As filed with the U.S. Securities and Exchange Commission on November 12, 2009

Registration No. 333-

 

 

U.S. SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM S-1

REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933

 

XStream Systems, Inc.

(Exact name of registrant as specified in its charter)

Delaware		3844		201180466
(State or other jurisdiction of incorporation or organization)		(Primary Standard Industrial Classification Code Number)		(I.R.S. Employer Identification Number)

10305 102nd Terrace
Suite 101
Sebastian, FL 32958
Tel: (772) 646-6201
(Address, including zip code, and telephone number, including
area code, of registrant’s principal executive offices)

James J. Lowrey
Chairman and Chief Executive Officer
XStream Systems, Inc.
10305 102nd Terrace
Suite 101
Sebastian, FL 32958
Tel: (772) 646-6201
(Name, address, including zip code, and telephone number,
including area code, of agent for service)

Copies to:
Bruce C. Rosetto, Esq.
Rebecca G. DiStefano, Esq.
Greenberg Traurig, P.A.
5100 Town Center Circle
Suite 400
Boca Raton, FL 33486
Tel: (561) 955-7600; Fax: (561) 367-6254

          Approximate date of commencement of proposed sale to the public: As soon as practicable after the effective date of this registration statement.

          If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box. þ

          If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. o

          If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. o

          If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. o

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

Large Accelerated Filer o		Accelerated Filer o		Non-accelerated Filer o		Smaller Reporting Company þ

     

CALCULATION OF REGISTRATION FEE

Title of each class of

Proposed maximum

Proposed maximum

Amount of

securities to be

offering price per unit

aggregate offering

registration

registered

Amount to be registered

(1)

price (1)

fee

Common Stock, $0.0001par value

2,500,000 Shares (2)

$15.00 per Share

$37,500,000

$2,092.50

Convertible Debentures

$6,000,000 in principal amount of Debentures (2)

$1,000 per Debenture

$6,000,000

$334.80

 

 

PROSPECTUS                                    2,000,000 Shares of Common Stock

          We are offering 2,000,000 shares of our common stock and $5,000,000 in principal amount of 5% subordinated convertible debentures convertible into shares of our common stock. This is our initial public offering and no public market currently exists for our securities.

          We anticipate that the public offering price will be $_____ per share of common stock.

          Interest on the debentures is payable on December 15 of each year, beginning on December 15, 2011. The interest rate on the debentures is 5% per year. We may elect to pay interest in cash, or in the form of shares of our common stock. The debentures initially are convertible by holders into                      shares of our common stock for each $1,000 principal amount of debentures (equivalent to an initial conversion price of $_____ per share based on the issue price of the debentures) as described in this prospectus.

          The debentures will mature on ______, 2020, unless earlier redeemed, repurchased or converted. We may redeem for cash some or all of the debentures at any time on or after ______, 2015 at a price equal to 100% of the principal amount of the debentures to be redeemed plus any accrued and unpaid interest to the redemption date. The debentures are our subordinated, unsecured obligations and rank junior to our other senior indebtedness.

          We are not using an underwriter for our offering of securities. We are conducting this offering as a self-underwriting on a best efforts basis through our officers and directors, and therefore, we will pay no underwriting fees or commissions. We have no arrangement to place the proceeds from this offering in an escrow, trust or similar account.

          We will apply for the listing of our common stock on the NASDAQ Capital Market, and expect such listing to occur concurrently with this offering.

						Proceeds, Before
						Expenses,
		Price to Public				to XStream Systems
Per Share		$				$
Per Debenture		$				$
Total		$				$

We expect that the securities will be ready for delivery on or about ___, 2009.

(1)		Based on 2,767,156 shares outstanding on November 3, 2009, and assuming the conversion of shares of our Series A, B, C, and D preferred stock into 3,510,638 shares of our common stock on the effective date of the registration statement for this offering, the number of shares to be outstanding after this offering excludes the following:

(1)		Reflects our sale of 2,000,000 shares of common stock and convertible debentures offered by this prospectus at an assumed public offering price of $       per share and $1,000 per debenture, after deducting the estimated offering expenses that we will pay, and the application of debt payable by us with respect to our notes payable.
(2)		Total general and administrative expenses, represents total operating expenses less research and development.

          A purchase of our securities involves a high degree of risk. You should consider carefully the following risk factors, in addition to the other information contained in this prospectus and the documents incorporated by reference into this prospectus, before purchasing any securities in this offering.

We have a history of annual net losses which may continue and which may negatively affect our ability to achieve our business objectives, and we received a going concern qualification in our 2008 audit.  

          For the year ended December 31, 2008, we had revenue of $439,000 and a net loss available to common stockholders of $(2,860,254). At December 31, 2008, we had a stockholders’ deficit of $(11,852,015), as compared with $(5,659,153) from December 31, 2007. Our stockholders’ deficit was $(13,721,221) as of the six months ended June 30, 2009. For the six months ended June 30, 2009, we had revenue of $179,000, compared to revenue of $260,000 for the comparable period in 2008. We had a net loss of $(827,086) for the six months ended June 30, 2009, compared to a net loss of $(1,545,233) for the comparable 2008 period. Our independent auditors, in their report dated September 16, 2009 for the related audit of our financial statements for the years ended December 31, 2008 and December 31, 2007, expressed doubt about our ability to continue as a going concern. There can be no assurance that our future operations will result in net income. Our failure to increase our revenues or improve our gross margins will harm our business. We may not be able to sustain or increase profitability on a quarterly or annual basis in the future. If our revenues grow more slowly than we anticipate, our gross margins fail to improve, or our operating expenses exceed our expectations, our operating results will suffer. The prices we charge for our XT250^TM system may decrease, which would potentially reduce our revenues. If we are unable to sell our solutions at acceptable prices relative to our costs, or if we fail to develop and introduce on a timely basis new products from which we can derive additional revenues, our financial results will suffer.

          Current conditions in the domestic and global economies are extremely uncertain. As a result, it is difficult to estimate the level of growth for the economy as a whole. It is even more difficult to estimate growth in various parts of the economy, including some of the markets in which we participate. Because all components of our budgeting and forecasting are dependent upon estimates of growth in the markets we serve, the prevailing economic uncertainty renders estimates of future income and expenditures even more difficult than usual. As a result, we may make significant investments and expenditures but never realize the anticipated benefits, which could affect adversely our results of operations. The future direction of the overall domestic and global economies will have a significant impact on our overall performance.

          We may fail to adequately manage our anticipated future growth. Any growth in our operations will place a significant strain on our administrative, financial and operational resources, and increase demands on our management and on our operational and administrative systems, controls and other resources. We cannot assure you that our existing personnel, systems, procedures or controls will be adequate to support our operations in the future or that we will be able to successfully implement appropriate measures consistent with our growth strategy. As part of this growth, we may have to implement new operational and financial systems, procedures and controls to expand, train and manage our employee base, and maintain close coordination among our technical, accounting, finance, marketing, and sales staff. We cannot guarantee that we will be able to do so, or that if we are able to do so, we will be able to effectively integrate them into our existing staff and systems. If we are unable to manage growth effectively, such as if our sales and marketing efforts exceed our capacity to manufacture our XT250^TM systems or if new employees are unable to achieve performance levels, our business, operating results and financial condition could be materially and adversely affected.

We are currently a defendant in a lawsuit with the manufacturer of the XT250^TM system, Kimball Electronics, Inc. in connection with $2.4 million we currently owe to its parent corporation, Kimball International, Inc., (also a party to the litigation) under a promissory note and Kimball has requested the court enter a judgment against us for $3.2 million.

          On or about September 16, 2008, Kimball International, Inc. and Kimball Electronics, Inc. (“Kimball”) filed suit against us in U.S. District Court in Evansville, Indiana. Kimball filed three claims against us including a claim alleging we defaulted on a $2,000,000 loan provided by Kimball in favor of us, breach of a reserve capacity agreement and breach of a supplier agreement.  We asserted counterclaims against Kimball for conversion, breach of contract and tortious interference with business relationship.  On June 30, 2009, the District Court granted partial judgment in favor of Kimball in the amount of $2,000,000 against us. On July 1, 2009, we reached an agreement with Kimball in principle to settle the parties’ claims, the specific details of which were to be memorialized in a final written settlement agreement.  Under the agreement in principle, we would pay Kimball $3,200,000, which includes approximately $780,000 for inventory in Kimball’s possession, payable on the following schedule.  We would make an initial payment of $500,000, on August 15, 2009, followed by six monthly payments of $25,000, four monthly payments of $50,000, followed by a final payment of $2,350,000 on June 15, 2010, provided, however, that if we completed a public offering before June 15, 2010, the balance of the $3,200,000 judgment would be due within 15 days of the closing.  The settlement agreement was never finalized and none of the payments have been made.  The parties have filed competing motions with the court to enforce their respective versions of the settlement terms.  Additionally, Kimball’s motion requests the court to enter a separate judgment in their favor and against us in the principal sum of $3,200,000. Should the litigation be settled according to these terms, we anticipate that a portion of the proceeds of the offering will be utilized to pay the monies due to Kimball.  We intend to vigorously pursue the settlement which will include terms under which Kimball will continue to supply XT250^TM units and allocate a portion of the payments to be made by us under the settlement agreement to the $780,000 in XT250^TM inventory in Kimball’s possession. If we are unable to settle this litigation in a timely manner, our results of operations may be adversely affected.

We are using a portion of the proceeds of this offering to repay indebtedness and we may be unable to successfully implement our business plan or accurately predict our future operating expenses, which could cause us to experience cash shortfalls in future periods.

          A portion of the proceeds of this offering may be used to repay indebtedness as of November 3, 2009 in the aggregate principal amount of approximately $2,731,000, together with accrued interest, as well as such additional amounts of $780,000 we anticipate will be applied to repayment to Kimball should settlement be reached in the case Kimball International, Inc., et al v. XStream Systems, Inc. The remainder we anticipate will be used for the development of new products, potential strategic acquisitions and for general working capital purposes including the payment of accrued and future salaries. In addition, in order to substantially grow our business, we will likely require additional funding. There can be no assurance that we will be able to raise any additionally needed funds on acceptable terms or at all. The procurement of any such additional financing may result in the dilution of your ownership interest in us. Furthermore, our prospects must be considered in light of the risks, expenses and difficulties frequently encountered by companies engaged in the development of a new business. Some of the specific risks associated with our business include our:

	•		need to manage our expanding operations;
	•		continuing need to raise additional capital; and
	•		dependence upon and need to hire key personnel.

To address these risks, we must, among other things, respond to our competitors, attract, retain and motivate qualified personnel, and market and sell our detection systems to companies seeking quality control. We cannot guarantee that we will be successful in addressing any or all of these risks and the other risks described herein, or that we will generate significant revenues or achieve or sustain significant profitability. The failure to address one or more of these risks and successfully implement our strategy could have a material adverse effect on our financial condition or results of operations.

We have identified a material weakness in our internal controls over financial reporting.

     During the preparation of our financial statements, we identified control deficiencies that have been classified as material weaknesses in our internal controls over financial reporting. A material weakness is a control deficiency that results in a more than remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected on a timely basis by employees in the normal course of their assigned functions. The identification of this material weakness may cause investors to lose confidence in us and our stock may be negatively affected.

     The standards that must be met for management to assess the internal control over financial reporting are relatively new and complex, and require significant documentation, testing and possible remediation to meet the detailed standards. We may encounter problems or delays in completing the activities necessary to make future assessments of our internal control over financial reporting and completing the implementation of any necessary improvements. Future assessments may require us to incur substantial costs and may require a significant amount of time and attention of management, which could seriously harm our business, financial condition and results of operations. If we are unable to assess our internal control over financial reporting as effective in the future, investors may lose confidence in us and our stock may be negatively affected.

If we do not successfully develop new detection products and solutions, our business may be harmed.  

          Our business and operating results may be harmed if we fail to expand our products (either through internal product or capability development initiatives or through partnerships and acquisitions) beyond our current XT250^TM

system in such a way that achieves market acceptance or that generates significant revenue and gross profits to offset our operating and other costs. We may not successfully identify, develop and market new product and service opportunities in a timely manner. If we introduce new products and services, they may not attain broad market acceptance or contribute meaningfully to our revenue or profitability. Competitive or technological developments may require us to make substantial, unanticipated investments in new products and technologies or in new strategic partnerships, and we may not have sufficient resources to make these investments. Because the markets for our solutions are subject to rapid change, we may need to expand and/or evolve our product and service offerings quickly. Delays and cost overruns could affect our ability to respond to technological changes, evolving industry standards, competitive developments or customer requirements and harm our business and operating results.

We do not own the technology which we utilize in connection with our XT250^TM system which patent rights are licensed from Rutgers University. If we are unable to maintain this license, our operations and financial condition we anticipate will be negatively affected.

          We do not own all of the software, other technologies and content used in our products and services. We license the technology utilized in connection with our XT250^TM system from Rutgers, The State University of New Jersey (“Rutgers”) pursuant to an exclusive license agreement for the patent rights to registered patent U.S. Patent No. 6,118,850 and U.S. Patent application Serial No. 60/352,952 (WO 03/065077). A disagreement between Rutgers and the Company could have a very negative effect on our ability to operate our business effectively. In addition, we could learn that the technologies we have licensed from Rutgers do not perform as purported, are not effective, or are not the property of Rutgers, or some similar problem with the license any of which would have an immediate and negative effect on our business. The technology is licensed under the agreement from the effective date of December 13, 2004 and remains in effect in each country of the world until the later of (i) expiration in a country of the last-to-expire of issued patents within the Rutgers patent rights licensed under the agreement, or (ii) 15 years from the first commercial sale of the licensed that country. As of November 2009, we are currently in arrears with respect to payment of $307,000, which equals the minimum annual royalty payment due under the agreement and accrued interest. The licensing agreement provides that if either party breaches or fails to perform any provision of the agreement, the other party may give written notice of the default to the breaching party. We have received an offer from Rutgers to settle the outstanding amounts under the license agreement including payment of an additional 3.5% of each sale of an XT250^TM unit and issuance of shares of our common stock. To date, however, a forbearance agreement has not been executed and the default under the agreement has not been cured. The loss of, or our inability to maintain, this license could result in our inability to sell our products including the XT250^TM systems without liability exposure. As a general matter, we anticipate that we will continue to license technology from third parties in the future. This technology may not continue to be available on commercially reasonable terms, if at all. Although we do not believe that we are substantially dependent on any individual licensed technology, some of the software that we license from third parties could be difficult for us to replace. The loss of any of these technology licenses could result in delays in the license of our products until equivalent technology, if available, is developed or identified, licensed and integrated. The use of additional third party software would require us to negotiate license agreements with other parties, which could result in higher royalty payments and a loss of product differentiation, which could negatively impact our operating results and financial condition.

If we do not adequately protect our intellectual property rights, we may experience a loss of revenue and our operations may be materially harmed.  

          We have not registered patents or copyrights on any of the software or technology we have developed. We rely upon confidentiality agreements signed by our employees, consultants and third parties, and trade secret laws of general applicability, to safeguard our software and technology. We cannot assure you that we can adequately protect our intellectual property or successfully prosecute potential infringement of our intellectual property rights. Also, we cannot assure you that others will not assert rights in, or ownership of, trademarks and other proprietary rights of ours or that we will be able to successfully resolve these types of conflicts to our satisfaction. Our failure to protect our intellectual property rights may result in a loss of revenue and could materially harm our operations and financial condition.

Our lengthy sales cycle may increase our exposure to customer cancellations and other risks.

          Our product sales cycle has been and is expected to continue to be lengthy and variable. We generally expect the need to educate our potential customers about the use and benefits of the XT250^TM system, which can require the investment of significant time and resources. This lengthy sales cycle creates risks related to customer decisions to cancel or change product plans, which could result in the loss of anticipated sales. We may incur significant research

and development, selling and general and administrative expenses as part of this process before it generates the related revenues from any such customer.

We may not be able to secure all rights to our intellectual property; our rights may be subject to claims of infringement by others, and other issues affecting production.

          We are relying on a combination of any applicable U.S. and foreign patent, trade secret, trademark and copyright laws, as well as employee and third party non-disclosure agreements and other protective measures to protect intellectual property rights pertaining to our products and technologies both in the U.S. and abroad. There can be no assurance, however, that these measures will provide meaningful protection of our technology, trade secrets, know-how, or other intellectual property in the event of any unauthorized use, misappropriation, or disclosure. There can also be no assurance that others will not independently develop similar technologies or duplicate any technology we develop or have developed without violating our intellectual property rights. In addition, there can be no assurance our intellectual property rights will be held to be valid will not be successfully challenged or will otherwise be of value.

          Our patent applications may be subject to a charging and retaining lien held by our counsel that prepare and file such applications. Failure to repay outstanding debts to such counsel could prevent us from fully commercially exploiting our technology. In addition to developing and seeking patent and other intellectual property protection for our technology, we do not currently, but may in the future, rely on licenses from third parties for material components of the technology embodied in our products. A dispute with a licensor of such products, or claims for infringement against the licensor by third parties with respect to the technology licensed to us, could materially adversely affect our business.

          Our pending patent applications or any future patent applications may not be approved or may be successfully challenged by others or invalidated through administrative processes or litigation. If our applications are not approved, we may not be able to enter into arrangements to allow us to continue to use our technology on commercially reasonable terms.

          While we do not believe that our products and technologies infringe on any existing patents or intellectual property rights of third parties, there can be no assurance that such infringement has not occurred or will not occur. The costs of defending an intellectual property claim could be substantial and could adversely affect our business, even if we were ultimately successful in defending any such claims. If our products or technologies were found to infringe the rights of a third party, we would be required to pay significant damages or license fees or cease production, any of which could have a material adverse effect on our business.

We depend on patents and other means to protect our intellectual property which may not be adequate.

          The law of patents and trade secrets is constantly evolving and often involves complex legal and factual questions. The coverage we seek in our patent applications can either be denied or significantly reduced before or after a patent is issued. Consequently, we cannot be sure that any particular patent we apply for will be issued, that the scope of the patent protection will exclude our competitors, that interference proceedings regarding any of our patent applications will not be filed, or that a patent will provide any other competitive advantage to us. In addition, we cannot be sure that any of our patents will be held valid if challenged or that others will not claim rights in or ownership of the patents and other proprietary rights held by us.

          Because patent applications are secret until patents are actually issued and the publication of discoveries in the scientific or patent literature lags behind actual discoveries, we cannot be certain if our patent application was the first application filed covering a particular invention. If another party’s rights to an invention are superior to ours, we may not be able to obtain a license to use that party’s invention on commercially reasonable terms, if at all. In addition, our competitors, many of which have greater resources than we do, could seek to apply for and obtain patents that will prevent, limit or interfere with our ability to make use of our inventions either in the U.S. or in international markets. Further, the laws of some foreign countries do not always protect intellectual property rights to the same extent as do the laws of the U.S. Litigation or regulatory proceedings in the U.S. or foreign countries also may be necessary to enforce our patent or other intellectual property rights or to determine the scope and validity of our competitors’ proprietary rights. These proceedings can be costly, result in product development delays, and divert our management’s attention from our business.

          We may also rely upon unpatented proprietary technology, and we cannot assure you that others will not independently develop substantially equivalent technology or otherwise gain access to or disclose our proprietary

technology. We may not be able to meaningfully protect our rights in this proprietary technology, which would reduce our ability to compete in the market.

Although we have confidentiality agreements in place with our employees, these agreements may not adequately prevent disclosure of proprietary information.

          Our policy is to execute confidentiality agreements with our employees and consultants upon the commencement of their employment or consulting arrangement with us. These agreements generally require that all confidential information developed by an individual or to which the individual is exposed during the course of his or her relationship with us must be kept confidential even after the individual has left our employment. These agreements also generally provide that inventions conceived by the individual in the course of rendering services to us shall be our exclusive property. We cannot be sure that these agreements will provide meaningful protection of our proprietary and other confidential information. In addition, in some situations, these agreements may conflict with, or be subject to, the rights of third parties with whom our employees or consultants have prior employment or consulting relationships. We may be forced to engage in costly and time-consuming litigation to determine the scope of and to enforce our proprietary rights. Even if successful, any litigation could divert our management’s attention from our business.

We have been subject to informal questioning and an informal inquiry from federal and state regulatory agencies recently related to an unidentified investigation and you should be aware that if we become a target or defendant in an investigation, litigation or other governmental proceeding our business prospects may potentially be adversely affected.

          On August 6, 2009, the Company was unexpectedly visited by special agents from the Office of Criminal Investigations of the federal Food and Drug Administration (“FDA”) and the Florida Department of Law Enforcement who informed our management that there was an investigation being conducted into two of our customers.  The agents proceeded to ask a series of general question based on which our management believes that the investigation involves the diversion of drugs.  The agents made an inquiry as to the capabilities of the Company’s XT250^TM machine and whether it can be used to aid in diverting drugs. Our management explained that its equipment cannot be used in such a fashion as to aid in the diversion of drugs and that the Company has at no time had any part in the diversion of drugs.  At this time, we have no reasonable basis to believe that we are a target of the investigation against our customers and will fully cooperate with the investigation.  To date, we have not received any formal or informal written correspondence from either regulatory agency relating to the investigation nor are we a party to any legal and/or regulatory proceeding related to this matter.

We will need to operate without infringing the proprietary rights of others.

          We cannot be certain that U.S. or foreign patents or patent applications of other companies do not exist or will not be issued that would materially and adversely affect our ability to commercialize our products. We may be sued for infringing or misappropriating the patent or other intellectual property rights of others. Intellectual property litigation is costly and, even if we prevail, the cost of this litigation could negatively affect our business. If we do not prevail in litigation, in addition to any damages we might have to pay, we could be required to stop the infringing activity or obtain a license requiring us to make royalty payments. Any license we are required to obtain may not be available to us on commercially acceptable terms, if at all. In addition, any license we are required to obtain may be non-exclusive, and therefore our competitors may have access to the same technology licensed to us. If we fail to obtain a required license or are unable to design around another company’s patent, we may be unable to make use of some of our technologies or distribute our products.

We may be liable for use of information we provide to third party customers.

          Incorrect information that results from the use of our systems could cause the end-user either to take an action or fail to take an action which could have a detrimental effect, and we could be liable for the damages resulting from the incorrect information. While we maintain product liability insurance coverage in an amount that we currently believe is sufficient for our business, we cannot assure you that this coverage will prove to be adequate or will continue to be available on acceptable terms, if at all. A claim brought against us regarding injuries related to the use of our system that is uninsured or under-insured could materially harm our business, financial condition, results of operations and prospects in the future. A claim could also result in negative publicity.

Our failure to comply with certain local, state and federal government regulations could negatively affect our operating results and future prospects.

          Certain computer applications, software and systems, such as ours, involving the detection of explosives, the identification of narcotics and the use of x-ray technologies are subject to regulation by numerous local, state and federal governments, including the Department of Defense, the Drug Enforcement Agency, and various other law enforcement agencies. As such, our products and operations are subject to various local, state and federal regulations and oversight. Compliance with such current and future regulations could have a material, adverse effect on our business, results of operations, financial conditions and prospects in the future.

Our failure to comply with federal Food and Drug Administration regulations could negatively affect our operating results.

          The FDA is responsible for, among other things, assuring the safety and effectiveness of medical devices. Certain computer applications, software and systems are considered medical devices, and therefore subject to regulation by the FDA. We do not believe that our system currently is subject to FDA oversight. Nevertheless, if the FDA were to determine that our system is subject to FDA jurisdiction, or in the event we expand our product line into medical diagnostics, we may become subject to FDA jurisdiction, as such compliance with FDA requirements could have a material, adverse effect on our business, results of operations, financial conditions and prospects in the future.

Product liability claims may exceed our insurance coverage.

          The manufacture and sale of our products carries the risk of product liability claims. Any error, no matter how unlikely, may cost lives and significant property damage. While we intend to maintain a prudent level of product liability insurance and errors and omissions coverage, there can be no assurance that our coverage limits will be adequate to protect us from any liabilities we might incur in connection with the sale of our products or that we will be able to maintain this level of coverage in the future. Because we plan to market and sell anti-terrorism technology to the U.S. government, however, damages paid resulting from lawsuits related to these activities may be limited or otherwise covered under the federal Support Anti-Terrorism by Fostering Effective Technologies (SAFETY) Act of 2002, a part of the Homeland Security Act of 2002.

          In addition, in order to maintain our competitive position, we will likely need to maintain a steady pace of new products and updates or enhancements of our existing product, the XT250^TM system. Accordingly, we may require increased product liability coverage as additional products and updates come to the market place. Such insurance is expensive and in the future may not be available on acceptable terms, if at all. A successful product liability claim or series of such claims in excess of our insurance coverage could have a materially adverse effect on our business.

We depend on certain key executive officers and the loss of such key employees could materially adversely affect our business.

          We are dependent on our executive officers, the loss of any one of whom could have an adverse effect on our business if we could not promptly secure a replacement with equivalent expertise and experience. We will rely on the management expertise and experience of, among others, Mr. Brian T. Mayo, our president and chief technology officer. We have a key-man insurance policy for Mr. Mayo in the amount of $2,000,000.

          While we believe that our management possesses the necessary experience to successfully manage our operations, there can be no guarantee that they will perform adequately or that our operations will be successful. In addition, our future success may depend in large part upon our ability to attract and retain additional highly skilled managerial and other personnel. We may not be successful in hiring or retaining the personnel we need and this could adversely affect our business.

Risks Related to Our Securities and this Offering

There is no minimum amount required to be raised in this offering, and if we cannot generate sufficient funds from this offering, we may be unable to execute our business strategy.

          There is no minimum amount of securities that need to be sold in this offering for us to access the funds. Therefore, this offering will be immediately available for use by us and we do not have to wait until a minimum number

of securities have been sold to keep the proceeds from any sales. We cannot assure you that subscriptions for the entire offering will be obtained. We have the right to terminate the offering of the securities at any time, regardless of the number of securities we have sold since there is no minimum subscription requirement. Our ability to meet our financial obligations and cash needs, and to achieve our objectives, could be adversely affected if the entire offering of securities is not fully subscribed for.

An active trading market for the debentures will not develop.

          We cannot assure you that an active trading market for the debentures will develop or as to the liquidity or sustainability of any such market, the ability of holders to sell their debentures or the price at which holders of the debentures may be able to sell their debentures. If an active market for the debentures fails to develop or be sustained, the trading prices of the debentures could be affected adversely. Future trading prices of the debentures also will depend on many other factors, including prevailing interest rates, the market for similar securities, the price of our common stock and our performance. The debentures are not listed on any securities exchange and we do not intend to apply for listing of the debentures on any securities exchange or trading market.

State Blue Sky laws may limit resale of the shares of common stock.

          The holders of our shares of common stock and persons who desire to purchase them in any trading market that might develop in the future should be aware that there may be significant state law restrictions upon the ability of investors to resell our shares. Accordingly, if we are not successful in having our shares listed on the NASDAQ Capital Market, investors should consider any secondary market for our securities to be a limited one including a trading market on the over the counter bulletin board (“OTCBB”). If the securities are traded on the OTCBB we intend to seek coverage and publication of information regarding the Company in an accepted publication which permits a “manual exemption.” This manual exemption permits a security to be distributed in a particular state without being registered if the company issuing the security has a listing for that security in a securities manual recognized by the state. However, it is not enough for the security to be listed in a recognized manual. The listing entry must contain (i) the names of issuers, officers, and directors, (ii) an issuer’s balance sheet, and (iii) a profit and loss statement for either the fiscal year preceding the balance sheet or for the most recent fiscal year of operations. Furthermore, the manual exemption is a non issuer exemption restricted to secondary trading transactions, making it unavailable for issuers selling newly-issued securities. Most of the accepted manuals are those published in Standard and Poor’s, Moody’s Investor Service, Fitch’s Investment Service, and Best’s Insurance Reports, and many states expressly recognize these manuals. A smaller number of states declare that they ‘recognize securities manuals’ but do not specify the recognized manuals. The following states do not have any provisions and therefore do not expressly recognize the manual exemption: Alabama, Georgia, Illinois, Kentucky, Louisiana, Montana, South Dakota, Tennessee, Vermont and Wisconsin.

An active trading market for our securities may not develop and we expect that our stock price will be volatile and could decline following this offering, resulting in a substantial loss in your investment.

          Prior to this offering, there has not been a public market for our securities. An active trading market for our securities may never develop or if it develops it may not be sustained, which could affect your ability to sell your securities and could depress the market price of your securities. In addition, the initial public offering price of the securities has been determined by the board of directors and management and may bear no relationship to the price at which the securities will trade upon completion of this offering. The offering price does not necessarily indicate the current value of the securities offered hereby and should not be regarded as an indicator of any future market performance or value thereof.

          In addition, the stock market can be highly volatile. As a result, the market price of our securities can be similarly volatile, and investors in our securities may experience a decrease in the value of their securities, including decreases unrelated to our operating performance or prospects. The market price of our securities after the offering will likely vary from the initial offering price and is likely to be highly unpredictable and subject to wide fluctuations in response to various factors, many of which are beyond our control. These factors include:

	•		variations in our operating results;
	•		changes in the general economy and in the local economies in which we operate;
	•		the departure of any of our key executive officers and directors;
	•		the level and quality of securities analysts’ coverage for our securities;
	•		announcements by us or our competitors of significant acquisitions, strategic partnerships, joint ventures or capital commitments;
	•		changes in the federal, state, and local laws and regulations to which we are subject; and
	•		future sales of our securities.

You will experience immediate and substantial dilution when you purchase securities in this offering.

          Upon the closing of this offering, investors will incur immediate and substantial dilution in the per share net tangible book value of their shares of common stock. At June 30, 2009, after giving pro forma effect to our receipt of the net proceeds of this offering, we would have had a pro forma net tangible book value of $       per share. Net tangible book value is the amount of our total assets minus intangible assets and liabilities. This represents a gain in our net tangible book value of $       per share for the benefit of our current stockholders, and dilution of $___, or ___% of the public offering price, for investors in this offering. Investors in this offering will be subject to increased dilution upon the exercise of existing outstanding stock options and warrants. These stock options and warrants, for which cash would need to be remitted to us for exercise, represent an additional 15,055,959 shares of common stock that could be issued in the future. However, each of our warrantholders has agreed not to exercise the warrants for three years subsequent to the effective date of the registration statement in this offering.

Shares of stock issuable pursuant to our stock options, warrants, and convertible preferred stock may adversely affect the market price of our common stock.

          As of November 3, 2009, we have outstanding under our 2004 Stock Option Plan, stock options to purchase an aggregate of 1,977,274 shares of common stock at a weighted average exercise price of $2.17 per share and outstanding warrants to purchase 13,078,685 shares of common stock (for which cash would need to be remitted for us to exercise) at a weighted average exercise price of $2.99 per share. In addition, as of November 3, 2009, we have outstanding shares of preferred stock as follows: Series A preferred stock – 962,101 shares convertible at $3.80 per share; Series B preferred stock – 1,619,127 at $3.00 per share; and Series C preferred stock – 365,996 at $3.00 per share; and Series D preferred stock – 563,414 at $3.00 per share, all of which are immediately convertible into shares of our common stock on a one-for-one basis on the effective date of this registration statement. In addition, 1,000,000 share based incentive grants are outstanding and 4,000,000 shares of our common stock are reserved for issuance under our 2009 Long Term Incentive Compensation Plan. The exercise of the stock options, preferred stock and warrants and the sales of stock issuable pursuant to them, would further reduce a

stockholder’s percentage voting and ownership interest. However, each of our warrantholders has agreed not to exercise the warrants for three years subsequent to the closing of this offering.

          The stock options, warrants, and preferred stock are likely to be exercised when our common stock is trading at a price that is higher than the exercise price of these options and warrants, and we would be able to obtain a higher price for our common stock than we will receive under such options and warrants. The exercise, or potential exercise, of these options and warrants could adversely affect the market price of our common stock and adversely affect the terms on which we could obtain additional financing.

The large number of shares eligible for future sale may adversely affect the market price of our common stock.

          The sale, or availability for sale, of a substantial number of shares of common stock in the public market could materially adversely affect the market price of our common stock and could impair our ability to raise additional capital through the sale of our equity securities. At the completion of this offering, excluding our over-subscription option to sell an additional 500,000 shares of common stock, there will be approximately 8,277,794 shares of common stock issued and outstanding. Of these shares, approximately 2,000,000 will be freely transferable, and approximately 6,277,795 shares will be eligible for resale under Rule 144 following the expiration of our lock-up agreements on the one year anniversary of the effective date of this registration statement, subject to exceptions for holders of 2,500 shares or less who have six-month lock-up agreements with us. Our executive officers and directors beneficially own 3,431,490 shares, which would be eligible for resale following expiration of the lock-ups, subject to the volume and manner of sale limitations of Rule 144 of the Securities Act of 1933, as amended (the “Securities Act”). Upon the conversion of our outstanding preferred stock into shares of common stock an additional 2,846,305 shares will be “restricted shares,” as that term is defined in Rule 144, and will be eligible for sale under the provisions of Rule 144 following expiration of the lock-ups. For additional information, see “Shares Eligible for Future Sale.”

We have provisions in our certificate of incorporation that substantially eliminate the personal liability of members of our board of directors for violations of their fiduciary duty of care as a director and that allow us to indemnify our officers and directors.

          Certain provisions in our certificate of incorporation could make it very difficult for you to bring any legal actions against our directors for such violations or could require us to pay any amounts incurred by our directors in any such actions. Pursuant to our certificate of incorporation and amended and restated by-laws, members of our board of directors will have no liability for violations of their fiduciary duty of care as a director, except in limited circumstances. This means that you may be unable to prevail in a legal action against our directors even if you believe they have breached their fiduciary duty of care. In addition, our certificate of incorporation and amended and restated by-laws allows us to indemnify our directors from and against any and all expenses or liabilities arising from or in connection with their serving in such capacities with us. This means that if you were able to enforce an action against our directors or officers, in all likelihood we would be required to pay any expenses they incurred in defending the lawsuit and any judgment or settlement they otherwise would be required to pay.

Our officers and directors have significant voting power and may take actions that may not be in the best interests of other stockholders.

          Our executive officers and directors currently beneficially own or control 70.6% of our outstanding common stock. Upon the completion of this offering, our executive officers and directors will beneficially own or control approximately 37.8% of our outstanding common stock. If these stockholders act together, they will be able to exert significant control over our management and affairs requiring stockholder approval, including approval of significant corporate transactions. This concentration of ownership may have the effect of delaying or preventing a change in control and might adversely affect the market price of our common stock. As a result, these stockholders could together control all matters presented to our stockholders for approval, including election and removal of our directors and change of control transactions. The interests of these stockholders may not always coincide with the interests of the other holders of our common stock.

We are restricted from paying dividends under the terms of our preferred stock designations and you should not buy our stock if you expect dividends.

          We currently intend to retain our future earnings to support operations and to finance expansion and, therefore, we do not anticipate paying any cash dividends on our capital stock in the foreseeable future. Furthermore, the terms of our preferred stock agreements restrict the payment of dividends and provide that except for the ratable payment of

dividends on the Series A, B, C and D preferred stock, we may not directly or indirectly declare or pay any cash or property dividends or make any cash or property distributions upon any of its capital stock or other equity securities. You should not buy our stock if you are expecting to receive cash dividends.

As a public company we will incur additional cost and face increased demands on our management and key employees.

          We have never operated as a public company. As a public company, we will incur significant legal, accounting and other expenses that we did not incur as a private company. In addition, the Sarbanes-Oxley Act of 2002, as well as rules implemented by the Securities and Exchange Commission, or SEC, and the exchange where we propose to trade our securities, impose various requirements on public companies. Our management and other personnel will devote substantial amounts of time to these requirements. We expect these requirements to significantly increase our legal and financial compliance costs and to make some activities more time-consuming and costly. In addition, we will incur additional costs associated with our public company reporting requirements. These rules and regulations also make it more difficult and more expensive for us to obtain director and officer liability insurance. We cannot predict or estimate the amount of additional costs we may incur or the timing of such costs. If our profitability is harmed by these additional costs, it could have a negative effect on the trading price of our common stock.

We will retain broad discretion in using the net proceeds from this offering and may spend a substantial portion in ways with which you do not agree.

          Our management will retain broad discretion to allocate the net proceeds of this offering. The net proceeds may be applied in ways with which you and other investors in the offering may not agree, or which do not increase the value of your investment. We intend to use a portion of our net proceeds from this offering to repay the outstanding balance under our existing debt instruments, which was approximately $2,662,000 as of June 30, 2009. We anticipate that we will use the remainder of the net proceeds for working capital and other general corporate purposes, which may include the acquisition of other businesses, products or technologies. We have not allocated these remaining net proceeds for any specific purposes. Our management might not be able to yield a significant return, if any, on any investment of these net proceeds.

We do not know whether a market will develop for our common stock or what the market price of our common stock will be and as a result it may be difficult for you to sell your shares of our common stock.

          Before this offering, there was no public trading market for our common stock. If a market for our common stock does not develop or is not sustained, it may be difficult for you to sell your shares of common stock at an attractive price or at all. We cannot predict the prices at which our common stock will trade. The initial public offering price for our common stock was determined by the board of directors and management and may not bear any relationship to the market price at which the common stock will trade after this offering or to any other established criteria regarding our value. It is possible that in one or more future periods our results of operations may be below the expectations of public market analysts and investors and, as a result of these and other factors, the price of our common stock may fall.

If securities analysts do not publish research or reports about our business or if they publish negative evaluations of our stock, the price of our stock could decline.

          The trading market for our common stock will rely in part on the research and reports that industry or financial analysts publish about us or our business. We do not currently have and may never obtain research coverage by industry or financial analysts. If no or few analysts commence coverage of us, the trading price of our stock would likely decrease. Even if we do obtain analyst coverage, if one or more of the analysts covering our business downgrade their evaluations of our stock, the price of our stock could decline. If one or more of these analysts cease to cover our stock, we could lose visibility in the market for our stock, which in turn could cause our stock price to decline.

You will experience immediate and substantial dilution in your investment.

          The offering price of the common stock is substantially higher than the net tangible book value per share of our common stock, which on a pro forma basis was $___ as of December 31, 2008. As a result, you will experience immediate and substantial dilution in pro forma net tangible book value when you buy shares of common stock in this offering. This means that you will pay a higher price per share than the amount of our total assets, minus our total liabilities, divided by the number of outstanding shares. Holders of our common stock will experience further dilution

if options or other rights to purchase our common stock that are outstanding or that we may issue in the future are exercised or converted, or if we issue additional shares of our common stock, at prices lower than our net tangible book value at such time.

Provisions in our organizational documents and in the Delaware General Corporation Law may prevent takeover attempts that could be beneficial to our stockholders.

          Provisions in our certificate of incorporation and amended and restated by-laws, both of which will be effective upon the closing of this offering, and in the Delaware General Corporation Law, may make it difficult and expensive for a third party to pursue a takeover attempt we oppose even if a change in control of our company would be beneficial to the interests of our stockholders. Any provision of our certificate of incorporation or amended and restated by-laws or Delaware law that has the effect of delaying or deterring a change in control could limit the opportunity for our stockholders to receive a premium for their shares of our common stock, and could also affect the price that some investors are willing to pay for our common stock. Our board of directors has the authority to issue up to 6,000,000 shares of preferred stock in one or more series and to fix the powers, preferences and rights of each series without stockholder approval. The ability to issue preferred stock could discourage unsolicited acquisition proposals or make it more difficult for a third party to gain control of our company, or otherwise could adversely affect the market price of our common stock. Further, as a Delaware corporation, we are subject to Section 203 of the Delaware General Corporation Law. This section generally prohibits us from engaging in mergers and other business combinations with stockholders that beneficially own 15% or more of our voting stock, or with their affiliates, unless our directors or stockholders approve the business combination in the prescribed manner.

CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

          Included in this prospectus are “forward-looking” statements, as well as historical information. Although we believe that the expectations reflected in these forward-looking statements are reasonable, we cannot assure you that the expectations reflected in these forward-looking statements will prove to be correct. Our actual results could differ materially from those anticipated in forward-looking statements as a result of certain factors, including matters described in the section titled “Risk Factors.” Forward-looking statements include those that use forward-looking terminology, such as the words “anticipate,” “believe,” “estimate,” “expect,” “intend,” “may,” “project,” “plan,” “will,” “shall,” “should” and similar expressions, including when used in the negative. Although we believe that the expectations reflected in these forward-looking statements are reasonable and achievable, these statements involve risks and uncertainties and no assurance can be given that actual results will be consistent with these forward-looking statements. Actual results may be materially different than those described herein. Important factors that could cause our actual results, performance or achievements to differ from these forward-looking statements include the factors described in the “Risk Factors” section and elsewhere in this prospectus.

          All forward-looking statements attributable to us are expressly qualified in their entirety by these and other factors. We undertake no obligation to update or revise these forward-looking statements, whether to reflect events or circumstances after the date initially filed or published, to reflect the occurrence of unanticipated events or otherwise, except to the extent required by federal securities laws.

USE OF PROCEEDS

     We estimate the net proceeds to us from the sale of the securities in this offering will be approximately $                    , or approximately $                     if our over-subscription option is exercised in full, based on an assumed public offering price of $                     per share and after deducting our estimated offering expenses. We intend to use the net proceeds from this offering for the following purposes and in the following order of priority:

						Estimated
		Estimated				Percentage of Net
Purpose		Amount				Proceeds
Repayment of notes payable		$					—	%
Working capital and general corporate purposes		$					—	%
Funding of research and development		$					—	%
Total		$					100.0	%

     We plan to use a significant portion of the net proceeds of this offering to finance research and product development as a part of our growth strategy. Working capital and general corporate purposes include amounts required to pay for salaries, professional fees, public reporting costs, office-related expenses and other corporate expenses, including interest and overhead. A description of the notes payable by us which proceeds in this offering are anticipated to repay is provided under the sections “Legal Proceedings and Risk Factors — We are using a portion of the proceeds of this offering to repay indebtedness. . . .”

     We have indicated the order of priority in the table above for use of the proceeds of this offering. If substantially less than the maximum proceeds are obtained, we anticipate we will apply the payment of the proceeds to the repayment of the notes payable and working capital and general corporate purposes. Pending these uses, we intend to invest most of the net proceeds from this offering in short-term, investment-grade, interest-bearing securities.

DETERMINATION OF OFFERING PRICE

     The initial public offering price of shares of our common stock and conversion price for the debentures was determined by our board of directors and management. Among the factors considered in determining the initial public offering price and conversion price were our future prospects and those of our industry in general, and certain other financial and operating information in recent periods, and other financial and operating information of companies engaged in activities similar to ours. We cannot assure you, however, that the prices at which the shares will sell in the public market after this offering will not be lower than the initial public offering price or debenture conversion price or that an active trading market in our common stock will develop and continue after this offering.

DIVIDEND POLICY

     We have never paid any cash dividends on our capital stock and do not anticipate paying any cash dividends in the foreseeable future. We currently intend to retain any future earnings to fund the development and growth of our business. Furthermore, the terms of our preferred stock agreements restrict the payment of dividends and provide that except for the ratable payment of dividends on the Series A, B, C and D preferred stock, we may not directly or indirectly declare or pay any cash or property dividends or make any cash or property distributions upon any of our capital stock or other equity securities. You should not buy our stock if you are expecting to receive cash dividends.

     The following table summarizes our short-term debt and capitalization as of June 30, 2009, (a) on an actual basis, (b) on a pro forma basis after giving effect to the conversion of all outstanding shares of our Series A, B, C, and D preferred stock into 3,510,638 shares of our common stock which will occur automatically on the effective date of the registration statement for this offering, and (c) on a pro forma as adjusted basis to reflect the estimated net proceeds we will receive from the sale of 2,000,000 shares of common stock and $5,000,000 principal amount of convertible debentures offered by this prospectus at an assumed public offering price of $                     per share and $1,000 per debenture, after deducting the estimated offering expenses we will pay, and the application of notes payable by us in the aggregate amount of $2,662,000.

		As of June 30, 2009
						Pro Forma Basis after giving effect				Pro Forma as Adjusted for
						to Conversion of				Note Extinguishment and
		Actual				all Preferred Stock				this Offering (1)
		(Unaudited)								(Unaudited)
Short-term debt		$	2,662,000				2,662,000
Series A Preferred stock, $.0001 par value, 7% and 5% cumulative dividend, 962,101 shares authorized, issued and outstanding			4,272,023				—
Series B Preferred stock, $.0001 par value, 7% and 5% cumulative dividend, 1,800,000 shares authorized and 1,619,127 issued and outstanding			5,355,742				—
Series C Preferred stock, $.0001 par value, 7% and 5% cumulative dividend, 1,350,000 shares authorized, 212,331 issued and outstanding			645,866				—
Stockholders’ equity:
Common Stock, $0.0001 par value: authorized 30,000,000 shares; issued and outstanding 1,767,156 shares, actual; issued and outstanding, pro forma as adjusted for this offering, ________ shares(1)			177				456
Additional paid in capital			1,979,867				12,253,219
Accumulated deficit			(15,701,265	)			(15,701,265	)
Total stockholders’ equity			(13,721,221	)			(3,447,590	)
Total capitalization		$	(785,590	)		$	(785,590	)

PRICE RANGE OF COMMON STOCK

     Our common stock is not currently traded on any market or exchange. We intend to apply to list our common stock on the NASDAQ Capital Market, and expect such listing to occur concurrently with this offering.

     As of November 3, 2009, we had 99 stockholders of record of our common stock.

DILUTION

     Purchasers of securities in this offering will be diluted to the extent of the difference between the public offering price per share and the net tangible book value per share of our common stock immediately after this offering. Net tangible book value dilution per share represents the difference between the amount per share paid by purchasers of common stock in this offering and the pro forma, adjusted net tangible book value per share of common stock immediately after completion of this offering.

     Our pro forma, adjusted net tangible book value (deficit) as of June 30, 2009, would have been $(                    ) or $(0.___) per share of common stock. Pro forma net tangible book value (deficit) per share as of a specified date is determined by dividing our tangible book value (deficit) (total tangible assets less total liabilities) by the number of outstanding shares of common stock at such date. After giving effect to our sale of the 2,000,000 shares of common stock and convertible debentures offered by this prospectus (based upon an assumed public offering price of $                     per share and $1,000 per debenture, after deducting our estimated offering expenses), and the application of notes payable by us in the aggregate amount of $                    , our pro forma net tangible book value as of June 30, 2009, would have been $                    , or $                     per share of common stock. This represents an immediate increase in pro forma net tangible book value to existing stockholders of $                     per share, and an immediate dilution to new investors of $                     per share, or                     % of the public offering price of the shares and                     % of the convertible debentures offered in this offering. The following table illustrates the per share dilution:

Assumed public offering price per share						$
Assumed public offering price per debenture						$	1,000
Pro forma net tangible book value (deficit) per share as of June 30, 2009 (giving effect to the extinguishment of notes)		$
Increase in pro forma net tangible book value (deficit) per share attributable to new investors in this offering		$
Pro forma net tangible book value per share as of June 30, 2009 after this offering						$
Pro forma net tangible book value dilution per share to new investors in this offering						$

     Sales by existing unaffiliated stockholders in this offering will reduce the number of shares held by all existing stockholders to                     , or ___% of the total number of shares of common stock to be outstanding after this offering, and will increase the number of shares to be purchased by new investors to                     , or ___% of the total shares of common stock to be outstanding after this offering.

     Investors in this offering will be subject to increased dilution upon the exercise of outstanding stock options and warrants. However, each of our Series B, C and D warrantholders has agreed not to exercise these warrants until the three year anniversary of the effective date of this registration statement. As of November 3, 2009, these stock options and warrants represent an additional 15,055,959 shares that could be issued (for which cash would need to be remitted to us for exercise) in the future.

     The following Management’s Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of various factors, including those set forth under “Risk Factors” and elsewhere in this prospectus. The following discussion should be read in conjunction with our financial statements and related notes thereto included elsewhere in this prospectus.

     We design and develop material authentication and detection solutions that allow molecular structure analysis on hidden materials. Our license of patented technology from Rutgers University combines penetrating x-rays, forensic analysis, and automated software algorithms that allow non-technical personnel to rapidly validate products even when sealed within their original packaging. The initial focus for our product, the XT250^TM Material Identification System, has been molecular screening to protect the distribution supply chain from counterfeits, adulterations, and contamination of pharmaceuticals.

     Our unique technology allows inventory that is packaged and sealed to be non-intrusively verified. Deviations, that may be harmful to the public, are detected by our XT250^TM system and removed from the supply chain. We believe our company has raised the level of awareness of the dangers of counterfeits via our advertising, speaking engagements, websites, and internet blog activities. We have educated our potential customers on our product offerings and worked with them to develop processes to better protect their inventories.

     Management has succeeded in developing strategic partnerships in key market segments. PILOT programs with major pharmaceutical manufacturers have allowed us to program the XT250^TM system for their specific needs. PILOT programs with major distributors helped us to develop processes and procedures to maximize value for all of our customers. PILOT programs with major returns logistics companies provided exposure and insight into the dispensing segment of the pharmaceutical market, resulting in enhanced capabilities of the XT250^TM that were developed. Each of the PILOT programs provided XStream Systems with an opportunity to further validate our technology and demonstrate value for a particular market segment. XT250^TM units were discounted to early adopters, who agreed to PILOT programs, to provide an additional incentive for the customer. As the PILOT programs complete, management expects to return to significantly reduced discounts off the retail purchase price for future sales of XT250^TM systems.

     Management believes that our Secure Pharma Network (SPN) may provide significant growth opportunities. SPN is a software product that allows customers to access via the Internet all of their systems purchased from XStream Systems. Customers may remotely manage their systems, downloading new material fingerprints or software updates, uploading results, and operating their systems remotely. Detailed reports can be generated, as well as customized and aggregated reporting across multiple systems. The ability to collect test results from multiple systems from our customers, process that data, and provide meaningful information across the industry provides significant value to our customers, which management believes can produce revenue in the future. We believe that integrating SPN into our customers’ inventory management systems provides additional value to our customers. Since SPN is software based, revenues we anticipate to generate from SPN in the future are expected to increase our profit margins. To date, no revenues have been earned from SPN.

     The XT250^TM system can be programmed for different materials. In addition to the pharmaceutical distribution market that is already established, management hopes to target other markets with the XT250^TM system. Some industries that perform visual inspections today, like customs inspections and cosmetics distribution, could enhance their verification process with the XT250^TM system. Field related industries that rely upon sending samples to forensic laboratories, such as mining and cement industries, could analyze samples themselves with the XT250^TM system. These are just some of the large markets that provide opportunity for our XT250^TM system to verify, detect or identify materials. In markets where the XT250^TM system may not meet the needs for the particular application, our technology is scalable in terms of speed, portability, and test sample size so that future products may be developed to meet those needs.

     Our initial net sales consist of XT250^TM units sold to equipment distributors at a significant discount off the retail purchase price as well as direct retail sales to pharmaceutical distributors and manufacturers. Sales to equipment distributors represented 100% and approximately 38% of our net sales during 2007 and 2008, respectively, with the remaining sales in 2008 directly to pharmaceutical distributors. Gross profit consists of net sales less product,

packaging and freight, field service, warranty, and financing costs. Selling and advertising costs consist of sales person expenses, advertising and marketing expenses, as well as royalty fees. Research and development expenses consist primarily of engineering personnel expenses, engineering consulting and prototype expenditures. General and administrative expenses include administrative salaries and payroll related expenses, stock-based compensation expenses, depreciation, rent and general overhead expenses.

     The management team reviews our performance on a regular basis using a variety of financial and non-financial metrics. These metrics include, but are not limited to, net sales, gross margin, sales and marketing expenses, personnel costs, accounts receivable and accounts payable aging, liquidity and cash resources. Management compares actual results against goals and budgets to take appropriate actions in order to improve performance.

     At June 30, 2009, we had 11 employees in our operations, 2 of whom were sales and business development executives. Most of our staff is employed at our corporate headquarters in Sebastian, Florida.

Critical Accounting Policies

     Our discussion and analysis of our financial condition and results of operations are based on our consolidated financial statements, which have been prepared in accordance with generally accepted accounting principles in the U.S. These accounting principles require management to make use of certain estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the financial statements and the reported amounts of revenues and expenses during the reported periods. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about carrying values of assets and liabilities that are not readily apparent from other sources. Actual results could differ from those estimates, and revisions to estimates are included from the period in which the actual amounts become known.

     We believe the following critical accounting policies affect our more significant judgments and estimates used in our preparation of our consolidated financial statements, and therefore should be read in conjunction with our summary of significant accounting policies (see Note 2 of our Notes to Consolidated Financial Statements). Our critical accounting policies are as follows:

Revenue Recognition

     Revenue is recognized upon delivery and installation of completed units. Prior to installation, deposits are ordinarily required from customers before manufacturing commences. These amounts are recorded as customer deposits until the units are delivered and installed.

Inventories

     We state inventories at the lower of cost, determined using the average cost method, or net realizable value. We review inventory for excess quantities and obsolescence based on our best estimates of future demand, product lifecycle status and product development plans. We use historical information along with these future estimates to reserve for obsolete and potentially obsolete inventory.

Share-based Payments

     We record all stock-based awards, including employee stock option grants, at fair value as of the grant date and recognize these awards as expenses in our statement of operations over the vesting period of the award in accordance with Statement of Financial Accounting Standards (“SFAS”)No. 123(R), “Share-Based Payments” (“SFAS No. 123R”).

     We estimate the fair value of each option grant on the date of grant using the Black-Scholes option pricing model. The weighted average assumptions utilized for our valuation analysis, for the years ended December 31, 2007 and 2008 and the six months ended June 30, 2008 and 2009 are as follows:

		Year Ended				Six Months
		December 31,				Ended June 30,
		2007		2008		2008		2009
Risk-free interest rate		3.96% - 5.19%		1.55% - 3.34%		2.49% - 3.34%		1.36% - 2.56%
Expected dividend yield		0%		0%		0%		0%
Expected volatility		53.89% - 70.74%		51.69% - 62.58%		51.69% - 58.67%		45.45% - 65.20%
Expected life in years		5 - 7		5 - 7		5 - 7		5 - 7
Service period in years		0 - 4		0 - 4		0 - 4		0 - 4
Weighted average fair value of options granted		$1.21		$0.16		$0.35		$0.38

     The risk-free interest rate is derived from the Daily U.S. Treasury Yield Curve Rate in effect as of the valuation date of each grant. The dividend yield of zero is based on the fact that our present intention is not to pay cash dividends. Since our common stock is not traded on any public market, we have used the historical volatility of select comparable publicly traded companies over a period equivalent to the Expected Term, which is the expected time from grant date until exercise.

Intangible Assets

     Intangible assets are accounted for at cost and are amortized over the estimated useful life of the asset on a straight-line basis, which is generally three to 15 years. In 2005, we purchased a license from a university for the exclusive right to produce and sell products which utilize the university’s patented x-ray defraction technology. In exchange for this license, the university was issued 73,500 shares of our common stock and we agreed to pay royalty fees during the term of the agreement. The initial license fee is stated at cost and amortized using the straight-line method over 15 years beginning in the year it was acquired.

Income Taxes

     We account for income taxes in accordance with SFAS 109, Accounting for Income Taxes in determining our effective tax rate, provision for tax expense, deferred tax assets and liabilities and the related valuation allowance. Our provision for income taxes is determined using the asset and liability method, which involves significant judgments and estimates. Under this method, deferred income tax assets and liabilities are calculated based upon the temporary differences between the financial statement and income tax bases of assets and liabilities using the combined federal and state effective tax rates that are applicable to us in a given year.

     The deferred income tax assets are recorded net of a valuation allowance when, based on the weight of available evidence; we believe it is more likely than not that some portion or all of the recorded deferred tax assets will not be realized in future periods. For the years ended December 31, 2007 and 2008 and the six months ended June 30, 2008 and 2009, we have recorded a valuation allowance against the full amount of our net deferred tax asset, because in our opinion, it is more likely than not that these deferred tax assets will not be realized through future taxable earnings or implementation of tax planning strategies. A change in our estimate of future taxable income may require a change to the valuation allowance.

     The Company adopted the provisions of FIN48 on January 1, 2007. As a result of the implementation of FIN48, the Company determined that no material adjustment was required; there are no unrecognized tax benefits, and accordingly no associated penalties and interest were required to be accrued as of December 31, 2008 or 2007.

Contingent Liabilities and Off-Balance Sheet Arrangements

     We are contingently liable for certain payments related to sales of our XT250^TM units. We signed recourse agreements whereby we guarantee the payment of the unamortized principle balance of certain capital lease agreements in the event the customer defaults on the payments for the units. As of June 30, 2009, the unamortized principle balance of these leases is approximately $155,000. We believe it is unlikely that we will be required to satisfy any of this amount and that the fair value of the guarantee is immaterial. Other than these arrangements, we do not have any off-balance sheet arrangements that have or are reasonably

likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results in operations, liquidity, capital expenditures or capital resources that is material to investors.

Results of Operations

Results of Operations for the Years Ended December 31, 2008 and 2007

     The following table summarizes certain selected items from the statement of operations for the year ended December 31, 2008 compared to the year ended December 31, 2007.

		Year Ended December 31,								Increase/(Decrease)
		2007				2008				$				%
Revenues		$	135,000			$	439,000			$	304,000				225	%
Cost of Sales			157,508				129,036				(28,472	)			(18	)
Gross Profit (Loss)		$	(22,508	)		$	309,964			$	332,472				(1477	)
Gross Profit (Loss) Percentage of Revenue			(17	%)			71	%							87	%

     Revenues for the year ended December 31, 2008 amounted to $439,000 as compared to revenues of $135,000 for the year ended December 31, 2007, an increase of $304,000 or 225%. This increase is primarily due to sales in 2008 at or near the retail price of our units while sales in 2007 were at significant price reductions below retail. We also had additional revenue of $150,000 during 2008 from a contract with the Transportation Security Administration for the production of explosive stimulants to be used in testing commercial x-ray equipment.

     Cost of Sales

     Cost of sales for the year ended December 31, 2008 totaled $129,036 as compared to $157,508 for the year ended December 31, 2007, a decrease of $28,472 or 18%. This decrease is due primarily to efficiencies gained in performing the alignment, calibration and tooling process (ACT) which is required at the time of sale. In addition, in 2008, we eliminated a financing program to distributors which allowed 12 months deferred payments and resulted in significant financing charges to us.

     Gross profit for the year ended December 31, 2008 amounted to $309,964 as compared to a gross loss of $22,508 for the period ended December 31, 2007, an increase of $332,472. Overall gross profit as a percentage of revenue increased to 71% for the year ended December 31, 2008 from (17%) during the year ended December 31, 2007. The increase in gross profit is due to the aforementioned increase in sales prices and decrease in cost of sales as well as additional revenues from a contract modification with the Transportation Security Administration for the production of explosive stimulants which had no costs associated with it in 2008. Excluding the revenue from the Transportation Security Administration, our gross profit in 2008 would have been $109,964 or 38% of revenues as compared to (17%) of revenues during the same period in 2007.

		Year Ended December 31,								Increase/(Decrease)
		2007				2008				$				%
OPERATING EXPENSES
Selling and advertising expenses		$	1,248,146			$	913,238			$	(334,907	)			(27	)%
Research and development expenses			1,900,897				635,531				(1,265,366	)			(67	)
Stock-based compensation expenses			424,462				235,323				(189,139	)			(45	)
Other general and administrative expenses			1,899,950				1,252,853				(647,097	)			(34	)
Total operating expenses			5,473,455				3,036,945				(2,436,510	)			(45	)
Loss from operations			(5,495,963	)			(2,726,981	)			2,768,982				(50	)
OTHER INCOME AND EXPENSES
Interest expense			(363,887	)			(159,429	)			(204,458	)			(56	)
Interest Income			52,360				26,156				(26,204	)			(50	)
NET LOSS		$	(5,807,490	)		$	(2,860,254	)		$	2,947,236				(51	)%

     Selling and advertising expenses for the year ended December 31, 2008 totaled $913,238 as compared to $1,248,146 for the year ended December 31, 2007, a decrease of $334,907 or 27%. This decrease is due primarily to changes implemented in 2008 whereby full-time sales and marketing headcount was reduced and outside consultants with pharmaceutical industry experience were retained on a commission basis.

     Research and development expenses for the year ended December 31, 2008 amounted to $635,531 as compared to $1,900,897 for the year ended December 31, 2007, a decrease of $1,265,366 or 67%. This decrease is due primarily to reductions in engineering headcount and prototype costs in 2008 as the engineering team transitioned the XT250^TM Material Identification System from development stage to production stage in late 2007.

     Stock-based compensation for the year ended December 31, 2008 totaled $235,323 as compared to $424,462 for the period ended December 31, 2007, a decrease of $189,139 or 45%. This decrease is due principally to aforementioned headcount reductions in sales and engineering as well as headcount reductions in general and administrative staff.

     General and administrative expenses for the year ended December 31, 2008 amounted to $1,252,853 as compared to $1,899,950 for the year ended December 31, 2007, a decrease of $647,097 or 34%. This decrease is due predominately to reductions in headcount in 2008 as the company transitioned the XT250^TM Material Identification System from development stage to production stage in late 2007.

     The following table summarizes certain selected items from the statement of operations for the six month period ended June 30, 2009 compared to the six month period ended June 30, 2008.

		Six months ended								Increase/(Decrease)
		June 30, 2008				June 30, 2009				$				%
		(Unaudited)
Revenues		$	260,000			$	179,000			$	(81,000	)			(31	)%
Cost of Sales			59,844				66,565				6,721				11
Gross Profit		$	200,156			$	112,435			$	(87,721	)			(44	)
Gross Profit Percentage of Revenue			77	%			63	%							(14	)%

     Revenues for the six months ended June 30, 2009 amounted to $179,000 as compared to $260,000 for the six months ended June 30, 2008, a decrease of $81,000 or 31%. This decrease is due to additional revenues of $150,000 during 2008 from a contract with the Transportation Security Administration for the production of explosive stimulants to be used in testing commercial x-ray equipment.

     Cost of sales for the six months ended June 30, 2009 totaled $66,565 as compared to $59,844 for the six months ended June 30, 2008, an increase of $6,721 or 11%. This increase is due primarily to outsourcing of the field service function which includes the alignment, calibration and tooling process (ACT) and warranty for the first 12 months after a unit is sold.

     Gross profit for the six months ended June 30, 2009 amounted to $112,435 as compared $200,156 for the six months ended June 30, 2008, a decrease of $87,721 or 44%. Overall gross profit as a percentage of revenue decreased to 63% for the six month period ended June 30, 2009 from 77% during the six month period ended June 30, 2008. This decrease in gross profit is due to the aforementioned additional revenue in 2008 from a contract with the Transportation Security Administration as well as the outsourcing of field service.

		Six months ended								Increase/(Decrease)
		June 30, 2008				June 30, 2009				$				%
		(Unaudited)
OPERATING EXPENSES
Selling and advertising expenses		$	367,041			$	223,726			$	(143,315	)			(39	)%
Research and development expenses			369,463				288,186				(81,277	)			(22	)
Stock-based compensation expenses			86,400				177,644				91,244				106
Other general and administrative expenses			870,821				694,213				(176,608	)			(20	)%
Total operating expenses			1,693,725				1,383,769				(309,956	)			(18	)
Loss from operations			(1,493,569	)			(1,271,334	)			(222,235	)			(15	)
OTHER INCOME AND (EXPENSES)
Interest expense			(65,960	)			(107,810	)			41,850				(63	)
Interest Income			14,296				226				(14,070	)			(98	)
Warrant Income			—				551,832				551,832				100	%
NET LOSS		$	(1,545,233	)		$	(827,086	)		$	718,147				44	%

     Selling and advertising expenses for the six months ended June 30, 2009 amounted to $223,726 as compared to $367,041 for the six months ended June 20, 2008, a decrease of $143,315 or 39%. This decrease is due primarily to changes implemented in third quarter 2008 whereby full-time sales and marketing headcount was reduced and outside consultants with pharmaceutical industry experience were retained on a commission basis.

     Research and development expenses for the six month period ended June 30, 2009 totaled $288,186 as compared to $369,463 for the six month period ended June 30, 2008, a decrease of $81,277 or 22%. This decrease is due primarily to reductions in engineering headcount and related costs implemented as cost saving measures.

     Stock-based compensation for the six months ended June 30, 2009 totaled $177,644 as compared to $86,400 for the six months ended June 30, 2008, an increase of $91,244 or 106%. This increase is due principally to aforementioned headcount reductions in sales and engineering as well as headcount reductions in general and administrative staff.

     Other general and administrative expenses for the six month period ended June 30, 2009 amounted to $694,213 as compared to $870,821 for the six month period ended June 30, 2008, a decrease of $176,608 or 20%. This decrease is due predominately to reductions in headcount and related costs in 2008 implemented as cost saving measures.

     We incurred a net loss of $827,086, including $177,644 of stock-based compensation expense as required by SFAS No. 123R, for the six months ended June 30, 2009. Our accumulated deficit since inception amounted to $15,701,265 as of June 30, 2009, including $1,293,132 of cumulative stock-based compensation expense.

     Our primary source of liquidity since inception has been cash generated from private equity and convertible debt transactions totaling approximately $11,000,000, net of offering costs, through June 30, 2009. Our primary operating cash requirements include the payment of salaries, employee benefits and other personnel-related costs, as well as costs of our sales and marketing efforts and our office facilities. We had cash of $104,589 as of June 30, 2009 and have generated additional cash from private equity transactions since this date in the amount of $460,995 which is being used to fund current operations. We believe our existing cash on hand, the net proceeds from this offering, and cash generated from operating activities will be sufficient to service our existing debt, finance internal growth, and invest in research and development of our technology. If we do not complete the initial public offering to which this prospectus relates or raise the maximum amount of funds contemplated in this prospectus, we cannot provide assurances that we will be able to find alternative financing on terms favorable to us or at all.

     On various dates from December 14, 2006 through February 14, 2007, we issued convertible promissory notes in the principal amount of $325,000, payable on demand at any time on or after February 28, 2007. In accordance with the terms of the notes, on March 14, 2007, all of the principal and interest due on the notes was converted into 87,094

shares of Series A Redeemable Convertible Preferred Stock, $.0001 par value per share (the “Series A Preferred Stock”).

     On various dates from August 31, 2005 to March 14, 2006, we sold debentures in the aggregate principal amount of $1,525,000 to accredited investors. In connection with such sale, each investor received a ten-year warrant to purchase 5,000 shares of common stock at a price of $2.34 per share for each $25,000 in principal amount of debentures. As a result, we issued warrants to purchase an aggregate of 305,000 shares of common stock. On December 21, 2007, a portion of these debentures in the principal amount of $1,000,000 and the related accumulated interest on that date, was exchanged for 336,248 shares of Series B Redeemable Convertible Preferred Stock, $.0001 par value per share (“Series B Preferred Stock”).

     On various dates from September 14, 2007 through December 4, 2007, we sold convertible debentures in the aggregate principal amount of $886,000 to accredited investors. On December 21, 2007, all of the principal and interest due on the debentures was converted into 298,116 shares of Series B Preferred Stock.

     In connection with a secured, revolving, demand promissory note dated November 16, 2006, we issued the holder of the note a warrant to purchase an aggregate of 21,000 shares of common stock at an exercise price of $3.80 per share on January 25, 2008.

     By stock purchase agreement dated March 14, 2007, as amended from time to time, we sold an aggregate of 962,101 shares of Series A Preferred Stock to accredited investors. Of those shares, 87,094 were issued in exchange for convertible promissory notes in the principal amount of $325,000 and the related accrued interest. The remaining 875,007 share of Series A Preferred Stock were issued at a purchase price of $3.80 per share, resulting in $3,325,000 of gross proceeds.

     On various dates from December 2007 through June 2008, we sold an aggregate of 1,585,795 shares of Series B Preferred Stock to accredited investors. The shares of Series B Preferred Stock were issued at a purchase price of $3.00 per share, resulting in $4,757,385 of gross proceeds. In addition, during this time period, we issued 33,332 shares of Series B Preferred Stock to the interim chief executive officer as compensation for services performed. Each investor received for each share of Series B Preferred Stock purchased, one ten-year warrant to purchase five shares of our common stock at an exercise price of $3.00 per share.

     On various dates from March 2009 through August 2009, we sold an aggregate of 365,996 shares of Series C Redeemable Convertible Preferred Stock, $.0001 par value per share (the “Series C Preferred Stock”) to accredited investors. The shares of Series C Preferred Stock were issued at a purchase price of $3.00 per share, resulting in $1,097,988 of gross proceeds. In addition, each investor received for each share of Series C Preferred Stock purchased, one ten-year warrant to purchase five shares of our common stock at an exercise price of $3.00 per share.

     During October 2009, we sold an aggregate of 563,414 shares of Series D Redeemable Convertible Preferred Stock, $.0001 par value per share (the “Series D Preferred Stock”) to accredited investors. The shares of Series D Preferred Stock were sold at a price of $3.00 per share, resulting in $1,690,242 of gross proceeds. In addition, each investor received for each share of Series D Preferred Stock purchased, one ten-year warrant to purchase five shares of our common stock at an exercise price of $3.00 per share.

     These securities were sold pursuant to the exemption from registration requirements provided by Section 4(2) of the Securities Act and Rule 506 promulgated thereunder.

Impact of Inflation

     We believe that inflation has not had a material impact on our results of operations for the years ended December 31, 2007 and 2008 or the six months ended June 30, 2008 and 2009. We cannot assure you that future inflation will not have an adverse impact on our operating results and financial condition.

Recently-Issued Accounting Standards

     In June 2008, the FASB ratified EITF Issue No. 07-05, Determining Whether an Instrument (or an Embedded Feature) is indexed to an Entity’s Own Stock (EITF 07-5). EITF 07-5 provides that an entity should use a two step approach to evaluate whether an equity-linked financial instrument (or embedded feature) is indexed to its own stock,

including evaluating the instrument’s contingent exercise and settlement provisions. It also clarifies on the impact of foreign currency denominated strike prices and market based employee stock option valuation instruments on the evaluation. EITF 07-5 is effective for fiscal years beginning after December 15, 2008.

     The initial impact of adopting EITF 07-5 was to record a warrant liability for approximately $403,649 with a corresponding charge to the accumulated deficit to reflect the cumulative effect of this change in accounting principle.

Quantitative and Qualitative Disclosures about Market Risk

     This disclosure is not required for smaller reporting companies.

BUSINESS

Company Overview

     XStream Systems, Inc. designs and develops material authentication and detection solutions that allow molecular structure analysis on hidden materials. Our patented technology which we license exclusively from Rutgers, The State University of New Jersey (“Rutgers”) combines penetrating x-rays, forensic analysis, and automated software algorithms that allow non-technical personnel to rapidly validate products even when sealed within their original packaging.

     We are a direct seller of hardware and software products and services. Our customers place sales orders by calling one of our internal sales representatives via our toll-free phone number. We also sell indirectly through contracted authorized sales agents.

History of the Business

     XStream Systems, Inc. was formed as a Delaware corporation in May, 2004. We first generated revenue through a contract in 2005 with the Transportation Security Administration, an agency under the Department of Homeland Security. We launched our website and developed our first material detection prototype system in 2006. Significant changes to the product design were incorporated and our first XT250^TM Material Identification System (“XT250™”) shipped in 2007. Some PILOT programs for the XT250^TM were held at Pfizer, McKesson, Massachusetts Institute of Technology, Pharmaceutical Dimensions, AmerisourceBergen, Henry Lee Institute of Forensic Science at University of New Haven, RX Reverse Distributors, and Stericycle. In 2006, we entered into Distributor Agreements and in 2008 we entered into sales agreements with our first authorized sales agents and field service representatives (Remetronix and Compass Engineering) to sell and service our products. In 2008, we focused exclusively on the pharmaceutical industry, hired an experienced sales force from that industry, and added Eastern Applied Research as an additional authorized sales agent and field service representative. We introduced our first network product, Secure Pharma Network (SPN), which is described more fully in this section, in 2008 to provide a truly integrated system wide solution.

Industry Background

     According to IMS Health, Inc., pharmaceutical sales grew to $773.0 billion in 2008¹, and sales in the U.S. reached $291.0 billion,² while non-U.S. sales reached $482.0 billion.³ Although precise and detailed data on counterfeit pharmaceuticals is difficult to obtain, estimates range from 1% of sales in developed countries such as the U.S. to over 10% in developing countries, depending on the geographic area.⁴ Overall, counterfeit pharmaceuticals were estimated to exceed $40.0 billion in 2005, and the Center for Medicines in the Public Interest projects worldwide counterfeits to increase to over $75.0 billion by 2010.⁵

     Our initial market focus has been on the pharmaceutical distribution industry. Until recently the pharmaceutical industry has focused a significant amount of its attention on good manufacturing practices (GMP).⁶ Various federal, state, and local government agencies have regulated the manufacturing process of pharmaceuticals as well. While there has been focus on the manufacturing side, we believe there remain opportunities for illegal and dangerous activities, such as counterfeiting, diversions, adulterations, and dosage substitutions.

     Industry efforts to combat counterfeiting pharmaceuticals include the use of scales to weigh products, visual inspections, documentation of transfers, use of forensic laboratories, and tagging products. We believe that each of these methods has limited success. State legislation, in form of pedigree laws, has been adopted in a number of states; yet, the amount of counterfeiting continues to increase.⁷ Forensic laboratories have the analytical capabilities to verify pharmaceuticals, but take a significant amount of time to provide test results.⁸ The high volumes shipped through pharmaceutical distribution points require rapid testing. Forensic testing at laboratories also requires destructive testing, where the product is removed from its packaging and the contents are destroyed while being tested. Combating counterfeiting of pharmaceuticals has become a major initiative for some manufacturing companies. These companies each have dedicated personnel and departments to try and eliminate counterfeits. When harm comes from counterfeits, not only are manufacturing companies affected, but distribution companies may be held liable and some litigation has moved in that direction. Therefore, we believe the entire pharmaceutical supply chain has significant risk of negative consequences that could result from counterfeiting of pharmaceuticals.

FDA Recall — Firm Press Release Hi-Tech Pharmaceuticals, Inc., Issues Nationwide Recall of All Lots of Stamina-Rx Dietary Supplement Products, June 15, 2009. http://www.fda.gov/Safety/Recalls/ucm167139.htm;

FDA Recall — Firm Press Release AS Medications Solution LLC Announces a Nationwide Recall of All Lots of Digoxin Tablets 0.25mg Due to Size Variability, May 11, 2009. http://www.fda.gov/Safety/Recalls/ArchiveRecalls/ucm150734.htm.

CSO Security and Risk, Case Study, Drug Busters: Tracking Down Counterfeiters, November 1, 2005. http://www.csoonline.com/article/220663/Drug_Busters_Tracking_Down_Counterfeiters

Key Target Markets

     Within the pharmaceutical distribution market, management believes we can most effectively add value to our customers when serving pharmaceutical distributors, re-packagers, mail order companies, government agencies, and return logistics companies.

     We believe there are a multitude of sites worldwide that could potentially utilize our technology. To date, we have focused on the U.S. segments of the market. Europe, Middle East, Africa, and Southeast Asia are the primary expansion areas outside the U.S. that management anticipates would be most effectively served by our products and services.

     Beyond the pharmaceutical markets, we believe there is significant potential for our technology and products. Both private entities, including cruise lines, transportation centers, and amusement parks, as well as government agencies, including the military, are concerned with explosive and nuclear threats. In the medical field, it is desirable to detect conditions such as cancer and osteoporosis as early as possible. The veterinarian market could potentially utilize our technology to monitor compound manufacturing products. In the mining industry field, operations could use our technology to detect metals, minerals, and other materials of interest. The chemical processing market has a wide variety of material inspection needs that could be met with our technology. The cosmetics market has health risks from fraudulent products that could be addressed by our solutions.

Business Strategy

     Our business strategy is to become the primary source for technology, products, and services for applications requiring material analysis of hidden objects. Management’s intention is to brand XStream Systems as the leading industry expert in molecular screening, providing trusted solutions in counterfeit detection, explosive detection, and material verification and identification. We believe our experience and innovative technology should allow us to solve some of the industries’ most demanding problems.

     We utilize a multi-pronged strategy to provide wide market exposure and capture early adaptors. We have a direct sales force, with extensive pharmaceutical experience, concentrating on early adaptors, market development, and large enterprise prospects. Meanwhile authorized sales representatives promote sales to smaller local customers.

     We believe technology spending will need to increase throughout the pharmaceutical distribution chain to block the increasing threat of counterfeits. We believe no single competitor is effectively meeting the counterfeit challenge. Management believes it is imperative to verify the contents inside the package to truly authenticate the product.

Growth Strategy

     We plan to grow organically and externally through the pursuit of strategic partnerships. We have and continue to provide PILOT programs with larger corporations, which over time could develop into significant growth opportunities as these corporations expand the PILOT program into other locations within their organization. We also signed group purchasing and marketing agreements with several major pharmaceutical purchasing organizations, including National Coalition of Pharmaceutical Distributors (NCPD), Armada Health Care, and PDM Healthcare. These agreements provide access to potential customers, market exposure for us on their web sites, and speaking opportunities at conferences. See section below entitled “Strategic Partners.”

     While past efforts have focused on the U.S. domestic markets, the non-U.S. markets represent a large growth opportunity for XStream Systems. We anticipate using some of the funds raised through this public offering to pursue non-U.S. opportunities.

     Management believes that increased marketing efforts, including advertising, publications, speaking opportunities, and attending conferences are critical for growth. We also believe that increased networking through

association membership and participation is critical for our growth. We believe that these increased marketing activities will lead to new customers for our products and services.

     Management believes that our SPN may provide significant growth opportunities. The ability to collect test results from multiple customers, process that data, and provide meaningful information across the industry provides significant value to our customers. We believe that integrating SPN into our customers’ inventory management systems provides additional value to our customers. Since SPN is software based, revenues we anticipate to generate from SPN in the future are expected to increase our profit margins.

     Management believes that expansion into markets beyond the pharmaceutical industry should open new opportunities for XStream Systems. We hope to scale our technology and develop products that meet the varying needs of our customers. We expect to develop marketing processes and recruit marketing professionals with pertinent industry expertise to maximize customer value.

Strategic Partners

     We are partnering with a number of recognized companies and intend to develop applications for our molecular screening technology in connection with these relationships. Our initial target market has been the pharmaceutical distribution market, including major pharmaceutical manufacturers, drug distributors and automated drug dispensing logistics (assembly line efficiencies) companies. Some of these teaming relationships include the following:

•      Pfizer, a leading pharmaceutical manufacturer, is hosting our XT250^TM system, under a PILOT program arrangement.

•      AmerisourceBergen Corporation, a pharmaceutical wholesale distributor is piloting our XT250^TM systems in two separate locations, under a PILOT program arrangement.

•      Swisslog Healthcare Solutions, a global provider of integrated logistics solutions for warehouses, distribution centers and hospitals has executed a Letter of Intent with us to jointly collaborate and investigate the development of customized screening solutions.

•      Eastman Kodak, a corporation utilizing technology to combine imaging and information, has agreed in a Letter of Intent to explore with us strategic opportunities for joint design, development, cross-licensing, and co-marketing of security solutions.

     We will attempt to leverage the respective strengths and leadership positions of our strategic partners in the healthcare industry to gain a competitive foothold in our industry. We are negotiating strategic partnerships with other pharmaceutical distributors, manufacturers and logistic companies. We are directing our strategic joint venture efforts to produce applications which require a combination of non-destructive penetrating capability with forensic analysis.

Sales and Marketing

     In 2008 we created a new sales and marketing organization specializing in pharmaceutical distribution. We believe that our pharmaceutical based website (www.securepharmachain.com), anti-counterfeiting blog (www. securepharmachain.blogspot.com) and professional networking at major pharmaceutical events have raised the level of awareness throughout the industry. Additionally, we believe that we are viewed as an industry innovator in addressing pharmaceutical counterfeiting and have received free publicity via television, major publications, and on-line articles.

     Within the pharmaceutical distribution market, there are a number of submarkets that XStream Systems is targeting. We market to pharmaceutical manufacturers, including brand, generic, and contract manufacturers. We also market our products and services to pharmaceutical distributors, including large international wholesalers, regional wholesalers, secondary distributors, specialty distributors, and reverse logistics companies. There is a wide range of pharmaceutical dispensers to which we market as well, including mail order pharmacies, central fill pharmacies, buying

group cooperatives, and warehousing groups. There are government regulatory agencies, such as the Food and Drug Administration, Department of Homeland Security, and international ministries of health to which we also market. Our Company is also engaging various non-government organizations, such as the Family Health International.

Our Technology, Products and Solutions

     We offer hardware and software products, services, expertise, and packaged solutions to our customers. Utilizing our licensed patented technology, network expertise, material science experience, and software knowledge base, management believes we offer unique end-to-end solutions to companies of all sizes. Our solutions help protect supply inventories for the public, reduce liability, and provide market differentiation for our customers.

     Our initial hardware product is the XT250™, based on Energy Dispersive X-Ray Diffraction (EDXRD), a technology for detecting, identifying, and verifying materials. The XT250^TM product provides easy to use, rapid, on-site material identification and authentication. We own worldwide exclusive licensing rights for all applications of this patented technology. For the pharmaceutical market, the XT250^TM verifies the contents of the product, even while sealed in its packaging. The XT250^TM product is currently our primary source of revenue.

     We also provide services, including library generation services and engineering consultation. Standards for new materials of interest can be generated and then programmed into the hardware products. Customized features can be developed and incorporated into our products. We also offer sublicensing opportunities for specific applications.

     Management believes that our SPN may provide significant growth opportunities. SPN is a software product that allows customers to access via the Internet all of their systems purchased from XStream Systems. Customers may remotely manage their systems, downloading new material fingerprints or software updates, uploading results, and operating their systems remotely. Detailed reports can be generated, as well as customized and aggregated reporting across multiple systems. The ability to collect test results from multiple systems from our customers, process that data, and provide meaningful information across the industry provides significant value to our customers, which management believes can produce revenue in the future. We believe that integrating SPN into our customers’ inventory management systems provides additional value to our customers. To date, we have not generated revenue from SPN.

     Our technology can scale to meet additional customer needs. Our goal is to develop a wide range of products that operate rapidly to match customer demand, as well as scale to test any sample size to meet customer requirements. Management also hopes to develop products that scale down that are smaller, more portable, and more cost effective. Customer requirements will drive the directions that our future products take.

Manufacturing

     Our hardware products are manufactured by a U.S. contract manufacturer. This allows us to scale as our demands change. It also allows us to leverage the purchasing power of a larger organization. We place orders for hardware products with our contract manufacturer and those products are shipped directly to our customer sites. We are currently a defendant in a lawsuit with our manufacturer. For more information, see “Legal Proceedings” and “Risk Factors — We are currently a defendant in a lawsuit with the manufacturer of the XT250^TM system, Kimball Electronics, Inc.”

     Our company provides all software products and services. The operating system and library of materials are provided for each system. Customers can contract for customized configurations, which are developed by our Company.

Field Service

     Hardware and software support services are by provided by contracted field service companies. Each authorized field service company is trained and certified by our Company. Each of our customers has a designated field service representative that provides support services. Our Company also provides an escalation process to support those field service companies.

Customers

     Our target customers range in size from small, privately owned distributorships with estimated revenues of less than $50,000,000 to large multinational distribution corporations with estimated revenues of more than $10.0 billion. Management believes these organizations have a need for a material identification and authentication system in order to protect their brands in the marketplace and reduce risk and potential litigation should they distribute a counterfeit product.

     A number of organizations set up PILOT programs before they commit to purchasing a larger volume of our products. Multiple returns logistics groups, which specialize in handling the complexities of returned pharmaceuticals have a PILOT program with our XT250^TM for screening returns of manufacturers’ products for counterfeit pharmaceuticals. A pharmaceutical manufacturer has a PILOT program utilizing our XT250^TM for quality control and has already asked to expand the scope of the PILOT program. A distributor has an XT250^TM PILOT program for screening their inventory and has not only extended the PILOT program, but requested expansion of the PILOT program into an additional site.

     All our shipments to date have been to sites within the U.S. Management believes that shipments outside the U.S. will represent a significant portion of sales in the future. We believe non-U.S. shipments should begin in the first half of 2010.

Research and Development

     We spent $1,900,897 and $635,531 in research and development during the fiscal years ended 2007 and 2008, respectively. This included hardware and software development and enhancements of the XT250^TM and SPN products. These funds also were used in the development of a molecular library generation laboratory. Multiple companies contributed pharmaceutical products to this facility to aid in the research and development of molecular fingerprints.

Competition

     We operate in an unusually competitive market. In many cases, our customers have non-technical personnel operating in a warehouse environment. Counterfeit detection is sometimes performed by weighing the product with a simple scale. Other times counterfeit detection is done by track and trace methods, which tracks the transfers of the drugs, and on rare occasions by visual inspection. Our research has shown that some counterfeit drugs have weighed the same as valid drugs, some even come with falsified tracking documents, and many have passed visual inspection. Track and trace methods, which include pedigree laws, radio frequency inventory devices, bar codes, and taggants, have been deployed for a number of years and in some case legislated for pharmaceuticals.

     If there is a reason to suspect a drug is counterfeit, the sample may be shipped to a forensic laboratory for analysis. Highly trained personnel typically open and destructively test the suspect drug with one or more analytical instruments. Destructive testing is not a practical solution for the industry. Management believes that our non-destructive technology combines the high penetration of x-rays with molecular structural analysis. Our XT250^TM product has been successfully operated by non-technical personnel in warehouse type environments to provide rapid, accurate, and easy to understand authentication of their drug inventories.

Regulation

     In addition to federal, state, and local laws applicable to all corporations and employers in general, each state has its own requirements and registration process for x-ray equipment. Our organization is also governed by Food and Drug Administration, Drug Enforcement Agency, Environmental Protection Agency, and Department of Homeland Security regulations for handling and disposing of special materials. Our facility received a facility security clearance from the Department of Defense. Our Company possesses Drug Enforcement Agency Researcher licenses for Schedule I-V drugs. Our Company has received exemption letters for drug research purposes from the Florida Department of Health. In addition, each country also has its own requirements for our type of equipment, which our Company must abide by in order to ship into those countries.

     The Federal Communications Commission (FCC), Underwriters Laboratories (UL), and Canadian Standards Association (CSA) have certified that the XT250^TM product meets safety, health, environmental, and radiated emissions requirements. The costs for these certifications were included in the research and development spending for 2007 and 2008. Management believes that the XT250^TM will be required to pass Restriction of Hazardous Substances (RoHS) directives required by the European community before the XT250^TM is allowed to ship into those countries.

     To date we have not incurred any costs associated with disposal of any hazardous materials. We continue to make efforts to recycle all hazardous materials and management hopes to continue this in the future. When and if disposal of hazardous materials is necessary, management anticipates that disposal companies specializing in the materials will be hired.

Employees

     As of November 3, 2009, we had 12 full-time employees, eight of which are located at our Sebastian, Florida corporate office. Two employees in our sales and marketing department are located outside of Florida. We have five employees in management and five employees are in our operations and engineering departments. None of our employees is covered by a collective bargaining agreement. We believe we have a good relationship with our employees.

Property

     Our operations are currently located at 10305 102nd Terrace, Suite 101, Sebastian, Florida 32958. We lease real property at this location, which is part of an industrial park, Liberty Office Park. Our lease commenced in 2007 and expires in 2012. We lease approximately 8,000 square feet, and currently utilize approximately 5,000 square feet. We share a 40,000 square foot facility with two other companies. We believe our current office space provides more than adequate space for our offices, engineering development area, demonstration area, and Drug Enforcement Agency secured laboratory. We believe our current 8,000 square feet is adequate for our current needs and provides expansion room for engineering to develop the next generation of systems. The adjacent 10,000 square feet will allow for long term expansion if we need additional engineering and operations space. We expect total rent expense to be approximately $107,000 under office leases for 2009.

Intellectual Property

     XStream Systems has worldwide, exclusive licensing rights to U.S. Patent #6118850 (granted Sept. 12, 2000), “Analysis Methods for Energy Dispersive X-Ray Diffraction Patterns” pursuant to a licensing agreement with Rutgers.

     Under the terms of the License Agreement, the minimum royalty payment for 2008 of $300,000 became due January 31, 2009. In addition, certain other payments became payable in 2009 under the License Agreement. We were unable to pay the required minimum royalty and have requested a modification to the License Agreement. While Rutgers has the right to terminate the License Agreement after certain notifications and cure periods have expired, Rutgers has indicated an interest in modifying the License Agreement and continuing the licensing arrangement. Final terms of the contract modifications are under review by Rutgers and will be presented to the Company’s Board of Directors for approval. The total amount due under the License Agreement as of June 30, 2009 was approximately $302,000.

     We conduct business with trademarks of our XStream Systems logo, XT250^TM Material Identification System, SECUREPHARMACHAIN^TM, and Beyond Pedigree^TM. At this time, we have not applied for registration of these marks.

Legal Proceedings

     Other than as set forth below, we are not a party to any pending legal proceeding nor is our property the subject of a pending legal proceeding that is not in the ordinary course of business or otherwise material to the financial condition of our business.

     On or about September 16, 2008, Kimball International, Inc. and Kimball Electronics, Inc. (“Kimball”) filed suit against us in U.S. District Court in Evansville, Indiana. Kimball filed three claims against us including a claim alleging we defaulted on a $2,000,000 loan provided by Kimball in favor of the Company, breach of a reserve capacity agreement and breach of a supplier agreement. We asserted counterclaims against Kimball for conversion, breach of contract and tortious interference with business relationship. On June 30, 2009, the District Court granted partial judgment in favor of Kimball in the amount of $2,000,000 against us. On July 1, 2009, Kimball and the Company reached an agreement in principle to settle the parties’ claims, the specific details of which were to be memorialized in a final written settlement agreement. Under the agreement in principle, we would pay Kimball $3,200,000, which includes approximately $780,000 for inventory in Kimball’s possession, payable on the following schedule. We would make an initial payment of $500,000, on August 15, 2009, followed by six monthly payments of $25,000, four monthly payments of $50,000, followed by a final payment of $2,350,000 on June 15, 2010, provided, however, that if we completed a public offering before June 15, 2010, the balance of the $3,200,000 judgment would be due within 15 days of the closing. The settlement agreement was never finalized and none of the payments have been made. The parties have filed competing motions with the court to enforce their respective versions of the settlement terms. Additionally, Kimball’s motion requests the court to enter a separate judgment in their favor and against us in the principal sum of $3,200,000. Should the litigation be settled according to these terms, we anticipate that a portion of the proceeds of the offering will be utilized to pay the monies due to Kimball. We intend to vigorously pursue the settlement which will include terms under which Kimball will continue to supply XT250^TM units and allocate a portion of the payments to be made by the Company under the settlement agreement to the $780,000 in XT250^TM inventory in Kimball’s possession. We do not believe that our ability to fill orders for inventory in a timely manner will be harmed as there are a number of other manufacturers which have the capability to produce the machines. If we are unable to settle this litigation in a timely manner, our results of operations may be adversely affected.

     We intend to vigorously pursue the settlement which will include terms under which Kimball will continue to supply XT250^TM units and allocate a portion of the payments to be made by us under the settlement agreement to $780,000 in XT250^TM inventory in Kimball’s possession.

MANAGEMENT

Directors and Executive Officers

     The following table sets forth the names and ages of our directors and executive officers, and their positions with us, as of November 9, 2009:

Name		Age				Position
James J. Lowrey(1)			70			Chairman of the Board and Chief Executive Officer
Joseph J. Melone(4)			78			Vice Chairman
Brian T. Mayo			52			President and Chief Technology Officer
Ash K. Chawla(7)			53			Director
Anthony Chidoni(1)(2)(3)(8)			57			Director, Secretary, Chief Operating Officer
Dennis H. Ferro(1)(5)			64			Director
Simon Irish(5)			40			Director
Robert E. Kennedy(2)(3)			67			Director
Philip A. Odeen(2)			73			Director
Dr. E. Darracott Vaughan, Jr.(6)			70			Director
Dr. Stuart L. Weinstein(6)			62			Director
Christie C. Butler			46			Chief Financial Officer and Treasurer
Alan Clock			46			Senior Vice President, Sales and Marketing

     The principal occupations for the past five years (and, in some instances, for prior years) of each of our directors and executive officers are as follows:

James J. Lowrey, Chairman of the Board and Chief Executive Officer

     Mr. James J. Lowrey has served as chairman of the board of directors and chief executive officer since August 2009. Mr. Lowrey served as the co-chairman of the board from March 2009 through August 2009 and as chairman of the finance committee from March 2009 to October 2009. He has been a significant investor in XStream since 2007. From 1964 to 1978, Mr. Lowrey was employed with Salomon Brothers in New York, New York where he served as the partner-in-charge of banking, sales and trading of government and corporate tax exempt securities, and as a general partner at the time of his retirement in October 1978. During March 1979 he formed James J. Lowrey & Company, Inc. a financial advisory firm to corporations, governments and governmental entities. In 1980, Mr. Lowrey initiated the independent power industry through his formation of Catalyst Energy (“Catalyst”). Mr. Lowrey was instrumental in leading Catalyst through a number of purchases of developing projects and non-nuclear energy companies and served

Catalyst as its chairman of the board and its chief executive officer. Catalyst became a public company in 1984, was listed on the New York Stock Exchange and later taken private in 1988. Mr. Lowrey retired again in 1989. In 1993 he co-founded Navarro Lowrey, Inc. a Palm Beach County, Florida based real estate development firm dealing in real estate in Colorado, Texas and Florida. The firm is managed by Mr. Frank Navarro and Ms. Jessica Lee Lowrey, Mr. Lowrey’s daughter. Ms. Lowrey earned her J.D./LL.M. and M.B.A. degrees from New York University and Columbia University, respectively.

Joseph J. Melone, Vice-Chairman

     Mr. Joseph J. Melone has served on our board of directors since August 2009 and as our vice-chairman since October 2009. Mr. Melone has served as the chairman of our nominating and corporate governance committee since October 2009. He is the former president and chief executive officer of Equitable Companies, (now part of the AXA Group) and served in those positions from February 1996 to September 1997. Additionally, he served as chairman and chief executive officer of its principal insurance subsidiary, The Equitable Life Assurance Society of the United States from September 1992 to July 1997. Mr. Melone joined The Equitable Life Assurance Society of the United States in November, 1990 as president and chief operating officer and served in those positions until September 1992. Prior to that, he had been president of The Prudential Insurance Company of America from March 1984 to November 1990. Upon the formation of The Equitable Companies in 1992, Mr. Melone was elected president and chief operating officer and served in those positions until February 1996. Also, from September 1992 to July 1997, he served as chief executive officer of Equitable Life, and two years later he was elected chairman. In February 1996, Mr. Melone was named chief executive officer of The Equitable Companies and served in that position until July 1997. Mr. Melone co-authored the book Retirement Plans: 401(k)s, IRAs and Other Deferred Compensation Approaches (Pension Planning) which is currently in its 10th edition of publication. He is a former Huebner Foundation Fellow and was an Associate Professor of Insurance at The Wharton School of the University of Pennsylvania. He also served as Research Director at The American College before joining The Prudential. He is a Chartered Life Underwriter (CLU) and Chartered Financial Consultant (ChFC) from The American College, as well as Chartered Property and Casualty Underwriter (CPCU) from the American Institute of Chartered Property and Liability Underwriters.

Ash K. Chawla, Director

     Mr. Ash Chawla has served on our board of directors since August 2009. Mr. Chawla has served as the chairman of our global business development committee since October 2009. Mr. Chawla has served as the founder and chief executive officer of PDM Healthcare, from 1991 to the present. PDM Healthcare is a resource management company providing group purchasing, supply chain management and delivery, business and clinical consulting, and educational services to healthcare facilities in the U.S. Under his leadership, PDM Healthcare has maintained its position as a major buying groups/supply chain management in the U.S. PDM Healthcare currently has business trading relationships with over multiple pharmaceutical, medical surgical supply, and ancillary product manufacturers that are listed in Fortune 1000. Additionally, from January 2004 to the present he has served as the chairman and chief executive officer of Avani International, which specializes in business development, product launches and marketing,

consulting, distribution, and global conferencing for the bio-technology, life sciences, pharmaceutical, medical device, and cosmetic markets. Avani is instrumental in creating relations and distribution channels between manufacturers abroad with customers in the U.S. as well as introducing products from the U.S. to international markets, including India.

Anthony Chidoni, Director, Chief Operating Officer, and Secretary

     Mr. Anthony Chidoni has served on our board of directors since April 2009. He commenced service as a member of our audit committee, as chairman of our compensation committee and as our corporate secretary in August 2009 and as our chief operating officer in October 2009. In addition, since October 2009, he has served as chairman of our executive committee and as a member of our finance committee. Mr. Chidoni has been the principal and owner of Lorelle Capital, a private hedge fund, since January 2004. From January 1990 to January 2004, he was the Managing Director of Private Client Business in the Los Angeles office of investment bank Credit Suisse First Boston, and its predecessor Donaldson Lufkin & Jenrette, where he had served in various positions for 21 years. Mr. Chidoni has served as a director of the public company Guess?, Inc. since November 2002 for which he also currently serves as the chairman of the audit committee.

Dennis H. Ferro, Director

     Mr. Dennis H. Ferro has served on our board of directors since August 2009 and as chairman of our finance committee and co-chairman of our investor relations committee in October 2009. Mr. Ferro was president and chief executive officer of Evergreen Investment Management Company from September 2003 through December 2008. Mr. Ferro joined Evergreen Investments as its chief investment officer in 1999. Mr. Ferro has also served as a director of New York Marine & General Insurance Company and as chairman of their finance committee from March 2009 to the present. From 1999 through 2003 he also served as their chief investment officer. From 1994 through 1999, Mr. Ferro was executive vice president of Zurich Investment Management Ltd and head of international equity investments based in London. In 1995, Mr. Ferro was named as one of the top 100 mutual fund portfolio managers by Barron’s magazine. From 1991 through 1994, he was senior managing director of CIGNA International Investments and also served as chief investment officer for all non-U.S. investments. From 1988 through 1991, he served as the managing director for Asia for CIGNA Corporation based in Tokyo, Japan. From 1985 through 1988, Mr. Ferro served as president and managing director of Japan Bankers Trust Company Ltd based in Tokyo, Japan. From 1978 to 1985, he served as a founding director, president and chief investment officer for Bankers Trust Company of Florida. From 1970 to 1978, he served as vice president and portfolio manager of Banker’s Trust Company based in New York.

Simon Irish, Director

     Mr. Simon Irish has served on our board of directors since August 2009 and as a co-chairman of our investor relations committee in October 2009. Mr. Irish is the former head of Man Global Strategies (“MGS”) in North America, an investment division of Man Group PLC where he provided services from October 2002 through January 2009. Man Group PLC is an investment business headquartered in the United Kingdom. At MGS, Mr. Irish established and grew a strategic investment program in hedge funds, which he operated for over six years. From October 2001 through October 2002, he held the position of director of U.S. business with FRM (Research) LLC, New York and held the position of senior vice president of FRM London from September 1999 through September 2001. From October 1995 through April 1999, Mr. Irish was a vice president of Credit Suisse Financial Products in London where he served as a quantitative analyst and as a trader in their Equity Derivatives Structuring and Trading Group.

Robert E. Kennedy, Director

     Mr. Robert E. Kennedy has served on our board of directors since April 2007 and as a member of the Company’s audit committee since May 2007. In addition, Mr. Kennedy has served as the co-chairman of our audit committee since October 2009. Mr. Kennedy is a retired advertising industry executive with 33 years of experience. At the time of his retirement, Mr. Kennedy was the president and chief operating officer of Saatchi and Saatchi Advertising worldwide. Mr. Kennedy directed all of the company’s communications operations, notably the advertising subsidiaries and marketing services groups. Mr. Kennedy was also a member of Saatchi and Saatchi, Inc’s board of directors. Mr. Kennedy joined Dancer-Fitzgerald-Sample in 1961 and spent most of his career in agency finances. He served as controller and became chief financial officer in 1980. When Saatchi and Saatchi and DFS merged in 1987, Mr. Kennedy became its vice-chairman and chief financial officer. Mr. Kennedy served on numerous industry committees during his working career. In retirement he has been active in community organizations, most notably the VNA/Hospice of Vero Beach, the Environmental Learning Center of Vero Beach and Habitat for Humanity.

Philip A. Odeen, Director

     Mr. Philip A. Odeen has served on our board of directors since July 2008. He commenced service as the chairman of our audit committee during August 2009. Mr. Odeen served as the chairman of AES Corporation since January 2008 and as non-executive chairman of Convergys Corporation since December 2007. He served as chairman of AVAYA from October 2006 to October 2007. He was chairman and acting chief executive officer of the Reynolds and Reynolds Company from July 2004 to February 2005 at which time he became non-executive chairman serving in that role until October 2006. He was also named chief executive officer of QinetiQ North America in October 2005 serving until June 2006. Previously, he had served as non-employee chairman and a director of TRW Inc. from February 2002 until December 2002. From 1998 to 2002 he held various leadership positions at TRW. Mr. Odeen joined TRW in 1997 when it acquired BDM International, Inc. where he had served as president, chief executive officer and director since 1992. Previously, Mr. Odeen was vice chairman, Management Consulting Services at Coopers & Lybrand after serving 13 years as managing partner of the firm’s public sector practice. Mr. Odeen served as a director of Northrop Grumman from May 2003 and May 2008. Mr. Odeen was appointed a member of the Defense Business Board (DBB) in 2008.

Dr. E. Darracott Vaughan, Jr., Director

     Dr. E. Darracott Vaughan, Jr. has served on our board of directors since August 2009 and as co-chairman of our medical advisory committee in October 2009. Dr. Vaughan is a physician and surgeon specializing in urology. Since 2001, he has served as the James J. Colt Professor, Chairman Emeritus Weill Cornell University Medical Center in the Department of Urology. From 1993 through 2001, Dr. Vaughan served as the James J. Colt Professor of Urology, Chairman, at Cornell University Medical Center. He is the executive vice dean and senior associate dean for Clinical Affairs since 2005. Dr. Vaughan was president of the American Urological Association in 2001. Dr. Vaughan is the recipient of numerous academic awards and honors which includes most recently the 2008 John Coleman Award, Department of Urology Weill Cornell University Medical Center. Dr. Vaughan’s research interests include obstructive uropathy, prostaglandins, renal hemodynamics, benign prostatic hyperplasia, hypertension and adrenal disorders. Dr. Vaughan has authored and co-authored over 350 publications in the field of renal and urological medicine.

Stuart L. Weinstein, M.D., Director

     Dr. Stuart L. Weinstein, has served on our board of directors since August 2009 and as co-chairman of our medical advisory committee in October 2009. Dr. Weinstein is the Ignacio V. Ponseti Chair and Professor of Orthopedic Surgery at The University of Iowa. He served as the president of the American Orthopaedic Association from 1997 to 1998; the American Board of Orthopaedic Surgery from 2000-2001 and The American Academy of Orthpaedic Surgeons from 2005-2006. He is a National Institutes of Health funded researcher. He has published more than 180 scientific articles in peer review journals on a wide variety of pediatric orthopaedic conditions. His research work has focused on spinal deformity in children, children’s hip and foot problems, and the natural history and long-term outcome of pediatric musculoskeletal conditions. He has edited three major textbooks including The Pediatric Spine: Principles and Practice; Lovell and Winter’s Pediatric Orthopaedics and Turek’s Orthopaedics. He has served as an Associate Editor and a member of the Board of Trustees of the Journal of Bone and Joint Surgery. Dr. Weinstein currently serves as chairman of doctors for Medical Liability Reform (DMLR), a Washington, DC based advocacy group, and chairman of the American Association of Orthopaedic Surgeons Political Action Committee. After interning in Internal Medicine at The University of California San Francisco, he returned to the University of Iowa for a residency in Orthopaedic Surgery. In 1976 he joined the faculty of the Department of Orthopaedic Surgery at The University of Iowa.

Executive Management

     The following individuals serve as our executive officers.

Brian T. Mayo, President and Chief Technology Officer

     Mr. Brian T. Mayo founded the Company in 2004. He is currently our president. Since July 2009, Mr. Mayo has also served as our chief technology officer. He has served as our chief executive officer from May 2004 to October 2007, as president from October 2007 to the present, and as our chief executive officer again from July 2008 to July 2009. Mr. Mayo was chairman of the board of directors from May 2004 to October 2007 and served as our director until November 2009. Mr. Mayo has 30 years experience in the electronics industry. Mr. Mayo was instrumental in several startup ventures including: Ardent Communications, which pioneered voice over the Internet and where he was the director of engineering from January 1997 to August 1997; and Ingenuity Designs, a company specializing in airport security solutions where he was founder, president and chief executive officer from September 2001 to May 2004. During his career, he enjoyed technical and management success at the following companies: Cisco Systems, where he was the director of engineering from August 1997 to September 2001; Nortel Networks (formerly Bay Networks) where he was the engineering director from July 1995 to January 1997; Ungermann-Bass Networks, where he was a corporate consulting engineer from May 1993 to July 1995; Digital Equipment Corporation, where he was the engineering manager from July 1987 to May 1993; Gould-Modicon, where he was program manager from April 1985 to July 1987; Teradyne, where he was hardware engineer from September 1978 to December 1980 and operations manager from December 1980 to April 1985; and Texas Instruments, where he was hardware engineer June 1977 to September 1977. Mr. Mayo has had involvement in the development of the communications industry’s first data network switch. Mr. Mayo has authored and co-authored a number of patents.

Christie C. Butler, Chief Financial Officer and Treasurer

     Ms. Christie C. Butler, has served as our chief financial officer and treasurer since February 2008. Ms. Butler served as our secretary from May 2008 to August 2009. She previously served as our controller from March 2007 until February 2008. Ms. Butler has over 18 years of financial experience, including as vice president of finance with Fortune 250 companies KB Home from October 2004 through December 2006 and Pulte Homes from March 2001 through July 2004. She began her career as a Certified Public Accountant (CPA) with Arthur Andersen and performed

financial statement audits and handled taxation matters for both publicly traded and privately held entities from August 1991 to February 1993. From February 1993 to April 1997, she was a senior tax manager with a regional accounting firm Vestal & Wiler, CPAs, working with private companies. From April 1997 to September 1999, Ms. Butler served as controller for a hedge fund and institutional money manager, Atlantic Portfolio Analytics & Management. She later served as controller for a publicly traded national defense contractor, ECC International Corp., from September 1999 to March 2001. Ms. Butler has expertise in the areas of strategic analysis, budgeting, forecasting, cash management, and risk management.

Alan Clock, Senior Vice President, Sales and Marketing

     Mr. Alan Clock joined us in 2007. He currently serves as our senior vice president of sales and marketing. Mr. Clock has 23 years experience in the healthcare and pharmaceuticals industry. Mr. Clock has held senior level sales positions at: Active Health Management, an early pioneer in evidenced based disease management programs where he was senior vice president of sales from July 2006 to August 2007; nuvado, LLC, a pharmaceutical software and consulting company where he was executive vice president of business development and sales from July 2005 to July 2006; and AmerisourceBergen, one of the world’s largest pharmaceutical services companies where he was the corporate vice president of alternate care from November 1998 to July 2005. During his career, he enjoyed sales, business development and management success at the following companies: McKesson, where he was the vice president of national accounts from October 1995 to November 1998 and Cardinal Health (formerly Whitmire Distribution/Amfac Healthcare) where he served and was promoted through a variety of local, regional and national sales positions, eventually becoming corporate director of Hospital Services from May 1987 to October 1995. Mr. Clock was instrumental in the creation, development and success of the pharmaceutical distribution and service industry’s first alternate care vertical.

Other Key Employees

     The following individuals are our key employees.

Patricia Ann Earl, Vice President of Business Development

     Mrs. Patricia Ann Earl has served as our executive strategic consultant and vice president of business development since May 2008. Mrs. Earl is a long time pharmaceutical industry veteran and has been actively involved in the pharmaceutical wholesale distribution industry since joining AmerisourceBergen Corporation (“Bergen”), one of the nation’s largest pharmaceutical services companies serving the U.S., Canada and selected global markets in 1986. She held a variety of executive management positions at Bergen including vice president general manager from February 1998 to December 2000 and corporate vice president of strategic development from January 2001 to May 2005. While at Bergen, she directed the strategic and marketing initiatives for U.S. health systems, the largest Pharmacy Benefit Management (PBM) organizations, and alternate care providers. She played a significant role in the acquisition, strategic positioning, and implementation of the company’s pharmacy technologies, packaging and service offerings that enhanced medication safety in the pharmaceutical supply chain. Mrs. Earl was one of the founding members and was elected the co-chairman of the first Healthcare Distribution Management Association (“HDMA”) Collaborative Commerce Committee that promoted the advancement of collaborative e-commerce business solutions between the nation’s largest pharmaceutical distributors and manufacturers. HDMA is the national association representing primary, full-service healthcare distributors and is the vital link in the healthcare system, working to provide value, remove costs and develop innovative solutions. During her tenure, the technological solutions investigated by the group and recommended to the industry included various bar code track and trace technologies, radio-frequency identification devices (RFID) in cooperation with the MIT Auto-ID center, and e-pedigree solutions that met the requirements of Prescription Drug Marketing Act of 1987. From May 2005 until March 2008, she was vice president institutional marketing at H.D. Smith. Prior to her career in pharmaceutical distribution, Mrs. Earl had a successful career as an owner/principal, member of board of directors and served as chief operating officer from April 1978 to December 1986 for TP Communications, a privately-held corporation that acquired several broadcast radio stations. Subsequently those stations were acquired by Clear Channel Broadcasting Network. As a board member and corporate officer, she provided executive leadership, management oversight, and strategic direction to the sales, operations and financial functional areas.

Paul J. Micciche, Vice President of Engineering

     Mr. Paul J. Micciche has served in the position of vice-president of engineering from November 2004 to the present. Mr. Micciche has over 24 years of experience in the high technology industry. Prior to his position at XStream

Systems he was principal member of Technical Staff at Lucent Technologies from June 2000 through October 2004 where he managed development teams in the architecture, design, development and deployment of high throughput multi-service IP edge router platforms. At Ascend Communications, from 1999 to 2000, Mr. Micciche served as technical manager where he oversaw the architecture, design and development teams for high performance central processing units, internet physical layer cards and high speed backplanes. Ascend Communications was acquired by Lucent Technologies for $22.0 billion in 1999. From 1996 to 1999, Mr. Micciche served as an engineering manager for BayNetworks Inc. and was responsible for the architecture and design for data compression cards, FPGA control units and overall Ethernet router systems. BayNetworks was acquired by Nortel Networks in 1998 for over $9.0 billion. As a Senior Engineering at UB Networks from 1993 to 1996, Mr. Micciche was part of the development team that architected and designed several products including one of the industry’s first Ethernet concentration platforms, ATM Universal Network Interfaces and desk top switch products. Prior to these roles, Mr. Micciche worked for Draper Laboratories from 1985 to 1993 on U.S. Navy related defense programs and held a secret security clearance.

Advisory Board

     Our advisory board offers counsel to our management on an informal basis concerning development of new technology, and strategic planning and partnering. We do not have contractual relationships with the members of our advisory board. Each member of our advisory board is eligible to receive an annual grant of 2,500 share-based incentive awards for advisory service.

     Dr. Mohammed Abuelkhair. Dr. Abuelkhair is the head of the pharma/medicine and medical products regulation section health authority in Abu Dhabi and the head of the drug and medical product department for the general authority of health services for the Emirates of Abu Dhabi.

     Mark S. Butler. Mr. Butler is the former executive vice president, chief administrative officer and general counsel to the public company Indevus Pharmaceuticals, Inc. which was acquired in March 2009 by Endo Pharmaceuticals, Inc.

     Dr. Ronald B. Gaeta. Dr. Gaeta is a veterinarian and a partner in Patterson Veterinary MRI an equine exclusive imaging center located in Patterson, New York and an owner of Dunbarton Equine, a three doctor equine exclusive sport horse medicine practice located in Brookfield, Connecticut. Dr. Gaeta serves as the equine consultant to the Bronx Zoo.

     Dr. William Hamilton. Dr. Hamilton is an orthopedic surgeon specializing in the foot and ankle related medical conditions of athletes and performing artists including ballet dancers. He has served as a clinical professor of orthopedic surgery at the College of Physicians & Surgeons, at Columbia University from July 1995 to the present.

     Dr. James D. Henry. Dr. Henry is a urologic surgeon and has served as the Chief of Urologic Surgery at Good Samaritan Hospital and Saint Mary’s Hospital in West Palm Beach, Florida. Dr. Henry is a co-founder of Jupiter Hospital in Jupiter, Florida.

     John R. Kennedy. Mr. Kennedy is the former president and chief executive officer of Federal Paper Board Company, Inc. He was employed with Federal Paper Board Company from 1952 in various management positions until his retirement in April 1996. Mr. Kennedy is past chairman of Georgetown University and is currently chairman emeritus. As past chairman for The East Hampton Healthcare Foundation, Inc., Mr. Kennedy now serves as one of its trustees. He is also vice chairman of the Indian River Memorial Hospital Foundation and a board member of the Riverside Theater.

Board of Directors and Corporate Governance

     Our board of directors is responsible for establishing broad corporate policies and for overseeing our overall management. In addition to considering various matters which require board approval, the board provides advice and counsel to, and ultimately monitors the performance of, our senior management.

     We established an Audit Committee and Compensation Committee in January 2005. In March 2009, we established a Finance Committee. In October 2009, we established a Nominating and Corporate Governance Committee. The charters for the Audit Committee, Compensation Committee and Nominating and Corporate Governance Committee are available at our website, www.xstreamsystems.com. We believe Messrs. Kennedy, Odeen, Chawla, Ferro, Irish, Vaughan, and Weinstein are independent members of our board of directors, under NASDAQ’s

independence standards. The audit, compensation and nominating and corporate governance committees are composed of at least one of these independent members. In accordance with NASDAQ phase-in rules for initial public offerings we anticipate that within one year of our expected listing on NASDAQ, each of the directors on the committees will be determined by the board to be “independent.”

     The board, its committees and our management strive to perform and fulfill their respective duties and obligations in a responsible and ethical manner. We have adopted a Code of Ethics for Senior Financial Officers that applies to our Chief Executive Officer, President, and Chief Financial Officer, as well as a Chief Accounting Officer and Controller if we employ persons in these positions in the future. In addition, we have adopted a Code of Conduct generally applicable to all of our employees. Upon request, we will provide to any person without charge a copy of our Code of Ethics or Code of Conduct. Any such request should be made to Christie C. Butler, Chief Financial Officer, XStream Systems, Inc., 10305 102nd Terrace, Suite 101, Sebastian, FL 32958.

Committees of the Board

     Audit Committee. The board has an Audit Committee comprised of three directors, Messrs. Philip A. Odeen (Co-Chairman), Anthony Chidoni and Robert E. Kennedy (Co-Chairman). Each member of the Audit Committee is independent as defined under NASDAQ’s listing standards, other than Mr. Chidoni. The board of directors has determined that Mr. Kennedy and Mr. Chidoni each qualify as an “audit committee financial expert.” The Audit Committee functions pursuant to a written charter, under which the committee has such powers as may be assigned to it by the board from time to time. The Audit Committee was established in January 2005. The Audit Committee is currently charged with, among other things:

	•		discuss with management and our independent public accountants our annual audited financial statements, quarterly financial statements, earnings press releases, and financial information and earnings guidance provided to analysts and rating agencies, if any;
	•		discuss with management and our independent public accountants our major financial risk exposures, the guidelines and policies by which risk assessment and management is undertaken, and the steps management has taken to monitor and control risk exposure;
	•		appoint, retain, compensate, evaluate, and terminate our independent public accountants for the purpose of preparing or issuing an audit report or performing other audit, review, or attest services for us and oversight of such work;
	•		pre-approve, or adopt procedures to pre-approve, all audit, audit related, tax, and other services permitted by law or applicable SEC regulations (including fee and cost ranges) to be performed by our independent public accountants;
	•		review, at least annually, the qualifications, performance, and independence of our independent public accountants, including to ensure the rotation of the lead audit partner at least every five years;
	•		reviewing the integrity of our financial reporting process with our independent auditors and with our management and internal auditor, if any;
	•		review the effect of regulatory and accounting initiatives, as well as off-balance sheet structures, on our financial statements;
	•		review with our independent auditors any audit problems or difficulties encountered and management’s response thereto;
	•		discuss the scope of the annual audit and review the form of the opinion the independent auditor proposes to issue;
	•		establish procedures for the receipt, retention, and treatment of complaints received by us regarding accounting, internal accounting controls, or auditing matters and the confidential, anonymous submission by our employees of concerns regarding questionable accounting or auditing matters;

	•		review and approve all related party transactions and review and make recommendations to the board of directors, or approve, any contracts or other transactions with our current or former executive officers, including consulting arrangements, employment agreements, change-in-control agreements, termination arrangements, and loans to employees made or guaranteed by us; and
	•		review and reassess the adequacy of the Audit Committee Charter on an annual basis and recommend any changes to the board of directors.

     Compensation Committee. The board has a Compensation Committee comprised of two directors, Messrs. Anthony Chidoni (Chairman) and Robert E. Kennedy. Mr. Kennedy is independent as defined under NASDAQ’s listing standards. The Compensation Committee functions pursuant to a written charter, under which the committee has such powers as may be assigned to it by the board from time to time. The Compensation Committee was established in January 2005. The Compensation Committee is currently charged with, among other things, assisting the board in:

	•		review and recommend for approval by the independent directors of the board of directors, the total compensation package of the chief executive officer and other members of senior management and key employees for the upcoming year, at least on an annual basis;
	•		discuss performance evaluation of the chief executive officer and recommend approval by the independent board of directors of bonus compensation and develop performance goals for the chief executive officer and other members of senior management for purposes of determining bonus compensation;
	•		review market data to assess our competitive position for all components of compensation for the chief executive officer and senior management to ensure we are competitive with comparable public companies;
	•		administer any plan, recommend to the board of directors the adoption of any amendments to a plan or modifying or canceling any existing grants under such plans; and review the sufficiency of the shares available for grant under the plans;
	•		review and recommend director compensation, including cash payments, equity awards and other benefits;
	•		retain consultants of its selection to advise it with respect to our salary and incentive compensation and benefits programs, and approve the consultants’ fees and other retention terms;
	•		review and reassess the adequacy of the Compensation Committee Charter annually and recommend any proposed changes to the board of directors for approval; and
	•		perform such other functions as necessary and appropriate under law, the rules of NASDAQ (or other exchange or interdealer electronic quotation service which rules may be applicable to us), our amended and restated certificate of incorporation or amended and restated by-laws and the resolutions and other directives of the board of directors.

     In general, the Compensation Committee formulates and recommends compensation policies for board approval, oversees and implements these board-approved policies, and keeps the board apprised of its activities on a regular basis. In addition, the Compensation Committee develops criteria to assist the board’s assessment of the Chief Executive Officer’s leadership of our Company.

     Nominating and Corporate Governance Committee. The board has a Nominating and Corporate Governance Committee comprised of two directors, Messrs. Robert E. Kennedy (Chairman) and Mr. James J. Lowrey. Mr. Kennedy is independent as defined under NASDAQ’s listing standards. The Nominating and Corporate Governance Committee functions pursuant to a written charter, under which the committee has such powers as may be assigned to it by the board from time to time. The Nominating and Corporate Governance Committee was established in October 2009. The Nominating and Corporate Governance Committee is currently charged with, among other things, assisting the board in:

•

selecting or recommending to the board for selection, the individuals to stand for election as directors at the annual meeting of stockholders;

	•		overseeing the selection and composition of committees of the board and, as applicable, oversee management continuity planning processes;
	•		identifying individuals believed to be qualified as candidates to serve on the board and select, or recommend that the board select, the candidates for all directorships to be filled by the board or by the stockholders at an annual or special meeting;
	•		reviewing and making recommendations to the full board, or determine, whether members of the board should stand for re-election and consider matters relating to the retirement of board members, including term limits or age caps;
	•		if applicable, in the case of a director nominated to fill a vacancy on the board due to an increase in the size of the board, recommend to the board the class of directors in which the director-nominee should serve;
	•		conducting all necessary and appropriate inquiries into the backgrounds and qualifications of possible candidates;
	•		considering questions of independence and possible conflicts of interest of members of the board and executive officers;
	•		reviewing and making recommendations, as the committee deems appropriate, regarding the composition and size of the board in order to ensure the board has the requisite expertise and its membership consists of persons with sufficiently diverse and independent backgrounds; and
	•		overseeing the evaluation, at least annually, and as circumstances otherwise dictate, of the board and management.

     Finance Committee. The board has a Finance Committee comprised of Messrs. Dennis H. Ferro (Chairman) and James J. Lowrey. The Finance Committee does not have a written charter. The Finance Committee was established in March 2009. This committee is currently charged with, among other things, assisting the board in:

	•		formulation of policies relating to the our cash flow, cash management and working capital, stockholder dividends and distributions, share repurchases and investments;
	•		adjustments to our capital structure;
	•		capital and debt issuances;
	•		financial strategies;
	•		working capital and cash flow management;
	•		policies for managing interest rate and investment risk;
	•		the financial aspects of insurance and risk management;
	•		tax planning and compliance;
	•		proposed mergers, acquisitions, divestitures and strategic investments; and
	•		other transactions or financial issues that management desires to have reviewed by the Finance Committee.

     Additionally, the finance committee reports periodically to the full board on our insurance and risk management programs.

     The board of directors has additional standing committees including the executive committee, the investor relations committee, the medical advisory committee and the global business development committee.

Director Compensation for the Year Ended December 31, 2008

     All directors are entitled to receive compensation for their services. In February 2008, a resolution was passed by the Compensation Committee granting directors the following annual compensation package:

	•		Grant of stock options to purchase 7,500 shares of our common stock pursuant to our Amended and Restated 2004 Stock Option Plan; and
	•		Grant of stock options to purchase 1,875 shares of our common stock for committee service.

     The following table summarizes the compensation of each member of our board of directors in 2008.

						Fees Earned or								Option				All Other
						Paid in Cash				Stock Awards				Awards				Compensation				Total
Name(1)			Year			($)				($)				($)(2)				($)				($)
James J. Lowrey Chairman(3)			2008				—				—				342,000				—
							—				—			$	30,438				—			$	30,438
Robert E. Kennedy(4)			2008				—				—				11,250
														$	4,149							$	4,149
Philip A. Odeen(5)			2008				—				—				3,280
							—				—			$	1,210							$	1,210

Executive Compensation

     The following table sets forth information concerning the annual and long-term compensation of our Chief Executive Officer and the other named executive officers, for services as executive officers for the last two fiscal years.

Summary Compensation Table

																						All
														Stock								Other
Name and Principal		Fiscal				Salary				Bonus				Awards				Option Award(s)				Compensation				Total
Position		Year				($)				($)				($)				($)(8)				($)				($)
James J. Lowrey(1)			2008				—												—								—
Chairman of the Board and Chief Executive Officer			2007				—												—								—
Brian T. Mayo (2)(3)			2008			$	221,546											$	32,354	(2)		$	120	(7)
President and Chief Technology Officer			2007			$	119,209								—			$	41,890	(3)		$	120	(7)
Christie C. Butler (4)(5)			2008			$	84,749											$	3,984	(4)		$	120	(7)
Chief Financial Officer			2007			$	61,398											$	2,450	(5)		$	120	(7)
Alan D. Clock (6)			2008			$	168,009											$	2,071	(6)		$	120	(7)
Senior Vice President of Sales and Marketing			2007			$	34,006											$	8,918	(6)		$	120	(7)

Employment and Severance Agreements

     We have entered into the agreements set forth below with the following executive officers Mr. Brian T. Mayo, Ms. Christie C. Butler and key employee Mr. Paul J. Micciche.

     Brian T. Mayo Employment Agreement

     We entered into an employment agreement with Mr. Mayo on November 1, 2006 whereby Mr. Mayo agreed to serve as our president and chief executive officer. The agreement terms provide for automatic annual renewal. Under the terms of the agreement Mr. Mayo’s base annual salary is $255,000, and he is entitled to receive an annual performance bonus in accordance with our annual bonus program. The base salary is reviewed each year by the board and it may in its discretion elect to increase the base salary at any time. Subject to certain conditions, Mr. Mayo is entitled to receive certain benefits under the agreement including health insurance, disability insurance, life insurance and paid vacation of not less than four weeks per year. The terms of the agreement additionally provide that we will maintain a directors’ and officers’ liability insurance policy covering Mr. Mayo in an amount of no less than $1,000,000. If Mr. Mayo’s employment is terminated by us without cause or by Mr. Mayo for good reason, Mr. Mayo will be entitled to receive a severance payment equal to all of the base salary, annual bonus, stock options, business expenses and benefits which are due, have accrued, or will otherwise become due or accrue through the end of the term of the agreement, or six months, whichever is the greater amount of time. If Mr. Mayo’s employment is terminated by Mr. Mayo without “good reason,” Mr. Mayo will be entitled to receive a severance payment of all base salary, annual bonus (if already awarded), stock options, business expenses and benefits which are due and accrued through the date of termination. If Mr. Mayo’s employment is terminated by us for cause, Mr. Mayo will be entitled to receive a severance payment of all base salary, annual bonus (if already awarded), stock options, business expenses and benefits which are due and accrued through the effective date of termination. If Mr. Mayo’s employment is terminated by Mr. Mayo by reason of Mr. Mayo’s death, his estate shall be entitled to receive all base salary, annual bonus (if already awarded), stock options, business expenses and benefits which are due and accrued through the date of death.

     In the event of Mr. Mayo’s termination upon a change of control as defined in the agreement, subject to certain conditions, he will be entitled to receive all base salary, annual bonus (if already awarded), stock options, business expenses and benefits which are due or otherwise become due or accrue for a period of six months. Prior to the effective date of the change of control, 25% of the stock options granted to Mr. Mayo will vest and be exercisable by Mr. Mayo for a period of one year following the effective date of termination of his employment.

     The agreement provides that Mr. Mayo is not permitted during the term and for 12 months after the effective date of the expiration or termination of the term of the agreement, to solicit any employees, agents and other business contacts of ours to terminate or modify their relationship with or compete against us or conduct business activities in competition with us.

     The agreement provides that the results of Mr. Mayo’s employment under the agreement, including any works of authorship resulting from the performance of his duties during his employment with us and any works in progress are works-made-for-hire for the benefit of us and we are the sole owner of the work.

     During October 2009, we entered into a verbal agreement with Mr. Mayo to temporarily reduce his salary to $127,500. We anticipate entering into an amended agreement with Mr. Mayo to memorialize the change in terms.

     Christie C. Butler Employment Agreement

     We entered into an employment agreement with Ms. Butler effective August 15, 2009 whereby Ms. Butler agreed to serve as our chief financial officer. The agreement terms provide for automatic annual renewal, unless either party notifies the other not later than 90 days prior to the then expiration date that such party does not intend for the employment period to automatically extend. Under the terms of the agreement, Ms. Butler’s base annual salary is currently $140,000, and she is entitled to receive an annual performance bonus in accordance with our annual bonus program. The base salary is reviewed each year by the board and it may in its discretion elect to increase the base salary at any time. Subject to certain conditions, Ms. Butler is entitled to receive certain benefits under the agreement including health insurance, disability insurance, life insurance and paid vacation of not less than three weeks per year. The terms of the agreement additionally provide that we will maintain a directors’ and officers’ liability insurance policy covering Ms. Butler in an amount of no less than $1,000,000 dollars.

     If Ms. Butler’s employment is terminated by us without cause or by Ms. Butler for good reason, Ms. Butler will be entitled to receive a severance payment equal to all of the base salary, annual bonus, stock options, business expenses and benefits which are due, have accrued, or will otherwise become due or accrue through the end of the term of the agreement, or six months, whichever is the greater amount of time. Ms. Butler’s employment may be terminated by Ms. Butler without “good reason” upon at least 60 days prior written notice to us. Upon such termination by Ms. Butler, Ms. Butler will be entitled to receive a severance payment of all base salary, annual bonus (if already awarded), stock options, business expenses and benefits which are due and accrued through the date of termination. We may terminate Ms. Butler’s employment at any time for cause. Upon such termination by us, Ms. Butler will be entitled to receive a severance payment of all base salary, annual bonus (if already awarded), stock options, business expenses and benefits which are due and accrued through the effective date of termination. If Ms. Butler’s employment is terminated by Ms. Butler by reason of her death, her estate shall be entitled to receive all base salary, annual bonus (based on the assumption that all criteria for such annual bonus were achieved), stock options, business expenses and benefits which are due and accrued through the date of death. In the event of Ms. Butler’s termination upon a change of control as defined in the agreement, subject to certain conditions, she will be entitled to receive all base salary, annual bonus (if already awarded), stock options, business expenses and benefits which are due or otherwise become due or accrue for a period of six months.

     The agreement provides that Ms. Butler is not permitted during the term and for 12 months after the effective date of the expiration or termination of the term of the agreement, to solicit any employees, agents and other business contacts of ours to terminate or modify their relationship with or compete against us or conduct business activities in competition with us.

     The agreement provides that the results of Ms. Butler’s employment under the agreement, including any works of authorship resulting from the performance of her duties during her employment with us and any works in progress are works-made-for-hire for the benefit of us and we are the sole owner of the work. The agreement also provides that we will indemnify and hold harmless Ms. Butler in the event she is made a party, or is threatened to be made a party, to any action, suit or proceeding, by reason of the fact that she is an officer or employee of ours to the fullest extent legally permitted by our certificate of incorporation, by-laws, or resolutions of the board or if greater, by the laws of the State of Florida.

     During October 2009, we entered into a verbal agreement with Ms. Butler to temporarily reduce her salary to $70,000 per year. We anticipate entering into an amended agreement with Ms. Butler to memorialize the change in terms.

     Paul J. Micciche Employment Agreement

     We entered into an employment agreement with Mr. Micciche on November 1, 2006 whereby Mr. Micciche agreed to serve as our vice president of engineering. The agreement terms provide for automatic annual renewal. Under the terms of the agreement Mr. Micciche’s base annual salary is currently $125,640, and he is entitled to receive an annual performance bonus in accordance with our annual bonus program. The base salary is reviewed each year by the board and it may in its discretion elect to increase the base salary at any time. Subject to certain conditions, Mr. Micciche is entitled to receive certain benefits under the agreement including health insurance, disability insurance, life insurance and paid vacation of not less than four weeks per year. If Mr. Micciche’s employment is terminated by us without cause or by Mr. Micciche for good reason, Mr. Micciche will be entitled to receive a severance payment equal to all of the base salary, annual bonus, stock options, business expenses and benefits which are due, have accrued, or will otherwise become due or accrue through the end of the term of the agreement, or six months, whichever is the greater amount of time. If Mr. Micciche’s employment is terminated by Mr. Micciche without “good reason,” he will be entitled to receive a severance payment of all base salary, annual bonus (if already awarded), stock options, business expenses and benefits which are due and accrued through the date of termination. If Mr. Micciche’s employment is terminated by us for cause, Mr. Micciche will be entitled to receive a severance payment of all base salary, annual bonus (if already awarded), stock options, business expenses and benefits which are due and accrued through the effective date of termination. If Mr. Micciche’s employment is terminated by Mr. Micciche by reason of Mr. Micciche’s death, his estate shall be entitled to receive all base salary, annual bonus (if already awarded), stock options, business expenses and benefits which are due and accrued through the date of death.

     In the event of Mr. Micciche’s termination upon a change of control as defined in the agreement and subject to certain conditions, he will be entitled to receive all base salary, annual bonus (if already awarded), stock options, business expenses and benefits which are due or otherwise become due or accrue for a period of six months. Prior to

the effective date of the change of control, 25% of the stock options granted to Mr. Micciche will vest and be exercisable by Mr. Micciche for a period of one year following the effective date of termination of his employment.

     The agreement provides that Mr. Micciche is not permitted during the term and for 12 months after the effective date of the expiration or termination of the term of the agreement, to solicit any employees, agents and other business contacts of ours to terminate or modify their relationship with or compete against us or conduct business activities in competition with us.

     The agreement provides that the results of Mr. Micciche’s employment under the agreement, including any works of authorship resulting from the performance of his duties during his employment with us and any works in progress are works-made-for-hire for the benefit of us and we are the sole owner of the work.

Outstanding Equity Awards at 2008 Fiscal Year End

     The following table lists all outstanding equity awards held by our named executive officers as of December 31, 2008.

						Equity Incentive
		Number of				Plan Awards:
		Securities				Number of
		Underlying				Securities
		Unexercised				Underlying
		Options				Unexercised				Exercise				Option
Name		Exercisable(1)				Unearned Options(1)				Price Option				Expiration Date
James J. Lowrey			26,316				0			$	3.80				7/14/2016
			45,000				0			$	3.80				5/1/2017
			342,000				0			$	3.00				8/14/2018
Brian T. Mayo			60,000				0			$	0.11				5/26/2009
			5,000				0			$	0.11				5/26/2009
			350				0			$	2.57				4/26/2010
			1				0			$	2.57				3/3/2011
			18,824				0			$	2.34				4/22/2016
			4,218				3,282			$	2.57				9/7/2011
			18,859				0			$	3.80				1/30/2017
			2				0			$	4.18				3/3/2012
			2,083				2,917			$	4.18				4/3/2012
			18,912				0			$	4.18				6/7/2012
			21,088				0			$	4.18				6/7/2012
			1,000				0			$	4.18				6/13/2012
			0				3,500	(2)		$	0.69				2/7/2018
			45,115				0			$	0.69				3/12/2018
			13,730				0			$	0.69				3/31/2018
			7,846				0			$	0.69				6/30/2018
			17,653				0			$	0.69				9/30/2018
			11,769				0			$	0.69				12/31/2018
Christie C. Butler			1,312				1,688			$	3.80				3/25/2017
			700				0			$	3.80				12/11/2017
			0				26,750	(3)		$	0.69				2/1/2018
			0				1,300	(4)		$	0.69				2/7/2018
Alan Clock			4,666				11,334			$	3.80				10/7/2017

     2004 Stock Option Plan

     On May 27, 2004, our board of directors and sole stockholder as of that date adopted a stock option plan (the “2004 Stock Option Plan”). Pursuant to this plan, which expires on May 27, 2014, incentive stock options or non-qualified options to purchase an aggregate of 2,600,000 shares of common stock may be issued, as adjusted. The plan may be administered by our board of directors or by a committee to which administration of the plan, or part of the plan, may be delegated by our board of directors. Options granted under this plan are not generally transferable by the optionee except by the optionee’s will or by the laws of descent and distribution or to optionee’s Immediate Family (as defined hereafter) or a trust for the benefit of optionee’s Immediate Family. “Immediate Family” as used in the 2004 Stock Option Plan means spouse, lineal descendant or antecedent, father, mother, brother or sister. In such case, the transferee or other recipient will receive and hold the option so transferred subject to the provisions of the 2004 Stock Option Plan and the respective optionee’s option agreement, except that the permitted transferee of the option will not be subject to the requirement of the original optionee to provide services to us. All options granted under the 2004 Stock Option Plan become exercisable at such times and in such installments (which may be cumulative) as the committee shall provide in the terms of each individual option agreement. All vested options and options that have become exercisable from time to time may be exercised in whole or in part in accordance with the terms of the applicable option agreement; provided, however, that the committee shall be authorized to require that any partial exercise be with respect to a minimum number of shares of common stock. Subject to the provision for permitted transferees of the options, to the extent that options are vested, they must be exercised within a maximum of three months of the end of the optionee’s status as an employee, director or consultant, or within a maximum of 12 months after such optionee’s termination or by death or disability, but in no event later than the expiration of the option term. The exercise price of all stock options granted under the plan will be determined by our board of directors or designated committee. No options may be granted under the 2004 Stock Option Plan after March 1, 2014, but options granted on or before that date may be exercised according to the terms of their respective option agreements and shall continue to be governed by and interpreted consistent with the terms of the 2004 Stock Option Plan. To date, we have 1,977,274 options outstanding under the Plan.

     2009 Long Term Incentive Compensation Plan

     On August 14, 2009, our board of directors adopted a stock incentive plan (the “2009 Incentive Compensation Plan” or “2009 Plan”). Pursuant to this plan, incentive stock options, non-qualified options, restricted stock awards, deferred stock awards, bonus stock and awards in lieu of obligations, dividends equivalents, performance awards and other stock based awards to purchase an aggregate of 5,000,000 shares of common stock may be issued, as adjusted. The 2009 Plan will be administered by a committee designated by the board of directors to administer the 2009 Plan except to the extent that our board of directors elects to administer the plan, in which case the 2009 Plan shall be administered by only those members of the board of directors who are independent members of the board.

     The 2009 Incentive Compensation Plan became effective upon the approval by the board of directors and by our stockholders eligible to vote in the election of directors, by a vote sufficient to meet the requirements of Code Sections 162(m) (if applicable) and 422, Rule 16b-3 under the Exchange Act of 1934, as amended (“Exchange Act”) (if applicable), applicable requirements under the rules of any stock exchange or automated quotation system on which the shares may be listed or quoted, and other laws, regulations, and obligations of the Company applicable to the plan, and the subsequent approval by any other securityholders of the Company which may be required to approve the plan. The 2009 Incentive Compensation Plan will terminate at the earliest of (i) such time as no shares remain available for issuance under the plan, (ii) termination of the plan by the board of directors, or (iii) the tenth anniversary of the Stockholder Approval Date. Awards outstanding upon expiration of the 2009 Plan shall remain in effect until they have been exercised or terminated, or have expired.

     No award or other right or interest granted under the 2009 Plan may be pledged, hypothecated or otherwise encumbered or subject to any lien, obligation or liability of such participant to any party, or assigned or transferred by such participant otherwise than by will or the laws of descent and distribution or to a beneficiary upon the death of a participant, and such awards or rights that may be exercisable shall be exercised during the lifetime of the participant only by the participant or his or her guardian or legal representative, except that awards and other rights may be transferred to one or more beneficiaries or other transferees during the lifetime of the participant, and may be exercised by such transferees in accordance with the terms of the award, but only if and to the extent such transfers are permitted by the committee pursuant to the express terms of an award agreement (subject to any terms and conditions which the committee may impose thereon). A beneficiary, transferee, or other person claiming any rights under the 2009 Plan

from or through any participant will be subject to all terms and conditions of the 2009 Plan and any award agreement applicable to such participant, except as otherwise determined by the committee, and to any additional terms and conditions deemed necessary or appropriate by the committee.

     The exercise price per share purchasable under an option granted under the 2009 Plan will be determined by the committee, provided that an exercise price may not be less than 100% of the fair market value of a share on the date of grant of the option and shall not, in any event, be less than the par value of a share on the date of grant of the option. The committee may impose on any award or the exercise thereof, at the date of grant or thereafter, additional terms and conditions, not inconsistent with the provisions of the 2009 Plan, as the committee may determine, including terms requiring forfeiture of awards in the event of termination of the participant’s continuous service and terms permitting a participant to make elections relating to his or her award.

     To date, there are 1,000,000 incentive awards outstanding under the 2009 Plan.

PRINCIPAL STOCKHOLDERS

     The following table sets forth information regarding the number of shares of our common stock beneficially owned on November 3, 2009, and as adjusted to reflect the sale of the shares of common stock offered by this prospectus, by:

	•		each of our executive officers,
	•		each of our directors,
	•		all of our directors and executive officers as a group, and
	•		each person who is known by us to beneficially own 5% or more of our common stock.

     Beneficial ownership is determined in accordance with the rules of the SEC and generally includes voting or investment power with respect to securities. Shares of our common stock which may be acquired upon conversion of preferred stock or exercise of stock options or warrants which are currently exercisable or convertible or which become exercisable or convertible within 60 days after the date indicated in the table are deemed beneficially owned by the optionees or warrant holders. Subject to any applicable community property laws, the persons or entities named in the table below have sole voting and investment power with respect to all shares indicated as beneficially owned by them.

     Unless otherwise indicated, the persons named in the table below have sole voting and investment power with respect to the number of shares indicated as beneficially owned by them. Unless otherwise indicated, the address of the beneficial owner is c/o XStream Systems, Inc., 10305 102nd Terrace, Suite 101, Sebastian, FL 32958.

						Percentage of Shares
						Beneficially Owned(1)
Name and Address		Number of Shares				Before This				After This
of Beneficial Owner		Beneficially Owned				Offering (%)				Offering (%)
Principal Stockholders:
Mayo Family Revocable Trust (2)			708,106				22.1	%			8.2	%
Dr. William E. Mayo (3)			496,000				17.9	%			6.0	%
James J. Lowrey 2009 Irrevocable Trust (4)			413,316				13.0	%			4.8	%
HLG, LLC (5)			259,914				8.6	%			3.1	%
Thomas W. Cook (6)			217,873				7.5	%			2.6	%
Management:
James J. Lowrey (7)			1,813,160				50.6	%			21.9	%
Joseph J. Melone (8)			91,227				3.2	%			1.1	%
Anthony Chidoni (9)			138,331				4.8	%			1.7	%
Robert E. Kennedy (10)			70,132				2.5	%			*
Brian T. Mayo (11)			1,025,863				29.7	%			11.5	%
Phillip A. Odeen (12)			49,771				1.8	%			*
Ash K. Chawla			—				—				*
Simon Irish (13)			100,000				3.5	%			1.2	%
Dennis H. Ferro (14)			16,666				*				*
Dr. E. Darracott Vaughan, Jr. (15)			10,000				*				*
Dr. Stuart Weinstein			—				—				*
Christie C. Butler (16)			46,674				1.7	%			*
Alan Clock (17)			69,666				2.5	%			*
All directors and executive officers as a group (13 persons)			3,431,490				70.6	%			37.8	%

CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS

     We engage a significant stockholder, Dr. William Mayo, under a consulting agreement to serve as chairman of our scientific advisory board. Dr. Mayo is also the brother of Brian T. Mayo, our president and chief technical officer. This agreement provides for an hourly fee for work performed under the agreement as well as 25,000 options, which vest over a period of four years. We have paid Dr. Mayo approximately $3,800 under the contract from the time period beginning October 2004 and ending June 2009.

     We periodically engage H&M Analytical Services, Inc. (“H&M”) to provide material analysis services and execution of the 2005/2006 Department of Homeland Security Simulants contract. H&M is owned by Dr. William Mayo, shareholder and brother or Brian T. Mayo, and Walter Helfrecht, shareholder and brother-in-law of Brian T. Mayo. The total amount paid to H&M under this arrangement was approximately $69,000.

     We engaged a consulting firm Catalyst Capital Investment, LLC (“Catalyst”), by written consulting agreement, dated May 1, 2007, to perform certain exclusive consulting services related to our capital structure, budgeting and financial planning. In addition, we had consulting agreements to provide introductions to potential new customers and suppliers with Catalyst, each agreement dated May 31, 2006 (the “Prospective Customer Agreement” and the “Prospective Supplier Agreement”). Mr. James J. Lowrey, our chief executive officer is a member of the consulting firm. A former director of the Company is also a managing member of Catalyst. As compensation to the consulting firm for services rendered under these consulting agreements, we issued fully vested options to purchase 180,000 shares of our common stock exercisable for a ten-year period at an exercise price of $3.80 per share. Effective August 14, 2008, the agreement was supplemented and amended to cancel 90,000 of the vested options granted under the original agreement and issue fully vested options to purchase 578,000 shares of our common stock exercisable for a ten-year period at an exercise price of $3.00 per share. During July, 2009, we and Catalyst agreed to terminate the Catalyst Consulting agreement dated May 1, 2007, the Prospective Customer Agreement and the Prospective Supplier Agreement.

     On November 16, 2006, we executed a secured revolving demand promissory note in principal amount not to exceed $400,000 in favor of Mr. Brian T. Mayo. The note was amended in February 2007 to increase the amount not to exceed $450.000. Under the terms of the note, Mr. Mayo agreed to make revolving loans to the Company from time to time with 9% interest accruing from the date the amount of the borrowing is received from the lender. All outstanding amounts of $465,938.77 including principal and interest were repaid under the note in March 2007.

     On March 12, 2009, we entered into a marketing agreement with Avani International (“Avani”) which is owned by Mr. Ash Chawla, a member of our board of directors. The marketing agreement seeks to engage Mr. Chawla to market our XT250^TM product in exchange for commissions at 15% of the actual purchase price of any XT250^TM system sold by Avani. As of November 3, 2009, we have paid Avani $13,878 under this arrangement.

     On October 7, 2009, Mr. James J. Lowrey loaned us $39,660 for general operating expenses. We executed a promissory note in principal amount of $39,660, bearing interest at 5% per year, in favor of Mr. Lowrey. All outstanding amounts of $39,763 including principal and interest were repaid to Mr. Lowrey under the note in October 2009.

Board of Directors

     Our preferred stock investors have the right to appoint three of our directors while shares of our preferred stock are outstanding. Upon the conversion of outstanding shares of our preferred stock into common stock on the effective date of this registration statement, the preferred stock investors’ right to appoint board members will terminate. We anticipate each of the preferred stock appointees will remain on our board following this offering.

Stock and Stock Options Granted to and Employment Arrangements with Directors and Executive Officers

     For more information regarding the grant of stock options to directors and executive officers and employment arrangements with our executive officers, please see “Director Compensation for the Year Ended December 31, 2008” and “Executive Compensation.”

     In October 2009, a resolution was passed by the Compensation Committee providing for the following annual compensation package to members of the board of directors:

	•		chairpersons of a committee will receive a share-based incentive grant to purchase 2,500 shares of our common stock pursuant to our 2009 Long Term Incentive Compensation Plan; and
	•		board members will receive a share-based incentive award to purchase 7,500 shares of our common stock for full board service.

Indemnification Agreements

     We have entered into indemnification agreements with each of our current directors. These agreements require us to indemnify these individuals to the fullest extent permitted under Delaware law against liabilities that may arise by reason of their service to us, and to advance expenses incurred as a result of any proceeding against them as to which they could be indemnified. We also intend to enter into indemnification agreements with our future directors and executive officers.

Procedures for Related Party Transactions

     Under our code of conduct, our employees, officers and directors are discouraged from entering into any transaction that may cause a conflict of interest for us. In addition, they must report any potential conflict of interest, including related party transactions, to their managers or our general counsel who then reviews and summarizes the proposed transaction for our audit committee. Pursuant to its charter, our audit committee must then approve any related-party transactions, including those transactions involving our directors. In approving or rejecting such proposed transactions, the audit committee considers the relevant facts and circumstances available and deemed relevant to the audit committee, including the material terms of the transactions, risks, benefits, costs, availability of other comparable services or products and, if applicable, the impact on a director’s independence. Our audit committee will approve only those transactions that, in light of known circumstances, are in, or are not inconsistent with, our best interests, as our audit committee determines in the good faith exercise of its discretion. A copy of our code of conduct generally applicable to all employees, our code of ethics for senior financial officers, and audit committee charter may be found at our corporate website, www.xstreamsystems.com, upon the completion of this offering.

DESCRIPTION OF DEBENTURES

     The following summary does not purport to be complete, and is subject to, and is qualified in its entirety by reference to, all of the provisions of the debentures and the indenture. We urge you to read the indenture and the form of the debentures which are filed as exhibits to the registration statement of which this prospectus forms a part.

General

     The debentures are subordinated, unsecured obligations of ours and are limited to an aggregate principal amount of $5,000,000, unless increased in the discretion of our board of directors to $6,000,000. The debentures will mature on                     , 2020. The debentures rank junior to our senior indebtedness.

     The debentures will be offered at a price to investors of $1,000 per debenture. The debentures were issued only in denominations of $1,000 principal amount and multiples of $1,000 principal amount. The debentures accrue interest at a rate of 5% per year from                     , 2010 or from the most recent interest payment date to which interest has been paid or duly provided, payable annually in arrears on December 15 of each year, beginning December 15, 2011. At the time interest is payable, we, in our sole discretion, may elect to pay interest in cash, or in the form of shares of our common stock. At any time during the term of the debenture prior to the stated maturity or the date on which the debenture is converted into shares of common stock, upon notice mailed to the holder not less than 30 days prior to an interest payment date, we may elect to defer the payment of unpaid interest until a subsequent interest payment date, or the earlier of the stated maturity or the date on which the debenture converts into shares of common stock.

     Interest will be paid to the person in whose name a debenture is registered at the close of business on December 1, immediately preceding the relevant interest payment date. Interest on the debentures will be computed on the basis of a 360-day year comprised of twelve 30-day months. At the time interest is payable, we may elect to pay interest in cash or in the form of shares of common stock. Notwithstanding anything to the contrary, at any time during the term of the debenture prior to the stated maturity or the date on which the security is converted into shares of common stock, upon notice mailed to the holders not less than 30 days prior to an interest payment date, we may elect to defer the payment of unpaid interest until the subsequent interest payment date.

     You have the option to convert your debentures into shares of our common stock under the circumstances set forth under “Conversion Rights” in this section. The initial conversion rate is                      shares of our common stock per debenture, which is equivalent to an initial conversion price of $                     per share of our common stock. The conversion rate is subject to adjustment if certain events occur. Upon conversion, you will receive only shares of our common stock. You will not receive any cash payment for interest accrued to the conversion date other than in the limited circumstances described under “Conversion Rights” in this section.

     If any interest payment date, maturity date, or redemption date of a debenture falls on a day that is not a business day, the required payment of principal and interest will be made on the next succeeding business day as if made on the date that the payment was due and no interest will accrue on that payment for the period from and after the interest payment date, maturity date, or redemption date, as the case may be, to the date of that payment on the next succeeding business day. The term “business day” means, with respect to any debenture, any day other than a Saturday, Sunday or day on which banking institutions in the City of New York are authorized or required by law, regulation or executive order to close.

     Interest on a debenture will generally be taxable to each holder as ordinary income at the time it is paid or accrued in accordance with the holder’s usual method of accounting for tax purposes. A holder will generally recognize gain or loss upon the sale, exchange, redemption or other disposition of a debenture equal to the difference between the amount realized upon the sale, exchange, redemption or other disposition and the holder’s adjusted tax basis in the debenture. A holder’s tax basis in a debenture will generally be equal to the amount the holder paid for the debenture. The amount realized does not include any amount attributable to accrued interest, which amount would be taxable as interest (to the extent not previously included in a holder’s income). If a holder receives solely cash in exchange for its debentures upon conversion, gain or loss generally will be determined in the same manner as if the holder disposed of the debenture in a taxable disposition. A holder, generally will not recognize any income, gain or loss upon conversion of a debenture into common stock except to the extent that the common stock is considered attributable to accrued interest not previously included in taxable income (which is taxable as ordinary income) or with respect to cash received in lieu of a fractional share of common stock. Distributions, if any, made on the common stock generally will be included in income as ordinary dividend income to the extent of our current and accumulated earnings and profits.

Upon the sale, taxable exchange or other taxable disposition of our common stock, a holder generally will recognize capital gain or loss equal to the difference between (i) the amount of cash and the fair market value of any property received upon such taxable disposition, and (ii) the holder’s adjusted tax basis in the common stock.

     HOLDERS SHOULD CONSULT THEIR TAX ADVISORS REGARDING THE TAX TREATMENT OF THE DEBENTURES AND WHETHER A PURCHASE OF THE DEBENTURES IS ADVISABLE IN LIGHT OF THE AGREED UPON TAX TREATMENT AND THE HOLDERS’ PARTICULAR TAX SITUATIONS.

Redemption of the Debentures at Our Option

     No sinking fund is provided for the debentures. Prior to                     , 2015, the debentures will not be redeemable. On or after                     , 2015, we may redeem for cash all or part of the debentures at any time, upon not less than 30 nor more than 60 days’ notice by mail to holders of the debentures, for a price equal to 100% of the principal amount of the debentures to be redeemed plus any accrued and unpaid interest to the redemption date.

Conversion Rights

     Subject to the conditions described below, holders may convert each of their debentures into shares of our common stock initially at a conversion rate of                      shares of our common stock per $1,000 principal amount of debentures (equivalent to an initial conversion price of $      per share of our common stock based on the issue price of the debentures). The conversion rate and the equivalent conversion price in effect at any given time are referred to as the “applicable conversion rate” and the “applicable conversion price,” respectively, and will be subject to adjustment as described below. A holder may convert a portion of such holder’s debentures so long as the debentures converted are an integral multiple of $1,000 principal amount.

     Holders may surrender their debentures for conversion into shares of our common stock prior to stated maturity under the following circumstances:

     Conversion Upon 30 Days’ Prior Written Notice to Us

     A holder may surrender its debentures, in whole or in part, for conversion into shares of our common stock, on or after                      2011, upon 30 days’ prior written notice to us.

     Conversion Upon Redemption

     A holder may surrender for conversion any debenture called for redemption at any time prior to the close of business on the business day immediately preceding the redemption date, even if it is not otherwise convertible at such time, unless we default in making the payment due on the redemption date, in which case the conversion right shall terminate at the close of business on the date such default is cured and such payment is made.

     Conversion Upon Specified Corporate Transactions

     If we are a party to a consolidation, merger, or sale or transfer of all or substantially all our properties and assets pursuant to which shares of our common stock would be converted into cash, securities or other property, a holder may surrender debentures for conversion at any time from and after the date that is 15 days prior to the date that we announce as the anticipated effective date of the transaction until 15 days after the actual effective date of such transaction. If we are a party to a consolidation or merger pursuant to which shares of our common stock are converted into cash, securities or other property, then at the effective time of the transaction, the right to convert a debenture into shares of our common stock will be changed into a right to convert, without the consent of any holders of the debentures, such debenture into the kind and amount of cash, securities or other property that the holder would have received if the holder had converted its debentures immediately prior to the transaction. This assumes that a holder of debentures would not have exercised any rights of election as to the consideration receivable in connection with such transaction.

     If a holder wishes to exercise its conversion right, such holder must (i) deliver an irrevocable conversion notice, together with the certificated security (if the debentures are in certificated form) and the appropriate endorsements and transfer documents, to the conversion agent who will, on the holder’s behalf, convert the debentures

into shares of our common stock and (ii) pay any applicable transfer or similar taxes. Holders may obtain copies of the required form of the conversion notice from the conversion agent or the trustee.

     Based on our treatment of the debentures for U.S. federal income tax purposes, as discussed above, a holder would be required to recognize ordinary income upon a conversion of a debenture into shares of our common stock equal to the excess, if any, between the value of the shares of our common stock received on the conversion and the holder’s adjusted tax basis in the debentures. For a more detailed discussion, see “Certain United States Federal Income Tax Considerations.”

     If we are party to a consolidation, merger or sale or transfer of all or substantially all our properties and assets pursuant to which the shares of our common stock would be converted into cash, securities or other property, then at the effective time of the transaction, the right to convert a debenture into common stock will be changed into a right to convert, without the consent of any holders of debentures, such debenture into the kind and amount of cash, securities or other property that the holder would have received if the holder had converted the holder’s debentures immediately prior to the transaction. This assumes that a holder of debentures would not have exercised any rights of election as to the consideration receivable in connection with the transaction.

     Mandatory Conversion At Our Option Upon 30 Days’ Notice to Holder

     The debentures are mandatorily convertible, at our option, into shares of our common stock upon notice mailed to the holder not less than 30 days’ prior to each interest payment date.

Ranking

     The debentures are our subordinated, unsecured obligations and rank junior to our senior indebtedness. Subordinate means that, in the event of any default in the payment of Senior Indebtedness (after giving effect to “cure” provisions, if any), if there has occurred an event of default with respect to any Senior Indebtedness permitting the holders to accelerate the maturity, or if any judicial proceeding is pending with respect to any such default, or in the event of any liquidation, insolvency, bankruptcy, reorganization, or similar proceedings relating to us, all sums payable on Senior Indebtedness will be paid in full, with interest, if any, before payment is made upon the indebtedness evidenced by the debenture, and, in such event, any subsequent payment or distribution of any character which is made with respect to this debenture will be paid over to the holders of Senior Indebtedness for application pro rata to the payment on that indebtedness, unless and until the Senior Indebtedness has been paid and satisfied in full. “Senior Indebtedness” means the principal of, and premium, if any, and interest on, all of our indebtedness, existing prior to the date of the debentures, to banks, trust companies, insurance companies, and similar lenders and any deferrals, renewals, extensions, or guarantees thereof, and to all other indebtedness of ours (including trade payables); provided, however that Senior Indebtedness does not include indebtedness of ours to any affiliate.

Events of Default

     The following are events of default with respect to the debentures:

     (1) our default in the payment of the principal amount plus accrued and unpaid interest on any debenture when it becomes due and payable at its maturity, upon redemption, or following a Change of Control (as defined in the debenture) when the same becomes due and payable, or otherwise;

     (2) our failure for ten business days to deliver shares of our common stock upon an appropriate election by holders of debentures to convert those debentures into shares of our common stock;

     (3) our failure to comply in any material respect with any of our covenants or agreements contained in the indenture or the debentures;

     (4) our failure to provide timely notice of a Change of Control;

     (5) certain events involving our bankruptcy, insolvency or reorganization.

Calculations in Respect of Debentures

     We will be responsible for making all calculations called for under the debentures. These calculations include determinations of the sale prices of shares of our common stock, the rate of interest payable on the debentures and the applicable conversion rate of the debentures. We will make all these calculations in good faith and, absent manifest error, our calculations will be final and binding on holders of the debentures. We will provide a schedule of our calculations to the trustee and the conversion agent, and the trustee and the conversion agent will be entitled to rely upon the accuracy of our calculations without independent verification. The trustee will forward our calculations to any holder of the debentures upon the request of that holder.

Governing Law

     The indenture and the debentures will be governed by, and construed in accordance with, the laws of the State of Florida.

Trustee

     We intend to engage an independent trustee, paying agent and conversion agent for the debentures.

DESCRIPTION OF CAPITAL STOCK

General

     Our authorized capital stock as of November 9, 2009 consists of 60,000,000 shares of common stock, $.0001 par value per share, and 6,000,000 shares of preferred stock, par value $.0001 per share. The preferred stock authorized may be issued from time to time in one or more series with the rights, preferences and designations for each such series of preferred stock to be determined by the Company’s board of directors. As of November 3, 2009, there were issued and outstanding:

	•		2,767,156 shares of common stock,
	•		stock options to purchase 1,977,274 shares of common stock at an average weighted price of $2.17 per share,
	•		warrants to purchase 336,000 shares of common stock in connection with our debentures (for which cash would need to be remitted to us for exercise), at an average exercise price of $2.48 per share,
	•		962,101 shares of Series A Redeemable Convertible Preferred Stock,
	•		1,619,127 shares of Series B Redeemable Convertible Preferred Stock,
	•		365,996 shares of Series C Redeemable Convertible Preferred Stock,
	•		563,414 shares of Series D Redeemable Convertible Preferred Stock,
	•		Series B and Series C warrants to purchase 9,925,615 shares of common stock (for which cash would need to be remitted to us for exercise), at an average exercise price of $3.00 per share, and
	•		Series D warrants to purchase 2,817,070 shares of common stock (for which cash would need to be remitted to us for exercise), at an average exercise price of $3.00 per share.