate  intrinsic value of options  outstanding and
options exercisable, based on the December 29, 2006 closing price of the Company
common stock ($0.35 per share) amounted to $2,000 and $2,000,  respectively.  In
addition  the table  includes  156,670  fully vested and  non-forfeitable  stock
options  outstanding that it issued to non-employees  through December 31, 2005.
As of December 31, 2006, these options have a weighted average exercise price of
$17.39,  weighted  average  remaining  contractual  term  of  6.1  years  and an
aggregate intrinsic value of $0.

The weighted-average  grant-date fair value of the 189,914 stock options granted
during the year ended December 31, 2006 amounted to $1.26 per share. The Company
granted 190,514 stock options with a weighted  average  grant-date fair value of
$7.85  per share or a total  fair  value of  $1,495,158  during  the year  ended
December 31, 2005.  There have also not been any  exercises of stock  options to
date.  The total fair value of options vested during the year ended December 31,
2006 amounted to $397,277. Additionally, the Company did not capitalize the cost
associated with stock based compensation.

Stock based  compensation  expense to non employees for services rendered during
the year ended  December 31, 2006 amount to $163,120  including  $63,120 for the
fair value of 50,000  stock  options  with an exercise  price of $2.40 per share
which are fully  vested and have a term of 3 years and  50,000  shares of common
stock with an  aggregate  fair value of  $100,000.  Assumptions  relating to the
estimated fair value of the stock options  granted to  non-employees  during the
year ended  December  31,  2006 are as  follows:  Fair value of common  stock of
$1.80,  risk-free  interest  rate of  4.98%;  expected  dividend  yield  of zero
percent;  expected option life of three years;  and current  volatility of 125%.
These options were recorded in accordance with measurement  guidelines  provided
for under EITF 96-18.

Aggregate stock based  compensation  to employees and non employees  amounted to
$523,915 for the year ended December 31, 2006.

Stock based compensation expense to non-employees  amounted to $1,239,083 during
the year ended December 31, 2005,  including  $708,750 relating to stock options
and  $530,333   relating  to  issuances  of  common  stock  for  services.   All
non-employee  stock based  compensation  awards were accounted for in accordance
with the  provisions of EITF 96-18.  Assumptions  relating to the estimated fair
value of the stock  options  granted  to  non-employees  during  the year  ended
December 31, 2005 are as follows: fair value of common stock of $2.70; risk-free
interest rate of 3.83%; expected dividend yield of zero percent; expected option
life of 3 years; and current volatility of 125%.

REVERSE STOCK SPLIT

On July 31,  2006,  the  Company  effected  an  equity  restructuring  through a
1-for-30  reverse  stock split of its common stock.  The Company split  adjusted
both the exercise price and number of shares underlying its outstanding employee
stock options in accordance  with stock option  agreement  equity  restructuring
provisions,  which include adjustments for stock splits. The Company applied the
guidance  specified  in  paragraph  54 and the related  implementation  guidance
included  in  Appendix  A  of  SFAS  123(R)  to  evaluate   whether  the  equity
restructuring  and  modification  of awards  resulted in an increase in the fair
value  of such  awards  and  whether  additional  compensation  cost  should  be
recognized.  In  accordance  with SFAS 123(R) awards that are modified in equity
restructurings  pursuant to existing  anti-dilution  provisions generally do not
result in the recognition of additional compensation cost. The Company evaluated
the effect of the  reverse-split  on the fair value of  existing  stock  options
before  and  after  the  equity  restructuring  in  accordance  with the  equity
restructuring  guidelines.  As a result,  the Company  determined that it is not
required to record additional stock-based compensation cost.


                                       60



NOTE 20 - DISCONTINUED OPERATIONS

SALE OF LUCIDLINE

LucidLine,  Inc.  ("LucidLine") was a provider of bundled and branded high speed
Internet access and synchronized remote data back-up, retrieval, and restoration
services.  The  acquisition of LucidLine was intended to supply the Company with
the expertise  needed to establish a homeland  security  architecture,  risk and
vulnerability  assessment  evaluation services and the development and operation
of the homeland  security data center solutions  originally  contemplated in the
business plan. The actual results were substantially  different. The Company was
unable to find any  parties  interested  in its  homeland  security  data center
solutions,  its risk and  vulnerability  assessment  services  and its  homeland
security architecture business. Additionally, LucidLine's commercial data backup
and  storage  business  was not  growing  sufficiently  to  cover  the  costs of
operating the business.

Because of the Company's  precarious  financial position,  the difficulty it was
experiencing in finding  parties  interested in pursuing the concept of homeland
security  compliant data centers and the general lack of government  funding for
municipalities   and   counties  to  address   homeland   security   focused  IT
infrastructure  projects,  the Company  decided in the first  quarter of 2006 to
abandon its focus on the homeland  security  market portion of its business plan
and to streamline its business to focus on enterprise level software and service
solutions designed to help customers create,  manage and apply complex rule sets
that support business policies, enhance work flow processes,  enforce regulatory
compliance,  and  reduce  the time,  cost and  overhead  of  electronic  message
management.

Having made this decision,  the Company's management undertook a thorough review
of all areas of its business, including the revenue, pricing, supplier contracts
and all other aspects of the LucidLine  business  unit, in an attempt to further
cost-reduce the already  cost-reduced  business which had approximately  $65,000
per month in  negative  cash  flow.  While this  effort  reduced  the  potential
negative cash flow to  approximately  $35,000 per month through  additional cost
reductions, price increases and improved contract management, this negative cash
flow would still result in a  substantial  drain on the  Company's  very limited
cash resources.  On the basis of this analysis,  the Company decided to sell the
business to a party who would purchase LucidLine and assume LucidLine's customer
and supplier contract commitments. Based on these factors, the Company undertook
an effort to identify a prospective  acquirer of this  business.  In March 2006,
Walnut  Valley,  Inc.  agreed to acquire the legal entity and all of LucidLine's
customer and supplier contract  commitments for a substantial  discount from the
price the  Company  paid in  February  2005.  As the  Company had found no other
interested  buyers and would have  incurred a cash cost to shutdown the business
far in excess of $50,000,  the Company decided to sell the LucidLine business to
Walnut Valley.

On April 18, 2006,  the Company  entered into a Stock  Purchase  Agreement  with
Walnut Valley,  Inc.,  pursuant to which the Company sold all of the outstanding
shares of  LucidLine  to Walnut  Valley,  Inc. for  aggregate  consideration  of
$50,000  consisting  of a cash payment in the amount of $25,000 and the issuance
of a  Promissory  Note in the  principal  amount of $25,000 by Walnut  Valley in
favor of the Company.  The Company  originally  purchased  LucidLine in February
2005 for  $3,940,000  including  cash of $200,000  and 146,667  shares of common
stock with a fair value of $3,740,000.

During the period from the acquisition of LucidLine on February 25, 2005 through
December  31,  2005,  LucidLine  generated  revenue of  approximately  $227,000,
incurred  a net  loss  of  approximately  $1.4  million  and  used  net  cash in
operations of approximately $1.4 million. For the period from January 1, 2006 to
March 31, 2006, LucidLine generated revenue of approximately $99,000, a net loss
of  approximately  $105,000  and used net cash in  operations  of  approximately
$194,000. Additionally, the Company recognized a loss on disposal of $75,920.


                                       61



                                          January 1, 2006     February 25, 2005
                                               through             through
                                           March 31, 2006     December 31, 2005
                                         -----------------    -----------------

Revenue ..............................   $          99,167    $         227,494
Cost of sales ........................              91,601              698,397
                                         -----------------    -----------------
   Gross profit (loss) ...............               7,566             (470,903)
Operating expenses ...................             111,992              907,074
                                         -----------------    -----------------
   Loss from operations ..............            (104,426)          (1,377,977)

Other income/(expense) ...............                (538)              (4,753)
                                         -----------------    -----------------
   Loss before income taxes ..........            (104,964)          (1,382,730)
Income taxes .........................                --                   --
                                         -----------------    -----------------
   Net loss ..........................   $        (104,964)   $      (1,382,730)
                                         =================    =================


POLICYBRIDGE CLASSIFICATION AS A DISCONTINUED OPERATION

During  December  2006,  the Company  made an  affirmative  decision to exit and
actively pursue a plan to sell its PolicyBridge  software product business. As a
result of this decision,  the Company has classified its  PolicyBridge  software
product business as a discontinued  operation in its financial  statements as of
December 31, 2006 in accordance  with SFAS 144.

During  the  period  from the  acquisition  of the  PolicyBridge  product in the
Entelagent acquisition on March 30, 2005 through December 31, 2006, PolicyBridge
generated   revenue  of   approximately   $547,000,   incurred  a  net  loss  of
approximately $4.4 million and used net cash of over $2.7 million.  For the year
ended  December  31,  2006,  PolicyBridge  generated  revenue  of  approximately
$311,000,  incurred a net loss of approximately  $1,932,000 and used net cash of
approximately  $1.4 million.  The net loss for the year ended  December 31, 2006
includes $719,636 associated with the write-off of the capitalized  PolicyBridge
software (Note 7),  $61,833  associated  with the write-off of the  PolicyBridge
intangible  assets (Note 8) and $210,716  associated  with the impairment of the
remaining Entelagent acquisition goodwill (Note 5).

                                                               March 30, 2005
                                            Year ended             through
                                         December 31, 2006    December 31, 2005
                                         -----------------    -----------------

Revenue ..............................   $         311,120    $         235,426
Cost of sales ........................              11,520               77,132
                                         -----------------    -----------------
   Gross profit (loss) ...............             299,600              158,294
Operating expenses ...................           1,239,110            1,259,889
Write-off of intangible assets .......             781,470            1,147,125
Goodwill impairment charge ...........             210,716                 --
                                         -----------------    -----------------
   Loss from operations ..............          (1,931,696)          (2,248,720)

Other income/(expense) ...............                --               (225,505)
                                         -----------------    -----------------
   Loss before income taxes ..........          (1,931,696)          (2,474,225)
Income taxes .........................                --                   --
                                         -----------------    -----------------
   Net loss ..........................   $      (1,931,696)   $      (2,474,225)
                                         =================    =================


                                       62



While management  continues to search for a buyer of this business,  the Company
will continue to provide  services  under the existing  maintenance  and support
agreements to its PolicyBridge customers.

NOTE 21 - INCOME TAXES

At December  31,  2006,  the Company  has federal and state net  operating  loss
carryforwards   available  to  offset  future   taxable   income,   if  any,  of
approximately  $31,000,000 expiring at various times through 2026. The Company's
determination  of the amount of its net operating  loss  carryforwards  includes
approximately  $11,000,000  associated with acquired business. The Company's net
operating losses (including those of the acquired  businesses) may be subject to
substantial  limitations due to the (a) "Change of Ownership"  provisions  under
Section 382 of the Internal  Revenue Code and similar state  provisions  and (b)
delinquencies that the Company has experienced with respect to filing its income
tax returns on a timely basis.  Such limitations may result in the expiration of
the net operating losses prior to their utilization.

The tax  effects of  significant  temporary  differences  which give rise to the
Company's deferred tax assets and liabilities are as follows:

                                                          DECEMBER 31,
                                                -------------------------------
                                                    2006               2005
                                                ------------       ------------
Net operating loss carry forwards ........      $ 11,803,887       $ 10,000,908
Start-up costs ...........................         7,278,114          7,278,114
Stock options ............................         2,687,527          2,530,339
Accrued compensation and expenses ........         2,602,755          2,447,333
Goodwill impairment ......................         4,794,331          4,794,331
Intangible impairment ....................           632,383            632,383
                                                ------------       ------------
                                                  29,798,997         27,683,408
Valuation allowance ......................       (29,798,997)       (27,683,408)
                                                ------------       ------------
Net deferred tax  asset ..................      $       --         $       --
                                                ============       ============

The increase in the Company's deferred tax assets during the year ended December
31, 2006  includes  the effects of deferred tax assets  associated  with the net
operating losses of acquired  business.  The Company fully reserves for deferred
tax  assets  recorded  in  purchase  accounting.  The  deferred  tax  assets and
subsequent  valuation allowance recorded in purchase accounting were accompanied
by a corresponding decrease and increase,  respectively, in goodwill at the time
the purchase  price  allocation  was  recorded.  The Company's  recorded  income
benefit,  net of the change in the  valuation  allowance  for each of the period
presented, is as follows:

                                                    YEARS ENDED DECEMBER 31,
                                                 ------------------------------
                                                    2006                2005
                                                 -----------        -----------
Current
      Federal ............................       $      --          $      --
      State ..............................              --                 --
                                                 -----------        -----------
                                                        --                 --
Deferred
      Federal ............................        (1,851,425)        (8,720,828)
      State ..............................          (264,163)        (1,244,297)
                                                 -----------        -----------
                                                  (2,115,588)        (9,965,125)

Change in valuation allowance ............         2,115,588          9,965,125
                                                 -----------        -----------
                                                 $      --          $      --
                                                 ===========        ===========


                                       63



Pursuant to SFAS No. 109 "Accounting for Income Taxes," management has evaluated
the  recoverability  of the  deferred  income  tax  assets  and the level of the
valuation  allowance  required with respect to such deferred  income tax assets.
After  considering  all  available  facts,  the Company  fully  reserved for its
deferred tax assets  because it is more likely than not that their  benefit will
not be realized in future  periods.  The Company  will  continue to evaluate its
deferred  tax assets to  determine  whether any changes in  circumstances  could
affect the  realization of their future  benefit.  If it is determined in future
periods that portions of the Company's  deferred income tax assets satisfies the
realization  standard of SFAS No. 109, the valuation  allowance  will be reduced
accordingly.

A reconciliation  of the expected Federal statutory rate of 34% to the Company's
actual rate as reported for each of the periods presented is as follows:

                                                     YEARS ENDED DECEMBER 31,
                                                   ---------------------------
                                                      2006             2005
                                                   -----------     -----------
Expected statutory rate ........................         (34)%           (34)%
State income tax rate, net of
  Federal benefit ..............................          (3)%            (3)%
Permanent Difference:
  Non-cash interest charges ....................           4 %            15 %
                                                   -----------     -----------
                                                         (33)%           (22)%
Valuation allowance ............................          33 %            22 %
                                                   -----------     -----------
                                                          --              --
                                                   ===========     ===========

NOTE 22 - MAJOR CUSTOMERS

During the year ended  December  31,  2006,  the  Company's  top four  customers
accounted  for 25%,  18%,  18% and 13% of net  revenues.  During  the year ended
December 31, 2005, the Company's top three customers  accounted for 27%, 23% and
17% of net revenues.

The four largest customers in accounts  receivable at December 31, 2006 are 24%,
19%, 21% and 20% of accounts receivable.

NOTE 23 - RESTATEMENT  OF FINANCIAL  STATEMENTS  FOR INTERIM  PERIODS DURING THE
YEAR ENDED DECEMBER 31, 2006

The Company, while undergoing the audit of its consolidated financial statements
for the year ended December 31, 2006, became aware of possible  misstatements in
its unaudited condensed consolidated interim financial statements filed with the
Securities and Exchange  Commission  during the year ended December 31, 2006. On
March 6, 2007, the Company's Board of Directors  determined that certain amounts
reported in its unaudited condensed  consolidated  interim financial  statements
for the quarters ended March 31, 2006, and June 30, 2006, and for the six months
ended June 30,  2006 and nine  months  ended  September  30,  2006  needed to be
restated as described below.

The specific errors that came to management's  attention relate to the Company's
accounting for certain transactions that occurred during the quarter ended March
31, 2006 and the quarter ended June 30, 2006. Upon review of these transactions,
Company  management  discovered  that  the  accounting  for  these  transactions
resulted in a  $2,408,250  overstatement  of its loss for the  quarterly  period
ended March 31, 2006 and a $593,765  overstatement of its loss for the quarterly
period ended June 30, 2006,  which also resulted in an overstatement of the year
to date  losses  in the six and nine  month  periods  ended  June  30,  2006 and
September 30, 2006, respectively.

Specifically,  the Company  recorded  for the three months ended March 31, 2006,
(1) a net loss of $858,213 on the  settlement of various  liabilities  under its
creditor  and  claimant  liabilities  restructuring  program when it should have
recorded a net gain of approximately  $906,987,  (2) excess non-cash interest of
$358,000 with respect to a conversion  option that became effective under two of
its Interim Bridge Financing III notes and (3) charged,  as interest expense,  a
$285,050  fee paid to the  placement  agent  in its  Series  A  Preferred  stock
financing  transaction  that  should have been  recorded  as a reduction  of the
offering  proceeds.  For the three  months  ended  June 30,  2006,  the  company
recorded a net gain of $371,616 on the settlement of various  liabilities  under
its creditor and claimant liabilities  restructuring program when it should have
recorded a net gain of  approximately  $965,381.  The nature of the  adjustments
required in the creditor and claimant liabilities  restructuring in the quarters
ended March 31, 2006 and June 30, 2006, relate to an overvaluation of the Series
A-1 preferred shares issued in the exchange offer offset


                                       64



by gains on the extinguishment of liabilities that originated in connection with
obligations to issue or repurchase stock.

The effect of the  restatement  on the  Company's  previously  issued  unaudited
condensed consolidated interim financial statements is as follows:



                            Three Months                    Three Months                    Six Months
                               ended                           ended                           ended
                          March 31, 2006                   June 30, 2006                   June 30, 2006
                   ----------------------------    ----------------------------    ----------------------------
                   As Previously        As         As Previously        As         As Previously        As
                     Reported        Restated        Reported        Restated        Reported        Restated
                   ------------    ------------    ------------    ------------    ------------    ------------
                                                                                 
Loss/(Gain)
associated
with settlement
agreements .....   $    858,213    $   (906,987)   $   (371,616)   $   (965,381)   $    486,597    $ (1,872,368)

Interest expense   $ (1,615,514)   $   (972,464)   $    (88,421)   $    (88,421)   $ (1,703,935)   $ (1,060,885)

Net loss from
continuing
operations .....   $ (4,400,074)   $ (1,991,824)   $ (1,420,313)   $   (826,548)   $ (5,715,425)   $ (2,713,410)

Net loss
available to
common
stockholders ...   $ (4,400,074)   $ (1,991,824)   $ (1,621,017)   $ (1,027,252)   $ (6,021,091)   $ (3,019,076)

Net loss per
share-
continuing
operations .....   $      (2.06)   $      (0.91)   $      (0.71)   $      (0.44)   $      (2.75)   $      (1.33)

Net loss per
share - total ..   $      (2.11)   $      (0.96)   $      (0.75)   $      (0.47)   $      (2.83)   $      (1.42)

Additional paid
in capital .....   $ 93,922,101    $ 91,513,851    $ 97,792,968    $ 94,790,953    $ 97,792,968    $ 94,790,953

Accumulated
Deficit ........   $(88,788,101)   $(86,379,851)   $(90,409,118)   $(87,407,103)   $(90,409,118)   $(87,407,103)



                            Nine Months
                               ended
                        September 30, 2006
                   ----------------------------
                   As Previously        As
                     Reported        Restated
                   ------------    ------------
                             
Loss/(Gain)
associated
with settlement
agreements .....   $    (93,944)   $ (2,452,909)

Interest expense   $ (1,768,499)   $ (1,125,449)

Net loss from
continuing
operations .....   $ (6,872,302)   $ (3,870,287)

Net loss
available to
common
stockholders ...   $ (7,300,152)   $ (4,298,137)

Net loss per
share-
continuing
operations .....   $      (1.44)   $      (0.83)

Net loss per
share - total ..   $      (1.48)   $      (0.87)

Additional paid
in capital .....   $ 97,468,961    $ 94,466,946

Accumulated
Deficit ........   $(91,688,179)   $(88,686,164)



                                       65



A) For the  quarter  ended  March  31,  2006,  a  reduction  in the net  loss of
$2,408,250  ($1.15 per  share)  and a  corresponding  reduction  in  accumulated
deficit  of  $2,408,250  and a  reduction  of  additional  paid  in  capital  of
$2,408,250.

B) For the quarter  ended June 30, 2006, a reduction in the net loss of $593,765
($0.27  per share)  and a  corresponding  reduction  in  accumulated  deficit of
$593,765 and a reduction of additional paid in capital of $593,765.

C) For the six  months  ended  June 30,  2006,  a  reduction  in the net loss of
$3,002,015  ($1.41 per  share)  and a  corresponding  reduction  in  accumulated
deficit  of  $3,002,015  and a  reduction  of  additional  paid  in  capital  of
$3,002,015.

D) For the nine months ended  September 30, 2006, a reduction in the net loss of
$3,002,015  ($0.61 per  share)  and a  corresponding  reduction  in  accumulated
deficit  of  $3,002,015  and a  reduction  of  additional  paid  in  capital  of
$3,002,015.

NOTE 24 - SUBSEQUENT EVENTS

MANAGEMENT CHANGES

On  January  18,  2007,  the board of  directors  of the  Company  approved  the
resignation  of Mr.  Robert  Cross as Chief  Executive  Officer of the  Company,
elected Mr.  Robert  Cross to chairman of the board of  directors of the Company
and elected Mr. Braden Waverley,  the Company's current Chief Operating Officer,
to the position of Chief Executive Officer of the Company.

ISSUANCE OF EMPLOYEE STOCK OPTIONS

On January 24, 2007, the board of directors  approved the grant of stock options
under the 2006  Patron  Systems,  Inc.  Stock  Incentive  Plan (the "2006  Stock
Plan").  A total of 5,270,553 stock options were granted at an exercise price of
$0.40 per share (the closing price of the Company's  common stock on January 24,
2007). These options have a term of 10 years. The total fair value of this stock
option grant is $1,705,918.  Assumptions relating to the estimated fair value of
these  options  are as  follows:  fair value of common  stock  $0.40;  risk-free
interest rate of 5.00%;  expected  dividend yield zero percent;  expected option
life of four  years;  and  current  volatility  of 125%.  Included in this stock
option  grant were stock  option  grants to Mr.  Brett  Newbold,  the  Company's
President  and Chief  Technology  Officer in the amount of 100,000  shares at an
exercise  price  of  $0.40  per  shares  and a grant to Ms.  Heidi  Newton,  the
Company's Vice  President-Finance  and  Administration  in the amount of 140,000
shares with an exercise price of $0.40 per share.

STOCK OPTION GRANT TO MR. BRADEN WAVERLEY

Included  in the  January 24, 2007 stock  option  grant,  the Company  issued to
Braden Waverley,  the Company's Chief Executive Officer, an option granted under
the Plan to  purchase  1,500,000  shares  of the  Company's  common  stock at an
exercise price of $0.40 per share and an option  granted  outside of the Plan to
purchase  547,121  shares of the Company's  common stock at an exercise price of
$0.40 per share.  Each  option has a term of 10 years and vests with  respect to
20% on the date of grant and 1/48th of the balance on the last day of each month
for the 48 months  following the date of grant until fully  vested.  Each option
expires on January 23, 2017. The Company and Mr. Waverley have agreed,  pursuant
to an amendment  dated  January 24, 2007, of that certain  Employment  Agreement
dated February 17, 2006 between the Company and Mr. Waverley, that these options
were issued in lieu of a grant


                                       66



that was intended to be made under the terms of the  Employment  Agreement as an
antidilutive grant,  following the Company's  completion of its recapitalization
under the  creditor  and  claimant  liabilities  restructuring  program  and the
effectiveness of a registration  statement for the resale of such shares so that
Mr.  Waverley would retain options to purchase up to 3.5% of the Company's fully
diluted common stock. Mr. Waverley's  Employment Agreement also provided for the
grant of an additional option to purchase that number of shares of the Company's
common stock  representing an aggregate of 3.5% of the outstanding shares of the
Company's common stock on a fully-diluted basis upon Mr. Waverley's  appointment
as the Company's Chief Executive Officer.

STOCK OPTION GRANT TO MR. MARTIN T. JOHNSON

Included  in the  January 24, 2007 stock  option  grant,  the Company  issued to
Martin T. Johnson,  the Company's Chief Financial  Officer,  an option under the
Plan to purchase  731,114  shares of the  Company's  common stock at an exercise
price of $0.40 per  share.  The  option  has a term of 10 years  and vests  with
respect to 20% on the date of grant and 1/48th of the balance on the last day of
each month for the 48 months following the date of grant until fully vested. The
option  expires on January 23,  2017.  The Company and Mr.  Johnson have agreed,
pursuant to an  amendment  dated  January 24, 2007,  of that certain  Employment
Agreement  dated  February  17, 2006 between the Company and Mr.  Johnson,  that
these  options were issued in lieu of a grant that was intended to be made under
the terms of the Employment  Agreement as an antidilutive  grant,  following the
Company's  completion  of its  recapitalization  under the creditor and claimant
liabilities  restructuring  program  and  the  effectiveness  of a  registration
statement for the resale of such shares so that Mr. Johnson would retain options
to purchase up to 1.25% of the Company's fully diluted common stock.

STOCK OPTION GRANT TO MR. ROBERT CROSS

Included  in the  January 24, 2007 stock  option  grant,  the Company  issued to
Robert Cross, the Company's chairman of the board of directors,  an option under
the Plan to purchase 757,318 shares of the Company's common stock at an exercise
price of $0.40 per  share.  The  option  has a term of 10 years  and vests  with
respect to 20% on the date of grant and 1/48th of the balance on the last day of
each month for the 48 months following the date of grant until fully vested. The
option  expires on January 23, 2017.  The Company and Mr. Cross have agreed that
these options were issued in lieu of a grant (approved by the board of directors
on March 7,  2006)  that was  intended  to be made to Mr.  Cross  following  the
Company's  completion  of its  recapitalization  under the creditor and claimant
liabilities  restructuring  program  and  the  effectiveness  of a  registration
statement  for the resale of such shares so that Mr. Cross would retain  options
to purchase 2.5% of the Company's fully diluted common stock.

STOCK OPTION GRANT TO MR. GEORGE MIDDLEMAS

Included  in the  January 24, 2007 stock  option  grant,  the Company  issued to
George  Middlemas,  a  director  of the  Company,  an  option  under the Plan to
purchase  50,000  shares of the Company's  common stock at an exercise  price of
$0.40 per share.  The option has a term of 10 years and vests  fully at the next
annual meeting of stockholders.

ADJUSTMENT OF SERIES A PREFERRED CONVERSION PRICE

On January 24, 2007, the Company issued 5,270,553 stock options under the Patron
Systems Inc. 2006 Stock Incentive Plan.  These options have an exercise price of
$0.40 per share.  This  issuance has resulted in the  adjustment of the Series A
Preferred  conversion price to $0.40 per share and has resulted in an additional
6,695,116 shares of Common Stock being reserved for issuance upon the conversion
of the Series A Preferred Stock.  The fair value of these additional  conversion
shares is $2,295,562.  Assumptions relating to the estimated fair value of these
additional  conversion shares are as follows:  Fair value of common stock $0.40,
risk-free  interest  rate of 5.0%;  expected  dividend  yield  of zero  percent;
expected option life of five years; and current volatility of 125%.


2007 BRIDGE NOTES

On February 20, 2007,  the Company,  in  consideration  of funds advanced in the
aggregate amount of $200,000,  issued a secured convertible promissory note (the
"2007 Bridge  Note") to Apex in the principal  amount of $200,000,  and issued a
common stock  purchase  warrant for 200,000 shares at an exercise price of $1.00
per share. The common stock purchase warrants have a term of five (5) years. The
Company's  obligations  under the 2007  Bridge  Note is  secured by liens on all
assets of the  Company  pursuant  to a Security  Agreement  entered  into by the
Company and Apex on February 20, 2007 (the "Security Agreement").  The aggregate
amounts  (principal  and any  accrued  interest)  under the 2007 Bridge Note are
payable to Apex on demand with simple interest accruing on any


                                       67



unpaid  principal  amount at a rate of nine (9) percent per annum. At the option
of Apex, the 2007 Bridge Note is convertible into shares of the Company's common
stock at any time,  in an amount  equal to the  quotient  of the  amounts  being
converted  under the 2007 Bridge Notes  divided by the offering  price per share
associated with any offering of equity securities made by the Company,  or in an
amount equal to the quotient of the amounts being converted by the fair value of
such shares. The Security Agreement terminates upon the full satisfaction of the
Company's  obligations  under the 2007 Bridge Note or upon the conversion of the
2007 Bridge Note.

On March 2, 2007, March 19, 2007 and March 27, 2007, the Company was advanced an
additional  $100,000,  $160,000 and $165,000  respectively.  These advances will
result in the  granting  of common  stock  purchase  warrants  in the  amount of
100,000 shares at an exercise price of $1.25  associated  with the March 2, 2007
advance,  160,000 shares at an exercise price of $1.14 associated with the March
19,  2007  advance and  165,000  shares at an exercise  price of $1.25 per share
associated with the March 27, 2007 advance. These common stock purchase warrants
have a term of 5 years.

ITEM 8.  CHANGES  IN  AND  DISAGREEMENTS  WITH  ACCOUNTANTS  ON  ACCOUNTING  AND
FINANCIAL DISCLOSURE

Not applicable

ITEM 8A. CONTROLS AND PROCEDURES

Members of Company  management,  including the Chief Executive Officer and Chief
Financial  Officer,  evaluated the effectiveness of our disclosure  controls and
procedures,  as defined by  paragraph  (e) of  Exchange  Act Rules  13(a)-15  or
15(d)-15 for the fiscal year ended December 31, 2006, the period covered by this
report.  Based  on that  evaluation,  the  Chief  Executive  Officer  and  Chief
Financial  Officer  concluded  that,  as of  December  31,  2006  the  Company's
disclosure controls and procedures were not effective.

DISCLOSURE CONTROLS AND INTERNAL CONTROLS

Disclosure  controls  are  procedures  that are designed  with the  objective of
ensuring  that  information  required to be disclosed in our reports filed under
the  Securities  Exchange  Act of 1934,  as  amended,  such as this  Report,  is
recorded,  processed,  summarized and reported within the time periods specified
in the SEC's rules and forms.  Disclosure  controls are also  designed  with the
objective of ensuring that such  information is accumulated and  communicated to
our  management,  including  our Chief  Executive  Officer  and Chief  Financial
Officer,   as  appropriate,   to  allow  timely  decisions   regarding  required
disclosure.  Internal  controls  are  procedures  which  are  designed  with the
objective of providing  reasonable  assurance that our transactions are properly
authorized,  recorded  and  reported  and our  assets  are  safeguarded  against
unauthorized  or  improper  use,  to permit  the  preparation  of our  financial
statements in conformity with generally accepted accounting principles.

Our company is not an "accelerated filer" (as defined in the Securities Exchange
Act) and is not  required  to deliver  management's  report on control  over our
financial  reporting  until our year ended December 31, 2007.  Nevertheless,  we
identified  certain matters that constitute  material weakness (as defined under
the Public Company  Accounting  Oversight Board Auditing  Standard No. 2) in our
internal controls over financial reporting.

In previous  periods,  we reported that we had identified  certain  matters that
constituted  material  weakness (as defined under the Public Company  Accounting
Oversight Board Auditing Standard No. 2) in our internal controls over financial
reporting.  The material  weaknesses that we identified related to the fact that
that our overall financial  reporting structure and current staffing levels were
not   sufficient  to  support  the   complexity   of  our  financial   reporting
requirements.  We  currently  lack  the  expertise  we  need  to  apply  complex
accounting   principles  relating  to  our  business   combinations  and  equity
transactions and have  experienced  difficulty in applying income tax accounting
principles.  As a result, our internal controls have not reduced to a reasonably
low level,  the risk of material  misstatement to our financial  statements.  We
also, until recently, lacked the structure we needed to ensure the timely filing
of our tax returns.

Until March 2005, we did not have any full time employees  including a Principal
Accounting  Officer  assigned  to perform  any duties  related to our  financial
reporting  obligations.  Accordingly we were unable, until the second quarter of
2005, to record,  process and summarize all of the information that we needed to
close our books and


                                       68



records on a timely basis and deliver our reports to the Securities and Exchange
Commission within the time frames required under the Commission's rules.

During the third  quarter of 2005,  under the  direction of our Chief  Executive
Officer,  we  addressed  personnel  changes  necessary to review and analyze our
internal control over financial reporting by engaging the services of an outside
financial  reporting  specialist to conduct the review and analysis.  During the
fourth quarter of 2005, this outside financial  reporting  specialist,  together
with our Chief Executive  Officer and our other full-time  personnel,  undertook
the process of forming a system of internal controls which was reasonably likely
to  materially  affect and  remedy the  material  weaknesses  identified  by our
management. During the fourth quarter of 2005, we hired additional personnel and
instituted  various  procedures  that have  enabled  us to record,  process  and
summarize  transactions  within  the time  frames  required  to timely  file our
reports  under  the  Commission's  rules.  These  changes  included  review  and
preapproval of all expenditures and commitments, payment authorization controls,
consolidation of checking accounts,  reduction of the number of authorized check
signers,  the  completion  of the  audits of the  acquired  company's  financial
statements and consolidation of the acquired company  financial  statements onto
our general  ledger  system.  The  improvements  have enabled us to resolve past
delinquencies  relating to the filing of our annual and  quarterly  reports with
the SEC. We also  resolved  the  delinquent  filing of our Form 8-K/A's from the
acquisitions  of CSSI,  Entelagent  and  LucidLine  in  December  2005.  We also
assigned  a key  member  of the  accounting  department  with the task of filing
previously delinquent tax returns and are undertaking a structure to ensure that
our tax  returns in the future are filed on a timely  basis.  We have  completed
filing all delinquent  tax returns  through the year ended December 31, 2004 and
have timely filed our tax returns for the year ended December 31, 2005.

Although the improvements we have made in our financial reporting processes have
enabled us to (a) bring the Company  into  compliance  with the SEC's  reporting
requirements,  (b) better plan  transactions  that  involve the  application  of
complex accounting principles and (c) improve our ability to comply with our tax
reporting  obligations,  additional  time is still required to test and document
our  internal  and  disclosure  control  processes  to  ensure  their  operating
effectiveness.  As a  result,  our  internal  controls  have  not  reduced  to a
reasonably  low  level,  the  risk of  material  misstatement  to our  financial
statements.

On March 6,  2007,  our  board of  directors  determined  that  certain  amounts
reported in its unaudited condensed  consolidated  interim financial  statements
for the quarters  ended March 31, 2006 and June 30, 2006, and for the six months
ended June 30,  2006 and nine  months  ended  September  30,  2006  needed to be
restated as described below.

While  performing  their audit of our  financial  statements  for the year ended
December 31, 2006,  Marcum & Kliegman LLP ("M&K"),  our  independent  registered
public accounting firm,  discovered that the accounting for certain transactions
occurring during the quarter ended March 31, 2006 and the quarter ended June 30,
2006,  may have been in error.  M&K  informed  our  management  of the  possible
misstatements.  Upon review of these transactions our management discovered that
the accounting for these transactions resulted in a $2,408,250  overstatement of
its  loss  for  the  quarterly  period  ended  March  31,  2006  and a  $593,765
overstatement  of its loss for the quarterly  period ended June 30, 2006,  which
also resulted in an overstatement of the year to date losses in the six and nine
month  periods  ended  June  30,  2006 and  September  30,  2006,  respectively.
Specifically,  we recorded for the three months ended March 31, 2006,  (1) a net
loss of $858,213 on the settlement of various liabilities under our creditor and
claimant  liabilities  restructuring  program when we should have recorded a net
gain of approximately  $906,987,  (2) excess non-cash  interest of $358,000 with
respect to a conversion  option that became  effective  under two of our Interim
Bridge Financing III notes and (3) charged,  as interest expense, a $285,050 fee
paid  to  the  placement  agent  in  our  Series  A  Preferred  stock  financing
transaction  that should  have been  recorded  as a  reduction  of the  offering
proceeds.  For the three months  ended June 30, 2006,  we recorded a net gain of
$371,616  on the  settlement  of  various  liabilities  under our  creditor  and
claimant  liabilities  restructuring  program when we should have recorded a net
gain of approximately  $965,381.  The nature of the adjustments  required in the
creditor and claimant liabilities  restructuring in the quarters ended March 31,
2006 and June 20, 2006,  relate to an  overvaluation of the Series A-1 Preferred
shares  issued in the exchange  offer offset by gains on the  extinguishment  of
liabilities   that  originated  in  connection  with  obligations  to  issue  or
repurchase stock.

We are  continuing  to  evaluate  potential  changes  to make  in our  financial
reporting procedures to enable us to reduce financial reporting risks that exist
as a result of our limited  resources.  We are  continuing to evaluate our risks
and  resources.  We will  seek  to  make  additional  changes  in our  financial
reporting  systems and procedures  wherever  necessary and appropriate to ensure
their effectiveness in future periods.


                                       69



ITEM 8B. OTHER INFORMATION

Not Applicable.


                                    PART III

ITEM 9.  DIRECTORS,   EXECUTIVE   OFFICERS,   PROMOTERS  AND  CONTROL   PERSONS;
COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT

DIRECTORS AND EXECUTIVE OFFICERS OF PATRON SYSTEMS, INC. AS OF MARCH 28, 2007

ROBERT W. CROSS, CHAIRMAN OF THE BOARD OF DIRECTORS; AGE 69

Robert  Cross  joined the  Company on February  28, 2005 as its Chief  Executive
Officer and served in that capacity  until his  resignation on January 18, 2007.
Since  January 18,  2007,  Mr.  Cross has served as the Chairman of the Board of
Directors  of the  Company.  Mr.  Cross has more  than  twenty  years  CEO-level
experience  in  the  development  and  marketing  of  information  technologies,
including secure systems for intelligence  agencies and NATO markets.  From 1984
through 2004, Mr. Cross was Chief Executive Officer of Cross Technologies, Inc.,
a  business  process  outsourcing  firm  specializing  in  the  structuring  and
commercialization of information technologies. From 1993 through 1998, Mr. Cross
was President and CEO of Nanophase Technologies Corp. (NASDAQ:  NANX). From 1984
through  1989,  he  was  Chairman  and  CEO  of  Delta  Data  Systems  Corp.,  a
manufacturer of secure  computers and  peripherals  for government  intelligence
agencies.  From 1983 to 1984, Mr. Cross led the financial  turnaround of Control
Video Corporation, predecessor to America Online (AOL). Prior thereto, Mr. Cross
was General Counsel of Electronic Data Systems.  Prior thereto,  Mr. Cross was a
securities  counsel with Winthrop  Stimson Putnam & Roberts.  Mr. Cross received
his business and legal education at Washington  University in St. Louis. He is a
Marine  Corps  veteran,  and is an active  member  of  Business  Executives  for
National Security and the Illinois Technology  Development  Alliance.  Mr. Cross
has served as a director  since  February  28, 2005 with a term  expiring at the
Company's 2007 Annual Meeting of Stockholders.

BRADEN WAVERLEY, CHIEF EXECUTIVE OFFICER AND DIRECTOR; AGE 40

Mr.  Waverley  joined the  Company on February  17, 2006 as its Chief  Operating
Officer  and served in that  capacity  until  January 18, 2007 at which time Mr.
Waverley was elected Chief  Executive  Officer of the Company.  Mr. Waverley has
been  an  active   advisor  to  start-up   companies  in  technology   services,
distribution and software,  Mr. Waverley was most recently President of Vsource,
Inc., a publicly traded business  process  outsourcing  (BPO) services firm from
2002 to  2004.  While at  Vsource,  he was  responsible  for  sales,  marketing,
solutions  development,  public and investor relations,  and strategic planning.
Under his leadership the Company expanded account  acquisition,  positioning the
business for a successful sale to an Asian based investment  group. From 1996 to
2001, Mr.  Waverley was with Dell Inc.,  where he was Vice President and General
Manager in the company's Canadian  operations.  With full P&L responsibility for
the Consumer and Small Business Divisions, he grew the combined business unit to
over  $500  million  in sales  and the top  market  share  position  in  Canada.
Previously,  he held marketing and general  management posts for Dell's business
throughout  the  Asia-Pacific  region,  where he grew a new  business  unit over
five-fold,  with sales in excess of $250 million.  Prior to Dell,  Mr.  Waverley
co-founded   Paradigm  Research,   a  successful   management   consulting  firm
specializing in business  process  automation and redesign  strategies.  Clients
came  from  industries  such  as  computer   hardware,   software  and  wireless
technology.  Earlier,  Mr.  Waverley held  operations  and marketing  management
positions  at  Motorola,  Inc. Mr.  Waverley  holds a bachelors  degree from the
University  of  Wisconsin at Madison,  and a masters of business  administration
from the J.L. Kellogg Graduate School of Management at Northwestern  University.
Mr.  Waverley has served as a director  since July 20, 2006 with a term expiring
at the Company's 2008 Annual Meeting of Stockholders.

BRETT NEWBOLD, PRESIDENT & CHIEF TECHNOLOGY OFFICER; AGE 54

Mr. Newbold rejoined the Company on February 28, 2005 as its President and Chief
Technology  Officer.  From  October  2002 until June 2003,  Mr.  Newbold was the
Company's Chief Technology Officer and President, Technology Products Group. Mr.
Newbold has more than twenty-five  years of software  development and technology
company  management  experience.  From 1989 through 1997,  Mr.  Newbold was Vice
President/Research  &  Development,  New  Technologies  for  Oracle  Corporation
(NASDAQ: ORCL), where he held senior operating management responsibility for the
selection,  development and integration of new technologies,  reporting directly
to


                                       70



Oracle's Chief Executive Officer, Mr. Larry Ellison. Thereafter, Mr. Newbold was
President and Chief Operating Officer of Open Text Corporation (NASDAQ: OTEX), a
market leader of collaboration and knowledge  management  software.  Since 1999,
Mr. Newbold served as an Executive  Consultant to various  software  development
companies.  Mr. Newbold received his  undergraduate  education in physics at the
University of Washington.

MARTIN T. "TORK" JOHNSON, CHIEF FINANCIAL OFFICER; AGE 55

Mr.  Johnson  joined the  Company on February  17,  2006 as its Chief  Financial
Officer.  Mr.  Johnson  has  served  as  an  independent   consultant  providing
financial,  strategy and operations consulting services since 2002. From 2000 to
2001, he was Vice  President - Planning and Business  Development  for Cabletron
Systems,  a provider  of  network  hardware,  network  management  software  and
consulting  services.  From 1999 to 2000, Mr. Johnson was Senior Vice President,
Chief Financial Officer for MessageMedia, Inc., a publicly-held e-mail messaging
services  and  software  company.  From 1993 to 1999,  he worked for  Technology
Solutions  Company,  a  publicly-held   management  and  information  technology
professional  services  firm.  Initially,  he led the business  case  consulting
practice  serving as Vice President,  Business Case Consulting and from February
1994 was the firm's Senior Vice President and Chief Financial Officer. From 1990
to 1993, he was Corporate  Controller for The Marmon Group, Inc., a $4.5 billion
autonomous  association of over 70 independent  member  companies.  From 1987 to
1990,  he was Vice  President-Finance  and  Chief  Financial  Officer  of COMNET
Corporation,  a publicly-held  computer  software and computer services firm and
was  also  Vice   President-Finance   and  Chief   Financial   Officer  for  its
publicly-held subsidiary, Group 1 Software, Inc. Mr. Johnson holds a bachelor of
science in electrical  engineering  degree from Lehigh  University and a masters
degree in  management  from the J.L.  Kellogg  Graduate  School of Management at
Northwestern University.

HEIDI B. NEWTON, VICE PRESIDENT - FINANCE AND ADMINISTRATION; AGE 45

Ms.   Newton  most   recently  was  Vice   President  of  Finance  and  CFO  for
IDK/NETdelivery,  having joined IDK/NETdelivery in June 2001. Prior to that, she
was CFO for both  ENSCICON  Corporation  and  American  Pharmaceutical  Services
(APS).  In  both  roles,  Ms.  Newton  was  responsible  for  reengineering  and
development of all areas of finance and administration  with a focus on customer
service.  With  APS,  she was  responsible  for over 20  acquisitions  and joint
ventures, assisting in growing the business from $50M to more than $330M in five
years.  She  has  participated  with a  variety  of  institutional  and  private
investors to market companies and business segments.  Ms. Newton is a CPA, holds
a BS in Accounting and an MBA from California Polytechnic University.

GEORGE M. MIDDLEMAS, DIRECTOR; AGE 60

Mr. Middlemas is Managing General Partner of Apex Investment Partners.  Prior to
joining Apex in 1991, Mr. Middlemas was a Senior Vice President and Principal of
Inco Venture  Capital  Management.  Prior  thereto,  he was Vice President and a
member of the investment  commitment  committee of Citicorp Venture Capital. Mr.
Middlemas was a founder of both America  Online (AOL) and RSA Security  (NASDAQ:
RSAS).  Mr.  Middlemas  holds a B.A.  in  history  and  political  science  from
Pennsylvania State University;  an M.A. in political science from the University
of  Pittsburgh;  and an M.B.A.  from the  Harvard  Graduate  School of  Business
Administration.  Mr.  Middlemas has served as a director since February 28, 2005
with a term expiring at the Company's 2009 Annual Meeting of Stockholders.

AUDIT COMMITTEE FINANCIAL EXPERT

Our board of directors  has  determined  that we do not have an audit  committee
financial  expert  serving  on the board of  directors.  Our board of  directors
performs the functions of the audit committee.  We are in the process of finding
an audit committee financial expert to fill this position.

SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE

Based upon its review of Forms 3, 4 and 5 submitted to us, we are not aware that
any  individuals  failed to file on a timely  basis,  as  disclosed in the forms
above, reports required by Section 16(a) of the Exchange Act.

CODE OF ETHICS

Our board of  directors  has  adopted a Code of  Ethical  Conduct  (the "Code of
Conduct"). We require all employees, directors and officers, including our Chief
Executive Officer and Chief Financial Officer,  to adhere to the Code of Conduct
in addressing legal and ethical issues encountered in conducting their work. The
Code of Conduct requires


                                       71



that these  individuals  avoid  conflicts of interest,  comply with all laws and
other legal  requirements,  conduct business in an honest and ethical manner and
otherwise  act with  integrity  and in our best  interest.  The Code of  Conduct
contains  additional  provisions that apply  specifically to our Chief Financial
Officer  and  other  financial  officers  with  respect  to  full  and  accurate
reporting.  We will provide to any person without  charge,  upon written request
sent to our executive offices and addressed to our corporate  secretary,  a copy
of the Code of Conduct.

ITEM 10. EXECUTIVE COMPENSATION

SUMMARY COMPENSATION TABLE

The following table sets forth, as to our named executive officers,  information
concerning all  compensation  paid to our named executive  officers for services
rendered  during our fiscal year ended  December  31, 2006.  No other  executive
officers  received total  compensation in excess of $100,000 for the fiscal year
ended December 31, 2006.



                                                                    Option
                                                                    Awards
  Name and Principal Position       Year     Salary($)  Bonus($)    ($)(1)    Total($)
-------------------------------   --------   --------   --------   --------   --------
                                                               
Robert Cross ..................     2006     $200,000   $278,558       --     $478,558
Chief Executive Officer(2)
-------------------------------   --------   --------   --------   --------   --------
Braden Waverley ...............     2006     $191,667       --     $ 96,850   $288,517
Chief Operating Officer(3)
-------------------------------   --------   --------   --------   --------   --------
Brett Newbold .................     2006     $182,361       --         --     $182,361
President & Chief Technology
Officer(4)
-------------------------------   --------   --------   --------   --------   --------
Martin T. Johnson .............     2006     $177,403       --     $ 34,589   $211,992
Chief Financial Officer(5)
-------------------------------   --------   --------   --------   --------   --------
Heidi Newton ..................     2006     $180,000       --         --     $180,000
Vice  President - Finance &
Administration(6)
-------------------------------   --------   --------   --------   --------   --------


(1)      Assumptions  relating  to the  estimated  fair  value  of  these  stock
         options,  which the Company is accounting  for in accordance  with SFAS
         123(R)  are as  follows:  risk-free  interest  rate of 4.45%;  expected
         dividend yield zero percent;  expected  option life of four years;  and
         current volatility of 125%.

(2)      Mr.  Cross became our Chief  Executive  Officer on February 28, 2005 in
         connection  with  the  consummation  of  Bridge  Financing  I  and  our
         acquisitions  of  LucidLine  and  CSSI.  Mr.  Cross  is  subject  to an
         employment agreement the terms of which are described hereafter. During
         the year ended  December  31, 2006,  Mr. Cross earned a bonus  totaling
         $278,558 associated with the Bonus Arrangement described hereafter.

(3)      Mr. Waverley  became our Chief Operating  Officer on February 17, 2006.
         Mr.  Waverley  was granted an option to purchase  73,371  shares of our
         common stock at a per share price of $1.65,  which option terminates on
         February 16, 2016. Mr.  Waverley is subject to an employment  agreement
         the terms of which are described hereafter.

(4)      Mr.  Newbold was named our  President and Chief  Technology  Officer on
         February  28,  2005 in  connection  with  the  consummation  of  Bridge
         Financing I and our  acquisitions of LucidLine and CSSI. Mr. Newbold is
         subject to an  employment  agreement  the terms of which are  described
         hereafter.

(5)      Mr.  Johnson became our Chief  Financial  Officer on February 17, 2006.
         Mr.  Johnson  was granted an option to  purchase  26,204  shares of our
         common stock at a per share price of $1.65,  which option terminates on
         February 16, 2016.  Mr.  Johnson is subject to an employment  agreement
         the terms of which are described hereafter.  Mr. Johnson's compensation
         for the period  February  17, 2006 to December  31, 2006 was  $156,667.
         Additionally, Mr. Johnson served as an independent financial consultant
         assisting  the  Company  in the  preparation  and  filing  its 2005 SEC
         filings and other projects and assignments.  For independent consulting
         services  provided  during the period  January 1, 2006 to February  17,
         2006,  Mr.  Johnson was paid $20,736.  This amount has been included in
         the Salary total.


                                       72



(6)      Ms. Newton became our Vice  President - Finance and  Administration  on
         February  26,  2005 in  connection  with  the  consummation  of  Bridge
         Financing I and our  acquisitions of LucidLine and CSSI. We do not have
         an employment agreement with Ms. Newton.

OUTSTANDING EQUITY AWARDS AT FISCAL YEAR-END TABLE

The following table presents information  regarding  outstanding options held by
our named  executive  officers as of the end of our fiscal year ending  December
31, 2006.



---------------------  --------------------   --------------------   ---------  ----------
                       Number of Securities   Number of Securities
                            Underlying             Underlying         Option      Option
                        Unexercised Options    Unexercised Options   Exercise   Expiration
        Name              (#) Exercisable      (#) Unexercisable     Price ($)     Date
---------------------  --------------------   --------------------   ---------  ----------
                                                                      
Robert Cross ........              33,334(1)                --       $   19.50    6/30/15
---------------------  --------------------   --------------------   ---------  ----------
Braden Waverley .....              28,125(2)              45,246(2)  $    1.65    2/16/16
---------------------  --------------------   --------------------   ---------  ----------
Brett Newbold .......                --                     --           --          --
---------------------  --------------------   --------------------   ---------  ----------
Martin T. Johnson ...              10,045(3)              16,159(3)  $    1.65    2/16/16
---------------------  --------------------   --------------------   ---------  ----------
Heidi Newton ........               2,084(4)               4,583(4)  $   10.20    8/16/15
---------------------  --------------------   --------------------   ---------  ----------


(1)      On July 1, 2005,  Mr.  Cross was granted an option to  purchase  33,334
         shares of our  common  stock at a per share  exercise  price of $19.50.
         This option vested as follows:  25% on July 1, 2005 and 25% on the last
         calendar day of each fiscal quarter thereafter until fully vested. This
         option terminates on June 30, 2015.

(2)      On February  17,  2006,  Mr.  Waverly was granted an option to purchase
         73,371  shares of our  common  stock at a per share  exercise  price of
         $1.65.  This  option  vests as follows:  20% on  February  17, 2006 and
         1/48th of the  balance  on the last day of each month for the 48 months
         following  February 17, 2006.  This option  terminates  on February 16,
         2016.

(3)      On February  17,  2006,  Mr.  Johnson was granted an option to purchase
         26,204  shares of our  common  stock at a per share  exercise  price of
         $1.65.  This  option  vests as follows:  20% on  February  17, 2006 and
         1/48th of the  balance  on the last day of each month for the 48 months
         following  February 17, 2006.  This option  terminates  on February 16,
         2016.

(4)      On August 17, 2005,  Ms. Newton was granted an option to purchase 6,667
         shares of our  common  stock at a per share  exercise  price of $10.20.
         This option vests as follows: 25% on August 17, 2006 and 6.25% for each
         quarter thereafter until fully vested. This option terminates on August
         16, 2015.

DIRECTOR COMPENSATION AND INDEPENDENCE

Patron's non-employee  directors do not receive compensation for their services.
Directors are reimbursed for travel expenses associated with attendance at Board
meetings.  There were no  reimbursement  of travel expenses in each of the years
ended December 31, 2006 and 2005. We do not have a separately  designated audit,
compensation  or nominating  committee of our board of  directors.  Our board of
directors  performs the  functions  of the audit,  compensation  and  nominating
committees.  We are not a "listed company" under SEC rules and are therefore not
required to have separate  committees  comprised of  independent  directors.  We
have, however, determined that George Middlemas is "independent" as that term is
defined in Section 4200 of the Marketplace Rules as required by the NASDAQ Stock
Market.


                                       73



EXECUTIVE EMPLOYMENT AGREEMENTS

BRADEN WAVERLEY, CHIEF EXECUTIVE OFFICER - EMPLOYMENT AGREEMENT

On February 17, 2006, we entered into an  employment  agreement  (the  "Waverley
Agreement") with Braden Waverley  ("Waverley"),  to serve as our Chief Operating
Officer. Mr. Waverley became our Chief Executive Officer on January 18, 2007 and
the terms of the Waverley  Agreement  remain in force.  The term of the Waverley
Agreement is one year with automatic  one-year  renewal  unless Mr.  Waverley is
provided with written  notice of  non-renewal 90 days prior to expiration of the
current term of the Waverley  Agreement.  The Waverley  Agreement provides for a
base  salary of  $200,000  per  year.  The  Waverley  Agreement  provides  for a
performance bonus determined in accordance with revenue  milestones  established
by the Board of  Directors  on a quarterly  basis.  Mr.  Waverley is eligible to
receive a bonus of up to 75% of base  salary for each  quarter  that the Company
achieves  the  agreed  upon  revenue  milestones.   Additionally,  the  Waverley
Agreement  provides for the grant of stock options in an amount  representing an
aggregate 3.5% of the outstanding  shares of Company common stock on the date of
grant  ("Waverley  Initial  Grant").  The Waverley  Initial  Grant is for 73,371
shares at an exercise price of $1.65 per share.  These options have a term of 10
years and vest 20% on the date of grant and  1/48th of the  balance  on the last
day of each month for the next 48 months  following the  effective  date of this
agreement.

On January 24, 2007,  we issued to Mr.  Waverley  options to purchase  2,047,121
shares of our common stock at an exercise price of $0.40 per share.  The options
have a term of 10 years  and vest with  respect  to 20% on the date of grant and
1/48th of the balance on the last day of each month for the 48 months  following
the date of grant until fully vested. The options expire on January 23, 2017. We
have agreed with Mr. Waverley,  pursuant to an amendment dated January 24, 2007,
of the Waverley  Agreement that these options fulfill our obligation to issue to
Mr. Waverley  certain options pursuant to the Waverley  Agreement.  The Waverley
Agreement  previously  provided for the grant of an option which,  together with
the option previously granted to Mr. Waverley on February 17, 2006, would enable
Mr.  Waverley to purchase  shares of our common stock  representing  3.5% of the
outstanding shares of our common stock on a fully-diluted  basis as of some date
after July 21, 2006 to be mutually agreed upon with Mr.  Waverley.  The Waverley
Agreement  also provided for the grant of an additional  option to purchase that
number of shares of our common  stock  representing  an aggregate of 3.5% of the
outstanding  shares  of our  common  stock  on a  fully-diluted  basis  upon Mr.
Waverley's appointment as our Chief Executive Officer.

MARTIN T. JOHNSON, CHIEF FINANCIAL OFFICER - EMPLOYMENT AGREEMENT

On February 17, 2006,  we entered into an  employment  agreement  (the  "Johnson
Agreement") with Martin T. Johnson ("Johnson"), our Chief Financial Officer. The
term of the Johnson Agreement is one year with automatic one-year renewal unless
Mr.  Johnson is provided  with written  notice of  non-renewal  90 days prior to
expiration of the current term of the Johnson  Agreement.  The Johnson Agreement
provides for a base salary of $180,000 per year. The Johnson Agreement  provides
for a  performance  bonus  determined  in  accordance  with  revenue  milestones
established  by the board of  directors  on a quarterly  basis.  Mr.  Johnson is
eligible to receive a bonus of up to 50% of base salary for each quarter that we
achieve the agreed upon revenue milestones.  Additionally, the Johnson Agreement
provides for the grant of stock options in an amount  representing  an aggregate
1.25%  of the  outstanding  shares  of our  common  stock  on the  date of grant
("Johnson Initial Grant").  The Johnson Initial Grant is for 26,204 shares at an
exercise  price of $1.65 per share.  These  options  have a term of 10 years and
vest 20% on the date of grant and 1/48th of the  balance on the last day of each
month for the next 48 months following the effective date of this agreement.

On January 24,  2007,  we issued to Mr.  Johnson an option to  purchase  731,114
shares of our common stock at an exercise  price of $0.40 per share.  The option
has a term of 10 years and vests  with  respect  to 20% on the date of grant and
1/48th of the balance on the last day of each month for the 48 months  following
the date of grant until fully vested. The option expires on January 23, 2017. We
have agreed with Mr.  Johnson,  pursuant to an amendment dated January 24, 2007,
of the Johnson  Agreement,  that this option fulfills our obligation to issue to
Mr.  Johnson  certain  options  pursuant to the Johnson  Agreement.  The Johnson
Agreement  previously  provided for the grant of an option which,  together with
the option previously  granted to Mr. Johnson on February 17, 2006, would enable
Mr.  Johnson to purchase  shares of our common stock  representing  1.25% of the
outstanding shares of our common stock on a fully-diluted  basis as of some date
after July 21, 2006 to be mutually agreed upon with Mr. Johnson.


                                       74



ROBERT CROSS - BONUS ARRANGEMENT

On March 7, 2006, our board of directors, in executive session without Mr. Cross
being present, approved a bonus arrangement ("Bonus Arrangement") for Mr. Cross.
The Bonus Arrangement  provides for (i) a cash bonus equal to $200,000,  grossed
up for taxes (the "Cash Bonus"), (ii) the Cash Bonus would be payable only after
agreement has been reached with creditors  holding the applicable  percentage of
Patron's  creditor  obligations  agree to convert  their  obligations  under the
creditor  and claimant  liabilities  restructuring  and when the funding  escrow
established by Laidlaw has been released (the "Eligibility  Date"), (iii) 50% of
the Cash Bonus would be paid on the Eligibility Date, and the other 50% would be
paid in ten  equal  monthly  installments  beginning  one  month  following  the
Eligibility Date, and (iv) on the Eligibility Date, Mr. Cross would be granted a
stock  option in an amount  representing  an aggregate  2.5% of the  outstanding
shares of Company common stock on the Eligibility  Date ("Initial Cross Grant").
The service  conditions  associated with Mr. Cross' employment were modified and
extended.  Mr.  Cross and the Company  agreed that he would remain as CEO beyond
the June 30, 2006 termination  date of his employment  agreement to complete the
creditor and claimant liabilities  restructuring and to raise additional working
capital.  Based on these changes, Mr. Cross' bonus arrangement was modified such
that the Company began, in August 2006, monthly payments of $10,000 for the cash
portion of the bonus. The Company accrued the unpaid balance of the cash portion
of the bonus  arrangement  at December 31, 2006, Mr. Cross' last date of payroll
as CEO of the Company. The total amount of Mr. Cross' bonus is $278,558 of which
$107,293  remained  unpaid at  December  31,  2006 and was  therefore  booked to
accrued  payroll at that date.  Additionally,  with the  extension of Mr. Cross'
service period,  the granting of Mr. Cross' stock option award was extended to a
future date.

On January 24, 2007, we issued to Mr. Cross an option to purchase 757,318 shares
of our common  stock at an exercise  price of $0.40 per share.  The option has a
term of 10 years and vests  with  respect to 20% on the date of grant and 1/48th
of the  balance  on the last day of each month for the 48 months  following  the
date of grant until fully  vested.  The option  expires on January 23, 2017.  We
have agreed with Mr. Cross that this option  fulfills our obligation to issue to
Mr. Cross certain options  pursuant to the Bonus  Arrangement  which  previously
provided  for the grant of an option  which would  enable Mr.  Cross to purchase
shares of our common stock  representing  2.5% of the outstanding  shares of our
common stock as of some date after June 14, 2006 to be mutually agreed upon with
Mr. Cross.

ITEM 11. SECURITY  OWNERSHIP OF CERTAIN  BENEFICIAL  OWNERS AND  MANAGEMENT  AND
RELATED STOCKHOLDER MATTERS

The  following  table  sets  forth  certain  information   regarding  beneficial
ownership of our Common Stock as of March 28, 2007, by (i) each person (or group
of affiliated  persons) who is known by us to  beneficially  own more than 5% of
the  outstanding  shares of our Common  Stock,  (ii) each of our  directors  and
executive  officers,  and (iii) all of our executive officers and directors as a
group.  Under Rule 13d-3,  certain shares may be deemed to be beneficially owned
by more than one person (if, for example, persons share the power to vote or the
power  to  dispose  of  the  shares).  In  addition,  shares  are  deemed  to be
beneficially owned by a person if the person has the right to acquire the shares
(for example, upon exercise of an option) within 60 days of the date as of which
the  information  is provided.  In  computing  the  percentage  ownership of any
person,  the amount of shares  outstanding  is deemed to  include  the amount of
shares  beneficially  owned by such person  (and only such  person) by reason of
these acquisition  rights. As a result,  the percentage of outstanding shares of
any person as shown in this  table does not  necessarily  reflect  the  person's
actual  ownership or voting power with respect to the number of shares of Common
Stock actually  outstanding at March 28, 2007. As of March 28, 2007,  there were
14,512,260 shares of Common Stock  outstanding.  Except as otherwise  indicated,
the  address  of each of the  executive  officers,  directors  and more  than 5%
stockholders  named below is c/o Patron Systems,  Inc.,  5775 Flatiron  Parkway,
Suite 230, Boulder, CO 80301.



                                                AMOUNT AND NATURE OF
CERTAIN BENEFICIAL OWNERS                       BENEFICIAL OWNERSHIP   PERCENT OF CLASS
----------------------------------------------  --------------------   ----------------
                                                                              
DIRECTORS, EXECUTIVE OFFICERS
Robert W. Cross(1) ...........................               237,509                1.6%
Braden Waverley(2) ...........................               578,915                3.8%
Brett Newbold(3) .............................               167,084                1.1%
Martin T. Johnson(4) .........................               206,756                1.4%
Heidi B. Newton(5) ...........................                52,989                  *
George M. Middlemas(6) .......................                   759                  *
ALL DIRECTORS AND EXECUTIVE ..................             1,244,012                8.6%
OFFICERS AS A GROUP(7)


                                       75




                                                AMOUNT AND NATURE OF
CERTAIN BENEFICIAL OWNERS                       BENEFICIAL OWNERSHIP   PERCENT OF CLASS
----------------------------------------------  --------------------   ----------------
                                                                             

5% STOCKHOLDERS
Apex Investment Fund V, L.P.(8) ..............            10,080,898               49.3%
    225 West Washington St., Ste. 1500
    Chicago, Illinois 60606

Per Gustafsson(9) ............................               994,289                6.8%
    Sodergatan 20A
    Vaxjo, Sweden 35235

Arco Van Nieuwland(10) .......................             2,065,529               12.8%
    Bunde 8
    2970 Schilde
    Belgium

Sherleigh Associates, Inc. Profit Sharing ....               837,501                5.8%
Plan
    c/o Jack Silver
    920 5th Avenue, Apt. 3B
    New York, New York 10021

Logan Hurst(11) ..............................               914,636                5.9%
    405 Hattie Clark Road
    Greene, NY 13778


*  Less than 1%

(1)      Consists of 235,286  shares of Common  Stock that may be acquired  from
         the  Company  within 60 days of March 28,  2007  upon the  exercise  of
         outstanding stock options.

(2)      Consists of 578,916  shares of Common  Stock that may be acquired  from
         the  Company  within 60 days of March 28,  2007  upon the  exercise  of
         outstanding stock options.

(3)      Consists of 49,167  shares of Common Stock that are  directly  owned by
         Mr.  Newbold,  86,667 shares of Common Stock owned by Newbold,  Inc., a
         corporation  of which Mr.  Newbold is the sole  stockholder  and 31,250
         shares of Common Stock that may be acquired from the Company  within 60
         days of March 28, 2007.

(4)      Consists of 206,756  shares of Common  Stock that may be acquired  from
         the  Company  within 60 days of March 28,  2007  upon the  exercise  of
         outstanding stock options.

(5)      Consists of 46,251 shares of Common Stock that may be acquired from the
         Company  within  60  days  of  March  28,   2007upon  the  exercise  of
         outstanding stock options.

(6)      George  Middlemas is one of three managers of Apex Management III, LLC,
         and one of five  managers of each of Apex  Management  IV, LLC and Apex
         Management  V, LLC.  Apex  Management  III,  LLC is the manager of Apex
         Investment  Strategic  Partners,  LLC and the  general  partner of Apex
         Investment  Fund III,  L.P. Apex  Management  IV, LLC is the manager of
         Apex Investment  Strategic  Partners IV, LLC and the general partner of
         Apex  Investment  Fund IV, L.P.  Apex  Management V, LLC is the general
         partner of Apex Investment Fund V, L.P. Mr. Middlemas,  in his capacity
         as a manager of each of Apex  Management  III, LLC, Apex Management IV,
         LLC and Apex Management V, LLC, cannot independently exercise voting or
         dispositive  power over the shares of Common Stock held by the entities
         controlled by each of Apex Management III, LLC, Apex Management IV, LLC
         and  Apex  Management  V,  LLC.  Mr.  Middlemas   therefore   disclaims
         beneficial  ownership of the shares of the Company's  Common Stock held
         by each of Apex  Investment  Strategic  Partners,  LLC, Apex Investment
         Strategic  Partners  IV, LLC,  Apex  Investment  Fund III,  L.P.,  Apex
         Investment Fund IV, L.P. and Apex Investment Fund V, L.P.

(7)      Consists of 1,098,458  shares of Common Stock that may be acquired from
         the  Company  within 60 days of March 28,  2007  upon the  exercise  of
         outstanding stock options.

(8)      Consists of 3,125,000  shares of Common Stock that may be acquired from
         the  Company  upon the  conversion  of  outstanding  shares of Series A
         Preferred Stock,  1,606,796 shares of Common Stock that may be acquired
         from the Company upon the conversion of outstanding  shares of Series B
         Preferred  Stock  and  1,813,388  shares of  Common  Stock  that may be
         acquired  from the Company upon the exercise of  outstanding  warrants,
         within 60 days of March 28, 2007.

(9)      Consists of 68,520 shares of Common Stock that may be acquired from the
         Company upon the exercise of  outstanding  warrants,  within 60 days of
         March 28, 2007.


                                       76



(10)     Consists of 1,500,000  shares of Common Stock that may be acquired from
         the  Company  upon the  conversion  of  outstanding  shares of Series A
         Preferred Stock and 116,670 shares of Common Stock that may be acquired
         from the Company upon the exercise of outstanding  warrants,  within 60
         days of March 28, 2007.

(11)     Consists of 609,757  shares of Common  Stock that may be acquired  from
         the  Company  upon the  conversion  of  outstanding  shares of Series B
         Preferred Stock and 304,879 shares of Common Stock that may be acquired
         from the Company upon the exercise of outstanding  warrants,  within 60
         days of March 28, 2007.

The  following  table  sets  forth  certain  information   regarding  beneficial
ownership  of our Series A  Preferred  Stock as of March 28,  2007,  by (i) each
person (or group of affiliated  persons) who is known by us to beneficially  own
more than 5% of the outstanding shares of Series A Preferred Stock, (ii) each of
our directors and executive  officers,  and (iii) all of our executive  officers
and directors as a group, as applicable. Under Rule 13d-3, certain shares may be
deemed  to be  beneficially  owned by more than one  person  (if,  for  example,
persons  share the  power to vote or the power to  dispose  of the  shares).  In
addition,  shares are deemed to be beneficially  owned by a person if the person
has the right to acquire the shares (for  example,  upon  exercise of an option)
within 60 days of the date as of which the information is provided. In computing
the  percentage  ownership of any person,  the amount of shares  outstanding  is
deemed to include  the amount of shares  beneficially  owned by such person (and
only such  person)  by  reason of these  acquisition  rights.  As a result,  the
percentage of  outstanding  shares of any person as shown in this table does not
necessarily  reflect the person's actual  ownership or voting power with respect
to the number of shares of Series A  Preferred  Stock  actually  outstanding  at
March  28,  2007.  As of March  28,  2007,  there  were 964  shares  of Series A
Preferred Stock outstanding.


                                        AMOUNT AND NATURE OF
CERTAIN BENEFICIAL OWNERS               BENEFICIAL OWNERSHIP   PERCENT OF CLASS
-------------------------------------   --------------------   ----------------
5% HOLDERS
Apex Investment Fund V, L.P.                        250                    25.9%
   225 West Washington St., Ste. 1500
   Chicago, Illinois 60606

Arco Van Nieuwland                                  120                    12.4%
   Bunde 8
   2970 Schilde
   Belgium

Peter Nordin APS                                     93.3334                9.7%
   Bakkevej 2A
   DK 3070 Snekkersten Denmark

Graham Smith                                         52                     5.4%
   Vicolo Sport 15
   20029 Turbigo
   Milan, Italy


The  following  table  sets  forth  certain  information   regarding  beneficial
ownership  of our Series B  Preferred  Stock as of March 28,  2007,  by (i) each
person (or group of affiliated  persons) who is known by us to beneficially  own
more than 5% of the outstanding shares of Series B Preferred Stock, (ii) each of
our directors and executive  officers,  and (iii) all of our executive  officers
and directors as a group, as applicable. Under Rule 13d-3, certain shares may be
deemed  to be  beneficially  owned by more than one  person  (if,  for  example,
persons  share the  power to vote or the power to  dispose  of the  shares).  In
addition,  shares are deemed to be beneficially  owned by a person if the person
has the right to acquire the shares (for  example,  upon  exercise of an option)
within 60 days of the date as of which the information is provided. In computing
the  percentage  ownership of any person,  the amount of shares  outstanding  is
deemed to include  the amount of shares  beneficially  owned by such person (and
only such  person)  by  reason of these  acquisition  rights.  As a result,  the
percentage of  outstanding  shares of any person as shown in this table does not
necessarily  reflect the person's actual  ownership or voting power with respect
to the number of shares of Series B  Preferred  Stock  actually  outstanding  at
March 28,  2007.  As of March 28,  2007,  there were  790.54  shares of Series B
Preferred Stock outstanding.


                                       77



                                        AMOUNT AND NATURE OF
CERTAIN BENEFICIAL OWNERS               BENEFICIAL OWNERSHIP   PERCENT OF CLASS
--------------------------------------  --------------------   ----------------
5% HOLDERS
Apex Investment Fund V, L.P.                        263.51                 33.3%
    225 West Washington St., Ste. 1500
    Chicago, Illinois 60606

Logan L. Hurst                                      100                    12.6%
    405 Hattie Clark Road
    Greene, New York 13778

Arthur Wirth                                         40                     5.1%
     4900 W. Belmont Ave.
     Chicago, IL   60641


CHANGES IN CONTROL

On January 12, 2006, we issued a Stock  Subscription  Agreement & Mutual Release
to each of our creditors  and claimants  pursuant to which we would sell to such
creditors  and/or claimants shares of our Series A-1 Preferred Stock in exchange
for a  final  and  binding  settlement  with  respect  to any  and  all  claims,
liabilities,  demands,  causes  of  action,  costs,  expenses,  attorneys  fees,
damages,  indemnities,  and  obligations  of every  kind and  nature  that  such
creditors  and/or  claimants may have with us.  Creditors  and/or claimants that
have  accepted  our  offer  have  been  issued  an  aggregate  of  approximately
36,993,054  shares of Series  A-1  Preferred  Stock.  The  shares of Series  A-1
Preferred Stock  automatically  converted into 12,331,056 shares of Common Stock
on July  31,  2006,  upon the  filing  of an  amendment  to our  certificate  of
incorporation,  as amended,  effecting a 1-for-30 reverse stock split.  Based on
14,512,260  shares Common Stock  outstanding as of March 28, 2007, the automatic
conversion of the Series A-1 Preferred  Stock  resulted in our former  creditors
and/or claimants owning approximately 85.0% of the issued and outstanding shares
of Common Stock.

SECURITIES AUTHORIZED FOR ISSUANCE UNDER EQUITY COMPENSATION PLANS

         The  following  table  sets  forth  information  concerning  our equity
compensation plans as of December 31, 2006.




                                  NUMBER OF SECURITIES                        NUMBER OF SECURITIES REMAINING
                                    TO BE ISSUED UPON     WEIGHTED-AVERAGE    AVAILABLE FOR FUTURE ISSUANCE
                                       EXERCISE OF       EXERCISE PRICE OF      UNDER EQUITY COMPENSATION
                                  OUTSTANDING OPTIONS,  OUTSTANDING OPTIONS,   PLANS (EXCLUDING SECURITIES
                                  WARRANTS AND RIGHTS   WARRANTS AND RIGHTS     REFLECTED IN COLUMN (a))
PLAN CATEGORY                             (a)                   (b)                        (c)
--------------------------------  --------------------  --------------------  ------------------------------
                                                                               
Equity compensation plans
approved by security holders ...            --                    --                    5,600,000

Equity  compensation  plans not
approved by security holders[1].         532,636              $  16.34                       --

TOTAL ..........................         532,636              $  16.34                  5,600,000


----------
[1]      Represents options granted pursuant to individual option agreements.


                                       78



ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

TRANSACTIONS WITH EXECUTIVE OFFICERS AND STOCKHOLDERS

Beginning on April 22, 2005 and continuing  through February 17, 2006, Martin T.
Johnson,  prior to becoming  our Chief  Financial  Officer,  worked for us as an
independent  financial  consultant assisting us in the preparation and filing of
our delinquent SEC filings, our 2005 SEC filings, the completion of the Form 8-K
filings  for  the  acquisitions   completed  in  2005  and  other  projects  and
assignments.  Mr.  Johnson  was paid a total of $137,593  for fees and  expenses
incurred during this time period.

On January 28, 2006, we issued Bridge III Extension  Warrants to purchase 20,000
shares of our common stock to Apex. The fair value of these Bridge III Extension
Warrants amounted to $20,316.

On February 13, 2006, we issued Bridge III Extension  Warrants to purchase 6,000
shares of our common stock to Apex. The fair value of these Bridge III Extension
Warrants amounted to $6,634.

On February 21, 2006, we issued Bridge III Extension  Warrants to purchase 1,250
shares of our common stock to Apex. The fair value of these Bridge III Extension
Warrants amounted to $1,382.

On March 1, 2006,  we issued  Bridge III  Extension  Warrants to purchase  6,417
shares of our common stock to Apex. The fair value of these Bridge III Extension
Warrants amounted to $10,029.

On March 17, 2006,  we issued Bridge III  Extension  Warrants to purchase  3,750
shares of our common stock to Apex. The fair value of these Bridge III Extension
Warrants amounted to $5,861.

On March 22, 2006,  we issued Bridge III  Extension  Warrants to purchase  2,500
shares of our common stock to Apex. The fair value of these Bridge III Extension
Warrants amounted to $3,907.

On March 27, 2006,  in repayment and full  settlement  of aggregate  obligations
outstanding to Apex amounting to $8,112,177,  including obligations  outstanding
under the Bridge III Notes issued to Apex, we issued to Apex  10,140,221  shares
of Series A-1 Preferred Stock.

On March 27, 2006, we issued 179 shares of Series A Preferred Stock and warrants
to purchase  124,306 shares of our common stock to Apex in  consideration  of an
investment of $895,000 in our Series A Preferred Financing.

On April 3, 2006,  in repayment  and full  settlement  of aggregate  obligations
outstanding to Apex  amounting to $373,676,  including  obligations  outstanding
under the Bridge III Notes issued to Apex,  we issued to Apex 467,095  shares of
Series A-1 Preferred Stock.

On April 3, 2006,  we issued 71 shares of Series A Preferred  Stock and warrants
to purchase  49,306  shares of our common stock to Apex in  consideration  of an
investment of $355,000 in our Series A Preferred Financing.

On April 18,  2006,  we entered  into a Stock  Purchase  Agreement  with  Walnut
Valley,  Inc.,  pursuant  to  which  we sold all of the  outstanding  shares  of
LucidLine to Walnut Valley,  Inc. in consideration for a cash payment of $25,000
and the  issuance of a  Promissory  Note in the  principal  amount of $25,000 by
Walnut Valley in our favor.  We consummated the sale of LucidLine as a strategic
business  transaction  designed  to  enhance  our  long-term  profitability  and
strategic operations, and to further streamline our business focus on electronic
message management.

We sold  LucidLine to Walnut  Valley,  Inc. for an  aggregate  consideration  of
$50,000.  In February  2005,  we paid to  LucidLine's  stockholders  cash in the
aggregate  amount of $200,000 and issued an  aggregate of 146,667  shares of our
common stock valued at $3,740,000.

The president of Walnut Valley, Inc., Rafiq Kiswani, was the former president of
LucidLine  prior to our acquisition of LucidLine in February 2005.

On October 13, 2006,  we issued  205.14  shares of Series B Preferred  Stock and
Investor  Warrants to purchase 285,257 shares of our common stock at an exercise
price of $2.40 per share to Apex in consideration of an investment of $1,027,572
in the first closing of our Series B Preferred Financing.


                                       79



On October 27, 2006, we issued 50,000 shares of our common stock to Mr.  Richard
Rozzi in  consideration  of services  to be  rendered  as an investor  relations
consultant to us.

On  November  16,  2006,  we issued 58  shares of Series B  Preferred  Stock and
Investor  Warrants to  purchase  176,830  shares of Common  Stock at an exercise
price of $1.03 per share to Apex in  consideration  of an investment of $290,000
in the second closing of our Series B Preferred Financing.

On November 16, 2006,  in  conjunction  with the second  closing of the Series B
Preferred Financing,  we adjusted the conversion price of the Series B Preferred
Stock  issued in the first  closing  to the  $0.82  per share  conversion  price
associated  with the second  closing and we adjusted the exercise  price and the
number of Investor  Warrants issued in conjunction with the first closing of the
Series B Preferred Financing. Because of this change, Apex was issued additional
Investor  Warrants to purchase 341,312 shares of our common stock at an exercise
price of $1.03 per share.

On February 20, 2007, in consideration of funds advanced in the aggregate amount
of $200,000,  we issued a secured convertible  promissory note (the "2007 Bridge
Note") to Apex in the  principal  amount of $200,000,  and issued a common stock
purchase warrant for 200,000 shares at an exercise price of $1.00 per share. The
common stock purchase  warrants have a term of five (5) years.  Our  obligations
under the 2007 Bridge  Note is secured by liens on all our assets  pursuant to a
Security  Agreement  entered into with Apex on February 20, 2007 (the  "Security
Agreement").  The aggregate  amounts  (principal and any accrued interest) under
the 2007 Bridge Note are payable to Apex on demand with simple interest accruing
on any unpaid  principal  amount at a rate of nine (9) percent per annum. At the
option of Apex,  the 2007 Bridge Note is  convertible  into shares of our common
stock at any time,  in an amount  equal to the  quotient  of the  amounts  being
converted  under the 2007 Bridge Notes  divided by the offering  price per share
associated  with any offering of equity  securities  made by us, or in an amount
equal to the quotient of the amounts  being  converted by the fair value of such
shares.  The Security  Agreement  terminates  upon the full  satisfaction of our
obligations under the 2007 Bridge Note or upon the conversion of the 2007 Bridge
Note.

On March 2,  2007,  March 19,  2007 and  March 27,  2007,  we were  advanced  an
additional  $100,000,  $160,000  and  $165,000,  respectively,  by  Apex.  These
advances  will result in the granting of common stock  purchase  warrants in the
amount of 100,000 shares at an exercise price of $1.25 associated with the March
2, 2007 advance,  160,000 shares at an exercise price of $1.14  associated  with
the March 19, 2007 advance and 165,000  shares at an exercise price of $1.25 per
share  associated  with the March 27, 2007 advance.  These common stock purchase
warrants have a term of 5 years.

We also have employment  agreements with certain of our executive officers.  The
terms of those employment agreements have been previously disclosed.

ITEM 13. EXHIBITS

SEE ATTACHED EXHIBIT INDEX.

ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES

AUDIT FEES

The aggregate  fees billed for each of the fiscal years ended  December 31, 2006
and 2005, for professional services rendered by the principal accountant for the
audit  of  our  annual   financial   statements   were  $261,967  and  $364,786,
respectively.

AUDIT RELATED FEES

None.

TAX FEES

None.


                                       80



ALL OTHER FEES

None

Our Board of Directors is directly  responsible for  interviewing  and retaining
our independent  accountant,  considering the accounting firm's independence and
effectiveness,  and pre-approving the engagement fees and other  compensation to
be paid to, and the services to be conducted by, the independent accountant. The
Board of Directors does not delegate these responsibilities.  During each of the
fiscal years ended  December 31, 2006 and December 31, 2005,  respectively,  our
Board of Directors pre-approved 100% of the services described above.


                                       81



                                   SIGNATURES

In accordance  with Section 13 or 15(d) of the Exchange Act, the Company  caused
this  report to be  signed on its  behalf  by the  undersigned,  thereunto  duly
authorized.


                                         PATRON SYSTEMS, INC.

                                         By: /S/ BRADEN WAVERLEY
                                             ----------------------------
                                             Braden Waverley
                                             Its: Chief Executive Officer

                                         Date: April 10, 2007


                                POWER OF ATTORNEY

The  undersigned  directors  and  officers  of Patron  Systems,  Inc.  do hereby
constitute and appoint each of Braden  Waverley and Heidi Newton with full power
of substitution and resubstitution, as their true and lawful attorney and agent,
to do any  and  all  acts  and  things  in our  name  and on our  behalf  in our
capacities as directors and officers and to execute any and all  instruments for
us and in our names in the capacities  indicated below,  which said attorney and
agent may deem necessary or advisable to enable said  corporation to comply with
the Securities Exchange Act of 1934, as amended, and any rules,  regulations and
requirements of the Securities and Exchange Commission,  in connection with this
Annual Report on Form 10-KSB,  including  specifically,  but without limitation,
power and  authority to sign for us or any of us in our names in the  capacities
indicated below, any and all amendments  (including  post-effective  amendments)
hereto,  and we do hereby  ratify and confirm all that said  attorney  and agent
shall do or cause to be done by virtue hereof.

In  accordance  with the Exchange  Act, this report has been signed below by the
following  persons on behalf of the  Company  and in the  capacities  and on the
dates indicated.

       SIGNATURE                         TITLE                        DATE
------------------------     ------------------------------     ----------------
/S/ BRADEN WAVERLEY             Chief Executive Officer         April 10, 2007
------------------------               & Director
    Braden Waverley

/S/ MARTIN T. JOHNSON           Chief Financial Officer         April 10, 2007
------------------------
    Martin T. Johnson

/S/ HEIDI B. NEWTON            Vice President-Finance and       April 10, 2007
------------------------          and Administration
    Heidi B. Newton          (Principal Accounting Officer)

/S/ ROBERT CROSS                   Chairman of the Board        April 10, 2007
------------------------
    Robert Cross

/S/ GEORGE MIDDLEMAS                    Director                April 10, 2007
------------------------
    George Middlemas


                                       82



                                  EXHIBIT INDEX

EXHIBIT
NUMBER                          DESCRIPTION OF EXHIBIT
-------  -----------------------------------------------------------------------

2.1      Agreement  and Plan of Merger  dated as of  November  24,  2002,  among
         Patron Systems,  Inc., ESC  Acquisition,  Inc. and Entelagent  Software
         Corp. Incorporated by reference to Exhibit 2.3 to the Current Report on
         Form 8-K filed November 27, 2002.

2.2      Supplemental  Agreement  dated as of November  24,  2002,  among Patron
         Systems,  Inc., ESC  Acquisition,  Inc. and  Entelagent  Software Corp.
         Incorporated  by reference to Exhibit 2.4 to the Current Report on Form
         8-K filed November 27, 2002.

2.3      Agreement and Plan of Merger dated as of March 26, 2003, between Patron
         Systems,  Inc. and Patron Holdings,  Inc.  Incorporated by reference to
         Exhibit A to the Definitive Information Statement on Schedule 14C filed
         on March 7, 2003.

2.4      Supplemental  Agreement dated February 24, 2005,  among Patron Systems,
         Inc., LL  Acquisition  I Corp.  and  LucidLine,  Inc.  Incorporated  by
         reference to Exhibit 10.2 to the Current Report on Form 8-K filed March
         2, 2005.

2.5      Agreement  and Plan of Merger dated  February  24,  2005,  among Patron
         Systems, Inc., LL Acquisition I Corp. and LucidLine,  Inc. Incorporated
         by reference  to Exhibit  10.3 to the Current  Report on Form 8-K filed
         March 2, 2005.

2.6      Supplemental  Agreement dated February 24, 2005,  among Patron Systems,
         Inc.,  CSSI  Acquisition Co. I, Inc. and Complete  Security  Solutions,
         Inc. Incorporated by reference to Exhibit 10.5 to the Current Report on
         Form 8-K filed March 2, 2005.

2.7      Agreement  and Plan of Merger dated  February  24,  2005,  among Patron
         Systems,  Inc.,  CSSI  Acquisition  Co. I, Inc. and  Complete  Security
         Solutions,  Inc.  Incorporated  by  reference  to  Exhibit  10.6 to the
         Current Report on Form 8-K filed March 2, 2005.

2.8      Amended and Restated  Supplemental  Agreement  dated as of February 24,
         2005, by and among Patron  Systems,  Inc.,  ESC  Acquisition,  Inc. and
         Entelagent Software Corp.  Incorporated by reference to Exhibit 10.1 to
         the Current Report on Form 8-K filed March 2, 2005.

2.9      Amended and Restated Agreement and Plan of Merger dated March 30, 2005,
         by and among Patron Systems Inc., ESC Acquisition,  Inc. and Entelagent
         Software Corp. Incorporated by reference to Exhibit 10.1 to the Current
         Report on Form 8-K filed April 5, 2005.

3.1.1    Second  Amended and Restated  Certificate  of  Incorporation  of Patron
         Systems,  Inc. dated as of March 7, 2003.  Incorporated by reference to
         Exhibit B to the Definitive Information Statement on Schedule 14C filed
         on March 7, 2003.

3.1.2    Certificate of Designation of  Preferences,  Rights and  Limitations of
         Series  A  Convertible  Preferred  Stock  and  Series  A-1  Convertible
         Preferred  Stock of Patron  Systems,  Inc.  dated as of March 1,  2006.
         Incorporated  by reference to Exhibit 3.1 to the Current Report on Form
         8-K filed on March 31, 2006.

3.2      Amended and Restated By-laws of Patron Systems, Inc., dated as of March
         7, 2003.  Incorporated  by  reference  to  Exhibit C to the  Definitive
         Information  Statement  on Schedule  14C filed with the SEC on March 7,
         2003.

10.1     Registration  Rights  Agreement  dated February 24, 2005,  among Patron
         Systems,  Inc.  and each of the  former  LucidLine,  Inc.  shareholders
         signatory  thereto.  Incorporated  by  reference to Exhibit 10.4 to the
         Current Report on Form 8-K filed March 2, 2005.

10.2     Registration  Rights  Agreement  dated February 24, 2005,  among Patron
         Systems, Inc. and each of the former Complete Security Solutions,  Inc.
         stockholders  signatory  thereto.  Incorporated by reference to Exhibit
         10.7 to the Current Report on Form 8-K filed March 2, 2005.

10.3     Form of  Subordinated  Promissory  Note issued to the former  preferred
         stockholders  of Complete  Security  Solutions,  Inc.  Incorporated  by
         reference to Exhibit 10.8 to the Current Report on Form 8-K filed March
         2, 2005.


                                       83



EXHIBIT
NUMBER                          DESCRIPTION OF EXHIBIT
-------  -----------------------------------------------------------------------

10.4     Form of Common Stock Purchase Warrant issued by Patron Systems, Inc. in
         favor  of  the  former  preferred  stockholders  of  Complete  Security
         Solutions,  Inc.  Incorporated  by  reference  to  Exhibit  10.9 to the
         Current Report on Form 8-K filed March 2, 2005.

10.5     Form of Subscription  Agreement  dated February 28, 2005,  among Patron
         Systems,  Inc. and each of the investors in Interim Bridge Financing I.
         Incorporated  by  reference to Exhibit  10.10 to the Current  Report on
         Form 8-K filed March 2, 2005.

10.6     Registration  Rights  Agreement  dated February 28, 2005,  among Patron
         Systems,  Inc. and each of the investors in Interim Bridge Financing I.
         Incorporated  by  reference to Exhibit  10.11 to the Current  Report on
         Form 8-K filed March 2, 2005.

10.7     Form  of 10%  Senior  Convertible  Promissory  Note  issued  by  Patron
         Systems,  Inc. in favor of  investors  in Interim  Bridge  Financing I.
         Incorporated  by  reference to Exhibit  10.12 to the Current  Report on
         Form 8-K filed March 2, 2005.

10.8     Form of Common Stock Purchase Warrant issued by Patron Systems, Inc. in
         favor of  investors in Interim  Bridge  Financing  I.  Incorporated  by
         reference  to  Exhibit  10.13 to the  Current  Report on Form 8-K filed
         March 2, 2005.

10.9     Registration  Rights  Agreement  dated February 28, 2005,  among Patron
         Systems, Inc. and Laidlaw & Company (UK) Ltd. Incorporated by reference
         to Exhibit 10.14 to the Current Report on Form 8-K filed March 2, 2005.

10.10    Form of Common Stock Purchase Warrant issued by Patron Systems, Inc. in
         favor of Laidlaw & Company (UK) Ltd. in connection with placement agent
         services.  Incorporated  by reference  to Exhibit  10.15 to the Current
         Report on Form 8-K filed March 2, 2005.

10.11    Form of Common Stock Purchase Warrant issued by Patron Systems, Inc. in
         favor of  Laidlaw  &  Company  (UK)  Ltd in  connection  with  advisory
         services.  Incorporated  by reference  to Exhibit  10.16 to the Current
         Report on Form 8-K filed March 2, 2005.

10.12    Executive  Employment  Agreement dated February 28, 2005, between Brett
         Newbold and Patron Systems,  Inc.  Incorporated by reference to Exhibit
         10.12 to the Annual Report on Form 10-KSB filed April 3, 2006.*

10.13    Executive  Employment  Agreement  dated  February 28, 2005,  between J.
         William Hammon and Patron  Systems,  Inc.  Incorporated by reference to
         Exhibit 10.13 to the Annual Report on Form 10-KSB filed April 3, 2006.*

10.14    Registration  Rights  Agreement  dated  March 30,  2005,  among  Patron
         Systems,  Inc.  and  each  of  the  former  Entelagent  Software  Corp.
         shareholders  signatory  thereto.  Incorporated by reference to Exhibit
         10.2 to the Current Report on Form 8-K filed April 5, 2005.

10.15    Form of  Promissory  Note  issued to certain  creditors  of  Entelagent
         Software Corp. Incorporated by reference to Exhibit 10.3 to the Current
         Report on Form 8-K filed April 5, 2005.

10.16    Settlement  Agreement  and Mutual  Release  dated  June 2, 2005,  among
         Patrick J. Allin,  The Allin  Dynastic Trust and Patron  Systems,  Inc.
         Incorporated by reference to Exhibit 10.16 to the Annual Report on Form
         10-KSB filed April 3, 2006.

10.17    Form of Subscription Agreement between Patron Systems, Inc. and each of
         the investors in Interim Bridge Financing II. Incorporated by reference
         to Exhibit 10.3 to the Quarterly Report on Form 10-QSB filed August 22,
         2005.

10.18    Registration  Rights  Agreement among Patron Systems,  Inc. and each of
         the investors in Interim Bridge Financing II. Incorporated by reference
         to Exhibit  10.18 to the Annual  Report on Form  10-KSB  filed April 3,
         2006.

10.19    Form  of 10%  Junior  Convertible  Promissory  Note  issued  by  Patron
         Systems,  Inc. in favor of investors in Interim  Bridge  Financing  II.
         Incorporated by reference to Exhibit 10.19 to the Annual Report on Form
         10-KSB filed April 3, 2006.

10.20    Form of Common Stock Purchase Warrant issued by Patron Systems, Inc. in
         favor of the  Placement  Agent for, and investors  in,  Interim  Bridge
         Financing II.  Incorporated by reference to Exhibit 10.20 to the Annual
         Report on Form 10-KSB filed April 3, 2006.

10.21    Option  Agreement  dated July 1, 2005,  between Robert Cross and Patron
         Systems,  Inc.  Incorporated  by  reference  to  Exhibit  10.1  to  the
         Quarterly Report on Form 10-QSB filed August 22, 2005.*


                                       84



EXHIBIT
NUMBER                          DESCRIPTION OF EXHIBIT
-------  -----------------------------------------------------------------------
10.22    Employment  Agreement  dated July 1,  2005,  between  Robert  Cross and
         Patron Systems,  Inc.  Incorporated by reference to Exhibit 10.2 to the
         Quarterly Report on Form 10-QSB filed August 22, 2005.*

10.23    Form of Subscription Agreement between Patron Systems, Inc. and each of
         the  investors  in  Interim  Bridge  Financing  III.   Incorporated  by
         reference  to Exhibit  10.23 to the Annual  Report on Form 10-KSB filed
         April 3, 2006.

10.24    Registration  Rights  Agreement among Patron Systems,  Inc. and each of
         the  investors  in  Interim  Bridge  Financing  III.   Incorporated  by
         reference  to Exhibit  10.24 to the Annual  Report on Form 10-KSB filed
         April 3, 2006.

10.25    Form  of 10%  Junior  Convertible  Promissory  Note  issued  by  Patron
         Systems,  Inc.  in favor of each of the  investors  in  Interim  Bridge
         Financing III. Incorporated by reference to Exhibit 10.25 to the Annual
         Report on Form 10-KSB filed April 3, 2006.

10.26    Form of Common Stock Purchase Warrant issued by Patron Systems, Inc. in
         favor  of each of the  investors  in,  Interim  Bridge  Financing  III.
         Incorporated by reference to Exhibit 10.26 to the Annual Report on Form
         10-KSB filed April 3, 2006.

10.27    Lease Agreement dated August 31, 2005, between Flatiron Boulder Office,
         Inc. and Patron Systems, Inc. Incorporated by reference to Exhibit 10.1
         to the Quarterly Report on Form 10-QSB filed November 21, 2005.

10.28    Employment  Agreement dated February 17, 2006,  between Patron Systems,
         Inc. and Braden Waverley.  Incorporated by reference to Exhibit 10.1 to
         the Current Report on Form 8-K filed February 23, 2006.

10.29    Employment  Agreement dated February 17, 2006,  between Patron Systems,
         Inc. and Martin  Johnson.  Incorporated by reference to Exhibit 10.2 to
         the Current Report on Form 8-K filed February 23, 2006.

10.30    Option Agreement dated February 17, 2006, between Patron Systems,  Inc.
         and Braden  Waverley.  Incorporated by reference to Exhibit 10.3 to the
         Current Report on Form 8-K filed February 23, 2006.

10.31    Option Agreement dated February 17, 2006, between Patron Systems,  Inc.
         and Martin  Johnson.  Incorporated  by reference to Exhibit 10.4 to the
         Current Report on Form 8-K filed February 23, 2006.

10.32    Form of Subscription Agreement between Patron Systems, Inc. and each of
         the  purchasers  of shares of the  Series A  Preferred  Stock of Patron
         Systems,  Inc. Incorporated by reference to Exhibit 10.1 to the Current
         Report on Form 8-K filed on March 31, 2006.

10.33    Form of Common Stock Purchase Warrant issued by Patron Systems, Inc. in
         favor of each of the  purchasers  of shares of the  Series A  Preferred
         Stock of Patron Systems, Inc. Incorporated by reference to Exhibit 10.2
         to the Current Report on Form 8-K filed on March 31, 2006.

10.34    Registration  Rights  Agreement  dated  March 27,  2006,  among  Patron
         Systems,  Inc.  and each of the  purchasers  of shares of the  Series A
         Preferred  Stock of Patron Systems,  Inc.  Incorporated by reference to
         Exhibit 10.3 to the Current Report on Form 8-K filed on March 31, 2006.

10.35    Form of Stock  Subscription  Agreement  and  Mutual  Release  issued by
         Patron Systems, Inc. in favor of each of the Creditors and/or Claimants
         exchanging  claims  for shares of the  Series  A-1  Preferred  Stock of
         Patron Systems,  Inc.  Incorporated by reference to Exhibit 10.4 to the
         Current Report on Form 8-K filed on March 31, 2006.

10.36    Post Closing  Escrow  Agreement  dated March 27, 2006,  between  Stubbs
         Alderton &  Markiles,  LLP and Patron  Systems,  Inc.  Incorporated  by
         reference  to Exhibit  10.5 to the Current  Report on Form 8-K filed on
         March 31, 2006.

10.37    Form of Subscription Agreement between Patron Systems, Inc. and each of
         the  purchasers  of shares of the  Series B  Preferred  Stock of Patron
         Systems,  Inc. Incorporated by reference to Exhibit 10.1 to the Current
         Report on Form 8-K filed on October 17, 2006.

10.38    Form of Common Stock Purchase Warrant issued by Patron Systems, Inc. in
         favor of each of the  placement  agent and the  purchasers of shares of
         the Series B Preferred  Stock of Patron Systems,  Inc.  Incorporated by
         reference  to Exhibit  10.2 to the Current  Report on Form 8-K filed on
         October 17, 2006.


                                       85



EXHIBIT
NUMBER                          DESCRIPTION OF EXHIBIT
-------  -----------------------------------------------------------------------
10.39    Registration  Rights  Agreement  dated  October 12, 2006,  among Patron
         Systems,  Inc.,  Laidlaw & Company (UK) Ltd. and each of the purchasers
         of shares of the  Series B  Preferred  Stock of  Patron  Systems,  Inc.
         Incorporated by reference to Exhibit 10.3 to the Current Report on Form
         8-K filed on October 17, 2006.

10.40    First  Amendment to Executive  Employment  Agreement dated February 17,
         2006,  entered into on January 24, 2007,  between Patron Systems,  Inc.
         and Braden Waverley.*

10.41    First  Amendment to Executive  Employment  Agreement dated February 17,
         2006,  entered into on January 24, 2007,  between Patron Systems,  Inc.
         and Martin T. Johnson.*

10.42    Secured Convertible  Promissory note dated February 20, 2007, issued by
         Patron Systems, Inc. in favor of Apex Investment Fund V, L.P.

10.43    Security  Agreement  dated February 20, 2007,  between Patron  Systems,
         Inc. and Apex Investment Fund V, L.P.

10.44    Form of  Warrant  issued  by  Patron  Systems,  Inc.  in  favor of Apex
         Investment Fund V, L.P.

24.1     Power  of  Attorney  (included  as part of the  signature  page of this
         Annual Report on Form 10-KSB).

31.1     Certification  of Principal  Executive  Officer  pursuant to Securities
         Exchange  Act Rules  13a-14(a)  and  15d-14(a)  as adopted  pursuant to
         Section 302 of the Sarbanes-Oxley Act of 2002.

31.2     Certification  of Principal  Financial  Officer  pursuant to Securities
         Exchange  Act Rules  13a-14(a)  and  15d-14(a)  as adopted  pursuant to
         Section 302 of the Sarbanes-Oxley Act of 2002.

32.1     Certification  of  Principal  Executive  Officer  pursuant to 18 U.S.C.
         Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley
         Act of 2002.

32.2     Certification  of  Principal  Financial  Officer  pursuant to 18 U.S.C.
         Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley
         Act of 2002.

*  Indicates a management contract or compensatory plan.


                                       86