**U.S.Securities and Exchange Commission**Washington, D.C. 20549

 

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**Form 10-QSB**

 

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**(Mark One)**

 
| **ý** | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**                                                                                                                                                                                                                                                                                                                       |
|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|       |                                                                                                                                                                                                                                                                                                                                                                                                                         |
| ** ** | **For the quarterly period ended June 30,  2005**                                                                                                                                                                                                                                                                                                                                                                       |
|       |                                                                                                                                                                                                                                                                                                                                                                                                                         |
| **o**      | **TRANSITION REPORT UNDER SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**                                                                                                                                                                                                                                                                                                                            |
|       |                                                                                                                                                                                                                                                                                                                                                                                                                         |
| ** ** | **For the transition period from                                 to                                 ** |
|       |                                                                                                                                                                                                                                                                                                                                                                                                                         |
|       | **Commission file no. 0-24921**                                                                                                                                                                                                                                                                                                                                                                                              |

 

**Power3Medical Products, Inc.**

(Exact name of smallbusiness issuer as specified in its charter)

 
| **New York**                                                     | ** ** | **65-0565144**                        |
|------------------------------------------------------------------|------------|---------------------------------------|
| (State or other  jurisdiction of  incorporation or organization) |       | (I.R.S. Employer  Identification No.) |

 

**3400 Research ForestDrive, Suite B2-3**

**Woodlands, Texas  77381**

(Address of principalexecutive offices)

 

**(281) 466-1600**

(Issuer’s telephonenumber)

 

Check whether the issuer (1) filed all reportsrequired to be filed by Section 13 or 15(d) of the Exchange Actduring the past 12 months (or for such shorter period that the registrant was requiredto file such reports), and (2) has been subject to such filingrequirements for the past 90 days. Yes  o  No  ý

 

As of August 15, 2005, there were 65,345,121 shares of voting commonstock of the registrant issued and outstanding.

 

Transitional Small Business Disclosure Format (checkone): Yes o  No ý

 

 

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**INDEX**

 
| RECENT  DEVELOPMENTS                                                    |   |
|-------------------------------------------------------------------------|--------|
|                                                                    |   |
| PART I.  FINANCIAL INFORMATION                                     |   |
|                                                                    |   |
| Item 1. Financial Statements                                       |   |
|                                                                    |   |
| Condensed Balance Sheet (unaudited)                                     |   |
|                                                                    |   |
| Condensed Statements of Operations (unaudited)                          |   |
|                                                                    |   |
| Condensed Statement of Cash Flows (unaudited)                           |   |
|                                                                    |   |
| Notes to Condensed Financial Statements (unaudited)                     |   |
|                                                                    |   |
| Item 1. Organization, Principal Activities  and Basis of Presentation   |   |
|                                                                    |   |
| Item 2. Management’s Discussion and  Analysis or Plan of Operation |   |
|                                                                    |   |
| Item 3. Controls and Procedures                                         |   |
|                                                                    |   |
| Part II. OTHER INFORMATION                                         |   |
|                                                                    |   |
| Item 1. Legal Proceedings                                               |   |
|                                                                    |   |
| Item 2. Unregistered Sales of Equity  Securities and Use of Proceeds    |   |
|                                                                    |   |
| Item 3. Defaults upon Senior Securities                                 |   |
|                                                                    |   |
| Item 4. Submission of Matters to a Vote of  Security Holders            |   |
|                                                                    |   |
| Item 5. Other Information                                               |   |
|                                                                    |   |
| Item 6. Exhibits                                                        |   |
|                                                                    |   |
| SIGNATURES                                                              |   |
|                                                                    |   |
| EXHIBIT INDEX                                                      |   |

 

2

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**RECENT DEVELOPMENTS**

 

*New Agreements Entered Into*

 

On May 24, 2005, the Power3 Medical Products, Inc. (the “Company”and “Power3”) entered into a collaboration agreement with BioSiteIncorporated.  The agreement providesthat the Company and BioSite will engage in a research program in which BioSitewill attempt to develop antibodies and diagnostic assays for selected targetbiomolecules proposed by the Company.  Ifthe antibodies and diagnostic assays are found to have diagnostic and/ortherapeutic potential, BioSite will develop and commercialize BioSite productsfor the detection and/or treatment of breast cancer and/or neurologicaldiseases.  BioSite will make milestonepayments to the Company, as well as pay royalties on the sale of any BioSiteproducts containing antibodies to any selected target biomolecule claimed in apatent application or an issued patent.

 

*Change in Accounting Treatment*

 

On May 18, 2004, Power3 entered into an Asset Purchase Agreementwith Advanced BioChem, doing business as ProteEx.  In the transaction, Power3 purchased substantiallyall of the assets and intellectual properties of Advanced BioChem and assumedcertain liabilities in exchange for the issuance of 15,000,000 shares of itscommon stock pursuant to the Asset Purchase Agreement.  For financial statement purposes, thetransaction had previously been accounted for as a recapitalization, as in areverse acquisition.  After review, theCompany has concluded that a more appropriate accounting treatment of thetransaction would be purchase accounting. Power3 has now completed a recharacterization of the transaction aspurchase accounting and the Company is producing revised financial statementsfor the period ending June 30, 2004, September 30, 2004, December 31,2004 and for the 1st Quarter of 2005, ending March 31,2005.  Power3 has issued an 8-K notifyingof non-reliance on previously issued financial statements for the periods namedabove.  Power3 intends to file amendedconsolidated financial statements for the aforementioned periods prior to, andcontemporaneously with the filing of its Form 10-KSB for year ended December 31,2004 and its quarterly reports for the the current quarter ended June 30,2005.  The Company, and its auditors, arein complete agreement as to the appropriate treatment to account for itsacquisition of the assets and a certain set of liabilities of Advanced BioChemon May 18, 2004.

 

*Filing Status of Reports*

 

On August 10, 2005, Power3 filed an 8-K reporting that it is inthe process of preparing a restatement of its unaudited consolidated financialstatements for the six and nine month periods ending June 30, 2004 and September 30,2004 and for the three month period ending March 31, 2005.  The company is recharacterizing theaccounting treatment of its May 18, 2004 transaction with Advanced BioChemwith the more appropriate treatment of purchase accounting, in a related party transaction,rather than its previous accounting treatment as recapitalization, in a reverseacquisition.

 

Power3, in conjunction with its auditors, is restating its financialstatements for the periods described above. In addition, Power3 is now completing its Form 10-KSB for 2004 andwill file this form as soon as it is completed, including audited financialstatements for each of the periods required. Since the financial statements presented in its Form 10-KSB for2004 represent a revision to the financial statements previously presented inthe Form 10-QSB filed for the 2nd Quarter, 2004, 3rdQuarter, 2004 and for the 1st Quarter of 2005, Power3 will issuerevised financial statements for each of these quarterly periods.

 

3

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*Dispute as to Certain Liabilities*

 

On May 12, 2005, Industrial Enterprises of America, Inc., theSuccessor to Advanced BioChem, filed an 8-K to disclose that the IndustrialEnterprises management was currently reviewing the Power3 sale.  Under the agreement, Power3 agreed topurchase all of the assets and certain liabilities of Advanced BioChem, thepredecessor to Industrial Enterprises. Industrial Enterprises stated, in the referenced 8-K and in its 10-QSBfiled for the 1st Quarter of 2005, that it is reviewing the claimedindebtedness and until recently Power3 had been in negotiations with IndustrialEnterprises, regarding an agreement with respect to the settlement of any andall claims between the two companies. Industrial Enterprises stated that it had terminated settlementdiscussions and would enforce any rights or remedies it may have with respectto the transaction and the specific liabilities involved.

 

The Company is not in agreement with Industrial Enterprises, as to thenature or the amount of liabilities assumed in the asset sale and feels it hasfairly represented the amount or its liabilities to Industrial Enterprises inits financial statements.  The Companyhas attempted to negotiate a settlement with Advanced BioChem as to the claimsasserted, however no settlement has been reached.  Power3 has therefore rescinded its previousrecognition of the referenced contingent liabilities in its financialstatements.  If it is determined bymanagement that Power3 has a contingent or material liability regarding thesecontingent liabilities, Power3 will reflect any such liabilities it may becomeobligated for in its financial statements as soon as such recognition occurs.

 

*Market Information*

 

Upon the Company’s failure to timely file its Form 10-KSB for2004, the OTCBB appended the symbol “E” to the Company’s trading symbol,effective on April 22, 2005, and notified the Company of its jeopardy ofhaving its securities no longer quoted on the OTCBB, pending the Company’sfiling of its form 10-KSB for 2004.

 

On June 14, 2005, upon the Company’s continued failure to file itsForm 10-KSB for 2004, Power3 was notified of the OTCBB’s action to notallow the Company’s securities to be quoted on the OTCBB, as of June 16,2005, pending the filing of the Company’s Form 10-KSB for 2004.  Accordingly, the Company’s securities are nolonger eligible for quotation on the OTCBB, and all quotations of the Company’ssecurities are deleted from the OTCBB. The Company is currently in the process of producing its Form 10-KSBfor 2004 and will file for reinstatement on the OTCBB, under Form 211 ofthe NASD rules, immediately upon filing its Form 10-KSB.

 

*Change in Control*

 

On June 3, 2005, Mr. Michael Rosinski, Chief FinancialOfficer of Power 3, resigned and terminated his employment at the Company as ofthat date.  In accordance with hisresignation, the employment agreement with Mr. Rosinski has terminated on June 5,2005, and the stock grant of 140,000 shares of Restricted Stock to Mr. Rosinskiis terminated.  The stock shares coveredin this agreement have been returned to the Company.

 

On June 3, 2005, the Company named John P. Burton as its ChiefAccounting Officer and Controller.  Mr. Burtonwas Chief Financial Officer of Affiniscape, Inc. from December, 2003 thruAugust, 2004.  Prior to that he was ChiefFinancial Officer of Bob Johnson & Associates, Inc. in Houston,Texas.

 

4

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*Recent Financing*

 

On April 5, 2005, the Company received a bridge loan in the amountof $ 251,000.  This bridge loan is dueand payable on the sooner of August 15, 2005 or one business day followingthe closing of the Company’s sale and issuance of the $1,600,000 aggregateprincipal amount of debentures which come due on August 15, 2005.  This bridge loan bears interest at a rate of10% per annum which, at the holder’s option, may be paid in (a) cash, or (b) thatnumber of shares of the Company’s common stock determined by dividing $ 251,000by the common stock price on the date of payment and multiplying the quotientso obtained by 20%.

 

On May 31, 2005, the Company received an Officer Advance in theamount of $ 55,000.  This advance is inthe form of a short-term Note Payable, to the Officer, and is payable on June 30,2005, and bears interest at a rate of 6% per annum until paid.

 

On June 3, 2005, the Company received an Officer Advance in theamount of $50,000.  This advance is inthe form of a short-term Note Payable, to the Officer, and is payable on June 30,2005, and bears interest at a rate of 6% per annum until paid.

 

On June 17, 2005, the Company received a bridge loan in the amountof $ 396,500.  This bridge loan is in theform of a promissory note, payable on the sooner of August 15, 2005, orthe fifth day following the effective date of the Company’s registrationstatement on Form SB-2.  The note issecured by a Stock Pledge Agreement, entered into on June 17, 2005, by theCEO of Power 3, wherein the Pledger ageed to pledge 6,000,000 shares of commonstock as security for the performance of the Company under the note.

 

*Change in Independent PublicAccounting Firm*

 

On July 28, 2005, the management of Power3 decided upon a changein its independent public accounting firm and confirmed that the Company wouldno longer engage Kingery & Crouse, P.A. as its independent publicaccounting firm.  On that same date, theCompany engaged the services of John A. Braden & Company, PC, as itspublic accounting firm for its fiscal year ending December 31, 2004.  Power3’s Board of Directors authorized theengagement of John A. Braden & Company, PC, as the Company independentpublic accounting firm.

 

5

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**I.  FINANCIAL INFORMATION**

 

**Item 1.Financial Statements**

 

**POWER3 MEDICAL PRODUCTS,INC. **

**(A Development Stage Enterprise)**

**CONDENSEDBALANCE SHEET AS OF June 30, 2005**

**(unaudited)**

 
| **ASSETS**                                                                                             |   |   |            |
|--------------------------------------------------------------------------------------------------------|--------|--------|-----------------|
|                                                                                                   |   |   |            |
| CURRENT ASSETS                                                                                         |   |   |            |
| Cash and cash  equivalents                                                                             |   | $      |  36,722    |   |
| Accounts  Receivable                                                                                   |   | $      |  2,350     |   |
| Total Current  Assets                                                                                  |   | $      |  39,072    |   |
| FIXED ASSETS                                                                                           |   |   |            |
| Furniture,  Fixtures and Equipment  (Net of accumulated depreciation of $339,760)                      |   | $      |  108,920   |   |
| Intellectual  Property  (Net of accumulated amortization)                                              |   | $      |  244,796   |   |
| Total Fixed  Assets                                                                                    |   | $      |  353,716   |   |
| OTHER ASSETS                                                                                           |   |   |            |
| Debt Issuance  Cost (net of amortization of $8,888)                                                    |   | $      |  172,964   |   |
| Deposits                                                                                               |   | $      |  25,900    |   |
| Total Other  Assets                                                                                    |   | $      |  198,864   |   |
|                                                                                                   |   |   |            |
| **TOTAL  ASSETS**                                                                                      |   | $      |  591,652   |   |
|                                                                                                   |   |   |            |
| **LIABILITIES  AND STOCKHOLDER’S DEFICIT**                                                        |   |   |            |
| CURRENT  LIABILITIES                                                                                   |   |   |            |
| Accounts Payable  and accrued liabilities                                                              |   | $      |  1,113,734 |   |
| Note Payable                                                                                           |   | $      |  781,650   |   |
| Other Current  Liabilities                                                                             |   | $      |  76,459    |   |
| Total Current  Liabilities                                                                             |   | $      |  1,971,843 |   |
| LONG TERM  LIABILITIES                                                                                 |   |   |            |
| Convertible  Debentures                                                                                |   | $      | 1,400,000       |   |
| Accrued Interest  on Convertible Debentures                                                            |   | $      | (1,122,221      | ) |
| Total Long Term  Liabilities                                                                           |   | $      | 277,779         |   |
| TOTAL  LIABILITIES                                                                                     |   | $      | 2,249,622       |   |
| STOCKHOLDER’S  DEFICIT                                                                            |   |   |            |
| Common Stock-$0.01  par value:150,000,000 shares authorized;  65,345,121 shares issued and outstanding |   | $      | 65,345          |   |
| Additional  Paid-In Capital                                                                            |   | $      | 65,354,406      |   |
| Deferred  Compensation                                                                                 |   | $      | (19,093,624     | ) |
| Retained  Earnings                                                                                     |   | $      | (38,905,240     | ) |
| Net Income  (current period)                                                                           |   | $      | (9,078,857      | ) |
| Developmental Stage Loss                                                                               |   | $      | (20,986,244     | ) |
| **TOTAL  LIABILITIES AND STOCKHOLDERS DEFICIT**                                                        |   | $      | 591,652         |   |

 

See notes to condensedfinancial statements.

 

6

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**POWER 3 MEDICAL PRODUCTS,INC. **

**(A Development Stage Enterprise )**

**CONDENSEDSTATEMENTS OF OPERATIONS**

**(unaudited)**

 
| ** **                                     | ** ** | **For the Three**      | ** ** | **For the Three**      | ** ** | **For the Six**        | ** ** | **For the Six**        | ** ** | **Development  Stage**     | ** **  |
|------------------------------------------------|------------|------------------------|------------|------------------------|------------|------------------------|------------|------------------------|------------|----------------------------|-------------|
| ** **                                     | ** ** | **Months Ended**       | ** ** | **Months Ended**       | ** ** | **Months Ended**       | ** ** | **Months Ended**       | ** ** | **May 18, 2004 thru** | ** **  |
| ** **                                     | ** ** | **June 30, 2005** | ** ** | **June 30, 2004** | ** ** | **June 30, 2005** | ** ** | **June 30, 2004** | ** ** | **June 30, 2005**     | ** **  |
|                                           |       |                   |       |                   |       |                   |       |                   |       |                       |        |
| REVENUES                                       |       |                   |       | $                      | 13,600     |                   |       |                   | $          | 25,090                     |        | $ | 4,000 |   |
|                                           |       |                   |       |                   |       |                   |       |                   |       |                       |        |
| COST OF GOODS  SOLD                            |       |                   |       | $                      | 5,250      |                   |       |                   | $          | 10,423                     |        |   |   |
|                                           |       |                   |       |                   |       |                   |       |                   |       |                       |        |
| GROSS PROFIT                                   |       |                   |       | $                      | 8,350      |                   |       |                   | $          | 14,667                     |        | $ | 4,000 |   |
|                                           |       |                   |       |                   |       |                   |       |                   |       |                       |        |
| OPERATING  EXPENSES                            |       |                   |       |                   |       |                   |       |                   |       |                       |        |
|                                           |       |                   |       |                   |       |                   |       |                   |       |                       |        |
| Stock based  compensation and consulting       |       | $                      | 3,609,438  |                   | $          | 6,189,653              |       | $                      | 7,218,876  |                       | $           | 6,189,653 |   | $ | 15,167,282 |   |
| Consulting Fees                                |       |                   |       | $                      | 7,089,016  |                   |       |                   | $          | 7,119,016                  |        | $ | 403,942 |   |
| Other operating  expenses                      |       | $                      | 832,266    |                   | $          | 819,693                |       | $                      | 1,637,291  |                       | $           | 1,802,349 |   | $ | 2,662,431 |   |
|                                           |       |                   |       |                   |       |                   |       |                   |       |                       |        |
| Total Operating  Expenses                      |       | $                      | 4,441,704  |                   | $          | 14,098,362             |       | $                      | 8,856,167  |                       | $           | 15,111,018 |   | $ | 18,233,655 |   |
|                                           |       |                   |       |                   |       |                   |       |                   |       |                       |        |
| LOSS FROM  OPERATIONS                          |       | (4,441,704             | )          | (14,090,012            | )          | (8,856,167             | )          | (15,096,351            | )          | $                          | (18,229,655 | ) |
|                                           |       |                   |       |                   |       |                   |       |                   |       |                       |        |
| INTEREST &  FINANCING EXPENSE         |       | (117,085               | )          | (1,238                 | )          | (222,949               | )          | (2,752                 | )          | $                          | (280,037    | ) |
|                                           |       |                   |       |                   |       |                   |       |                   |       |                       |        |
| OTHER  INCOME & EXPENSE               |       | 35                     |       |                   |       | 259                    |       |                   |       | $                          | (2,476,868  | ) |
|                                           |       |                   |       |                   |       |                   |       |                   |       |                       |        |
| Write Off Debt                                 |       |                   |       | 641,859                |       |                   |       | 641,859                |       |                       |        |
|                                           |       |                   |       |                   |       |                   |       |                   |       |                       |        |
| NET LOSS                                       |       | (4,558,754             | )          | (13,449,391            | )          | (9,078,857             | )          | (14,457,244            | )          | $                          | (20,986,560 | ) |
|                                           |       |                   |       |                   |       |                   |       |                   |       |                       |        |
| NET LOSS PER SHARE  (basic and dilluted)       |       | $                      | (0.07      | )                      | $          | (0.20                  | )          | $                      | (0.14      | )                          | $           | (0.22 | ) | $ | (0.32 | ) |
|                                           |       |                   |       |                   |       |                   |       |                   |       |                       |        |
| Weighted average  number of shares outstanding |       | 65,345,121             |       | 66,922,630             |       | 65,345,121             |       | 66,922,630             |       | 65,345,121                 |        |

 

Seenotes to condensed financial statements.

 

7

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**POWER 3 MEDICAL PRODUCTS, INC******

**(A Development Stage Enterprise)**

**CONDENSED STATEMENTS OF CASHFLOWS**

**(unaudited)**

 
| ** **                                                                 | ** **        | **For the Six**        | ** ** | **For the Six**        | ** ** |
|----------------------------------------------------------------------------|-------------------|------------------------|------------|------------------------|------------|
| ** **                                                                 | ** **        | **Months Ended**       | ** ** | **Months Ended**       | ** ** |
| ** **                                                                 | ** **        | **June 30, 2005** | ** ** | **June 30, 2004** | ** ** |
|                                                                       |              |                   |       |                   |       |
| NET INCOME                                                                 |              | $                      | (1,859,981 | )                      | $          | (522,476 | ) |
|                                                                       |              |                   |       |                   |       |
| NET CASH USED IN  OPERATING ACTIVITIES                                     |              | $                      | (586,347   | )                      | $          | (1,004,299 | ) |
|                                                                       |              |                   |       |                   |       |
| CASH USED IN  INVESTING ACTIVITIES                                         |              | $                      | (163,754   | )                      | $          | (158,692 | ) |
|                                                                       |              |                   |       |                   |       |
| NET CASH  PROVIDED BY FINANCING ACTIVITIES                                 |              | $                      | 628,041    |                   | $          | 1,246,322 |   |
|                                                                       |              |                   |       |                   |       |
| NET CHANGE IN  CASH AND CASH EQUIVALENTS                                   |              | $                      | (122,060   | )                      | $          | 83,330 |   |
|                                                                       |              |                   |       |                   |       |
| CASH AT  BEGINNING OF PERIOD                                               |              | $                      | 158,782    |                   | $          | 547 |   |
|                                                                       |              |                   |       |                   |       |
| CASH AND CASH  EQUIVALENTS, END OF PERIOD                                  |              | $                      | 36,722     |                   | $          | 83,877 |   |
|                                                                       |              |                   |       |                   |       |
| SUPPLEMENTAL  DISCLOSURE OF NON-CASH   INVESTING AND FINANCING ACTIVITIES: |              |                   |       |                   |       |
|                                                                       |              |                   |       |                   |       |
| INTEREST PAID                                                              |              | $                      | 222,949    |                   | $          | 3,990 |   |
|                                                                       |              |                   |       |                   |       |
| Shares issued (at market, date of effective  agreement):                   |              |                   |       |                   |       |
|                                                                       |              |                   |       |                   |       |
| For consulting contracts                                                   | 15,881,033 shares |                   |       |                   | $          | 9,519,930 |   |
|                                                                       |              |                   |       |                   |       |   |
| For acquisition                                                            | 15,000,000 shares |                   |       |                   | $          | 13,500,000 |   |
|                                                                       |              |                   |       |                   |       |   |
| For compensation                                                           | 32,810,000 shares |                   |       |                   | $          | 29,524,500 |   |

 

See notes to condensed financial statements.

 

8

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**POWER 3 MEDICAL PRODUCTS, INC**

**(A Development Stage Enterprise)**

 

**NOTES TO CONDENSED FINANCIALSTATEMENTS**

**(unaudited)**

 

***Item 1. ORGANIZATION, PRINCIPALACTIVITIES AND BASIS OF PRESENTATION***

 

Priorto January 1, 2004, Power3 Medical Products, Inc. and itssubsidiaries (collectively “Power3” or “the Company”), formerly known asSurgical Safety Products, was primarily engaged in product development, sales,distribution and services for the healthcare industry.  In 2003, the Company was in a prior developmentstage, marketing devices to aid surgical procedures. Prior to May 18,2004, the products had received only minor market acceptance and sales hadslowed to the point that Power3 was searching for other products and markets toincrease its presence in the healthcare industry.   .

 

Inearly 2004, Power3 became aware of a biotech company that appeared to have aset of assets and intellectual properties that it required to more effectivelypursue its business model.  That company,named Advanced BioChem, doing business as ProteEx, provided contract-for-feelab services analyzing protein biomarkers. At the conclusion of negotiationswith Advanced BioChem, Power3 entered into an Asset Purchase Agreement dated May 18,2004, whereby it purchased substantially all the assets and intellectualproperties of Advanced BioChem, and assumed certain liabilities, as scheduledin the agreement, from Advanced BioChem. After the transaction, certain employees from Advanced BioChem becameemployees of Power3 and were later issued Employment Agreements by Power3.  As consideration in the Asset PurchaseAgreement, Power3 issued 15,000,000 shares of common stock to Advanced BioChem.

 

Power3Medical Products, Inc. did not continue the business activity of AdvancedBioChem and never conducted any contract-for-fee lab service workwhatsoever.  Subsequent to the assetpurchase, the business model of Power3 was significantly changed and expandedto become the commercialization of the intellectual property acquired in thetransaction, with its focus in the early detection, monitoring and targeting ofdiseases through the analysis of proteins. Power3’s new developmental stage objective, and activity, is to developits intellectual properties by focusing on disease diagnosis, protein andbiomarker identification and early detection indicators in the areas ofcancers, neurodegenerative and neuromuscular diseases, as well as otherscientific areas of interest associated with protein biomarkers.

 

Afterthe asset purchase transaction on May 18, 2004, the previous management ofPower3 resigned and left the employ of the Company.  Subsequent to these resignations, twoemployees of Advanced BioChem were granted employment agreements byPower3.  These two employees were StevenB. Rash as President and CEO and Dr. Ira Goldknopf as Chief ScientificOfficer.

 

TheCompany’s subsidiary, Tenthgate, a Nevada corporation, is not active in Power3’scurrent line of business activity.  Aspart of the acquisition of the assets of Advanced BioChem, it was contemplatedthat Power3 would distribute shares of its subsidiary to its shareholders ofrecord prior to the Advanced BioChem transaction.  Previous management of Power3 and the Company’ssubsidiary, Tenthgate, have been independently operating Tenthgate since theAdvanced BioChem transaction.  Power3intends to divest itself of its subsidiary due to the differences in businessactivity between Tenthgate and Power3 operating under its current businessmodel.  Some of the principal reasons forthe divestiture of Tenthgate are as follows: Power3’s business focus and strategy is significantly different fromthat of Tenthgate and its subsidiary; the disposition of Tenthgate will allowthe Company’s management to focus exclusively on its business objectives andpermit management of Tenthgate more flexibility in its operation; and thedisposition will allow the market to separately identify and evaluate eachbusiness.  The Company is continuing itsefforts to complete the disposition of Tenthgate and its subsidiary; however,current

 

9

----

 

managementof Tenthgate has advised the Company that Tenthgate has issued a significantnumber of shares of its common stock purportedly reducing the Company’sownership interest to less than 1%.  TheCompany is considering its alternatives with respect to these action and stilldesires to complete a divestiture of Tenthgate.

 

Theconsolidated balance sheets, statements of operations and statements of cashflow included herein are unaudited, but include, in the opinion of management,all the adjustments, consisting only of normal recurring adjustments, necessaryfor a fair presentation of the financial position, results of operations andcash flows for the periods presented. Results for interim periods are not necessarily indicative of resultsthat may be expected for any future interim period or for a full year.

 

2.RESTATEMENT

 

OnMay 18, 2004, Power3 executed the Asset Purchase Agreement (“the Agreement”)referred to above, to purchase substantially all the assets of Advanced BioChemand assume certain liabilities in exchange for the issuance of 15,000,000shares of common stock of Power3.  Forfinancial statement purposes, the transaction was treated, at the time, as arecapitalization of the equity structure of Power3 and therefore, theaccumulated deficit of Power3 was eliminated, no stock-based expenses wererecorded as a result of this transaction, and the assets and liabilities ofPower3 and Advanced BioChem were combined, based on the accounting treatment asrecapitalization, in a reverse acquisition. Subsequent to the filing of Form 10-QSB and Amendment No. 1for the quarter ended March 31, 2005, during its interim revue, managementdetermined that the purchase of assets and the acquisition of certainliabilities of Advanced BioChem, which occurred on May 18, 2004, isproperly accounted for as a purchase transaction, in a related partytransaction.  In addition, managementdetermined that, due to the specific nature of the transaction and becausePower3 did not continue the business activity of Advanced BioChem whatsoever,Advanced BioChem cannot be considered a predecessor.  In addition, because the asset acquisition byPower3 was a purchase of equipment and intellectual property from an entitythat continued its existence and its previous business activity after thepurchase transaction, rather than being merged into Power 3, and because thecombination did not contain other elements of an equity merger of the twocompanies, the Company determined that the facts of the transaction had beenmisapplied and that purchase accounting is the more appropriate accounting treatmentand Advanced BioChem would not be presented as a predecessor.  This accounting treatment represents arestatement of the transaction referenced above, which was previously characterizedas a recapitalization of Power3, as in a reverse acquisition.  The Balance Sheet, Statement of Operationsand the Statement of Cash Flow shown in Part I, Item 1, display thefinancial statements of the Company consistent with the restatement of the assetacquisition as purchase accounting.

 

Theeffect of the restatement on the balance sheet of Power3 Medical Products, Inc.,besides eliminating the financial condition of Advanced BioChem as thepredecessor for the period of January 1, 2004 through May 17, 2004,is to restore Power3’s previously existing deficit in Retained Earnings,recognize the stock-based compensation expenses associated with the transactionand reclassify certain items within the Stockholder’s Deficit section ofthe Company’s balance sheet.

 

Theeffect of the restatement on the statement of operations of Power3 is primarilyto increase the stock-based compensation expenses associated with the May 18,2004 transaction and recognize the difference in the historical cost of theassets acquired and the liabilities assumed in the transaction.

 

OnAugust 10, 2005, the Company issued an 8-K reporting non-reliance onpreviously issued financial statements for the quarter ended June 30,2004, September 30, 2004 and March 30, 2005, which had beenpreviously presented under the previous accounting treatment.

 

SincePower3’s planned principal operations have not yet commenced, it was and isconsidered to be in the developmental stage, as of May 18, 2004, asdefined in Financial Accounting Standards Board Statement No. 7.  Accordingly, some of the Company’s accountingpolicies and procedures have not yet

 

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beenestablished.  The Company has been in itscurrent developmental stage since its acquisition of its set of intellectualproperties on May 18, 2004.

 

(1) SUMMARYOF SIGNIFICANT ACCOUNTING POLICIES

 

Principles of Consolidation

 

Theaccompanying consolidated financial statements include the accounts of Power3and its wholly-owned subsidiary, Power3 Medical, Inc., a Nevadacorporation (collectively “the Company”). All intercompany transactions and balances have been eliminated inconsolidation.  Tenthgate’s statement ofcondition and operating results are not consolidated, since the Company now ownsless than 1% of Tenthgate’s common stock outstanding and its financial resultswould not be consolidated, nor are they material to the financial statements ofPower3.

 

Basis of Presentation

 

Theaccompanying unaudited financial statements have been prepared in accordancewith accounting principles generally accepted in the United States of America (“GAAP”)for interim financial information and with the instruction to Form 10-QSBand Item 310(b) of Regulation S-B. They do not include all of the information and footnotes required byGAAP for complete financial statements. In the opinion of management, all adjustments (consisting of normalrecurring adjustments) considered necessary for a fair presentation have been included.

 

Theresults of operations for the periods presented are not necessarily indicativeof the results to be expected for a full year. For further information, refer to the financial statements of theCompany for the years ended December 31, 2003 and 2002, including notesthereto, and/or the consolidated financial statements of the Company as of December 31,2003 and 2002, including notes thereto included in the Company’s Form 10-KSBfor the respective periods.  However, dueto the completely different business activity and previous history, Power3’sprevious year’s results are not indicative of future periods.

 

Use of Estimates

 

The preparation of financial statementsin conformity with accounting principles generally accepted in the UnitedStates of America requires management to make certain estimates and assumptionsthat affect the reported amounts of assets and liabilities and disclosure ofcontingent assets and liabilities at the date of the financial statements. Thereported amounts of revenues and expenses during the reporting period may beaffected by the estimates and assumptions management is required to make.  Estimates that are critical to theaccompanying financial statements include assessing the impact of contingencies(see above) and the amortization periods for the debt issuance costs and debtdiscount on the convertible debentures (see Note 8) as well as estimatingdepreciation and amortization periods of tangible and intangible assets, andlong-lived impairments, among others. The markets for the Company’s products are characterized by intensecompetition, evolving standards and price competition, all of which couldimpact the future realizability of the Company’s assets.  Estimates and assumptions are reviewedperiodically and the effects of revisions are reflected in the financialstatements in the period they are determined to be necessary.

 

Financial Instruments and Concentrations of Credit Risk 

 

Management believes thebook value of the Company’s cash and cash equivalents, accounts payable andaccrued liabilities approximates their fair values due to their short-termnature.  Management has used certainvaluation techniques to estimate the fair value of the convertible debentures,loans notes and stockholder receivables because of the lack of similar typearrangements in the marketplace and because of uncertainty surrounding the datethe receivables will be recovered.

 

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Financial instruments,which potentially subject the Company to significant concentrations of credit risk,consist primarily of cash and cash equivalents. We occasionally maintain cash and cash equivalents balances in excess offederally insured limits.  We have notexperienced any losses in such accounts.

 

Furniture, Fixtures and Lab Equipment

 

Furniture,fixtures and lab equipment are stated at cost. Major additions are capitalized, while minor additions and maintenanceand repairs, which do not extend the useful life of an asset, are expensed asincurred. Depreciation and amortization are provided using the straight-linemethod over the assets’ estimated useful lives. At June 30, 2005, certain lab equipment having a net book value ofapproximately $37,500 serves as security for certain liabilities.

 

Debt Acquisition Costs 

 

Debt acquisition costs are being amortized over themaximum term of the convertible debentures of three years using the straightline method.

 

Unamortized Discount

 

Unamortized discount resulting from the allocation ofvalue to warrants and the beneficial conversion feature embedded in theconvertible debentures (see Note 8) is being amortized to interest expense overthe contractual lives of the debentures using the interest method.

 

Other Intangibles 

 

Other intangibles consist primarily ofpatents which are recorded at cost and arise from legal and filing fees.  Patents and other intangibles are beingamortized over ten years on a straight-line basis.

 

Long-Lived Assets 

 

Statement of Financial AccountingStandards (SFAS) 144, “Accounting for the Impairment or Disposal of Long-LivedAssets” requires that long-lived assets, including certain identifiableintangibles, be reviewed for impairment whenever events or changes incircumstances indicate that the carrying value of the assets in question maynot be recoverable. The Company evaluated its long-lived assets at December 31,2004 and determined that certain impairment losses were necessary. As a result,operations were charged for $15,832 during the period May 18, 2004 (dateof acquisition) to December 31, 2004. Management believes that the remaining balances of the Company’slong-lived assets are recoverable at June 30, 2005.

 

Net Loss Per Share 

 

Net loss per share is computed inaccordance with SFAS No. 128 “Earnings per Share” (“SFAS No. 128”)and SEC Staff Accounting Bulletin No. 98 (“SAB 98”).  Under the provisions of SFAS No. 128 andSAB 98, basic net loss per share is computed by dividing the net loss availableto common stockholders for the period by the weighted average number of commonshares outstanding during the period.  Diluted net loss per share is computed bydividing the net loss for the period by the number of common and commonequivalent shares outstanding during the period.  In periods in which they would beanti-dilutive, common equivalent shares are ignored in the loss per sharecalculations.  As a result, basic anddiluted net loss per share is identical for each of the periods in theaccompanying financial statements.

 

Stock – Based Compensation 

 

TheCompany accounts for equity instruments issued to employees for services basedon the intrinsic value of the equity instruments issued and accounts for equityinstruments issued to those other than

 

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employeesbased on the fair value of the consideration received or the fair value of theequity instruments, whichever is more reliably measurable.  Fair value is measured herein as the closingmarket price of the common stock on the effective date of the agreement orBoard resolution, rather than imputed value of the agreement or imputedservices.

 

TheCompany has adopted Statement of Financial Accounting Standards No. 148 “Accountingfor Stock-Based Compensation - Transition and Disclosure” (SFAS No. 148).This statement amends FASB Statement No. 123, “Accounting for Stock BasedCompensation”. It provides alternative methods of transition for an entity thatvoluntarily changes to the fair value based method of accounting for employeestock based compensation. It also amends the disclosure provision of FASBstatement No. 123 to require prominent disclosure about the effects onreported net income of an entity’s accounting policy decisions with respect tostock-based employee compensation. As permitted by SFAS No. 123 andamended by SFAS No. 148, the Company continues to apply the intrinsicvalue method under Accounting Principles Board (“APB”) Opinion No. 25, “Accountingfor Stock Issued to Employees,” to account for its stock-based employeecompensation arrangements.

 

Income Taxes 

 

TheCompany computes income taxes in accordance with Financial Accounting StandardsStatement No. 109 “Accounting for Income Taxes” (“SFAS 109”). The Companyalso prepares its income taxes in accordance with this standard. Under SFAS109, deferred taxes are recognized for the tax consequences of temporarydifferences by applying enacted statutory rates applicable to future years todifferences between the financial statement carrying amounts and the tax basisof existing assets and liabilities. Also, the effect on deferred taxes of achange in tax rates is recognized in income in the period that included theenactment date. There were no significant temporary differences at June 30,2005.

 

Research and Development 

 

Research and development costs, whichapproximated $176,513 for the six months ended June 30, 2005 and the $53,083 for the six months ended June 30, 2004, are expensed as incurred.

 

Cash Equivalents

 

For purposes of thestatements of cash flows, the Company considers all highly liquid debtinstruments purchased with a maturity of three months or less to be cashequivalents.

 

Investments 

 

The Company accounts for itsinterest in Power 3 Medical, Inc., a Nevada corporation, now known asTenthgate, Inc., using the cost method. The value of Power3’s investment in Tenthgate is considered to beminimal since the Company now owns less than 1% of the common stock and Power3does not consider that inclusion of this minimal amount would significantlyeffect the financial statements

 

(2) GOING CONCERN

 

TheCompany’s financial statements are presented on a going concern basis, whichcontemplates the realization of assets and satisfaction of liabilities in thenormal course of business. The Company is in the development stage and hasprimarily been involved in research and development and capital raisingactivities; as such the Company has incurred significant losses from operationsand has a significant stockholders’ deficit at June 30, 2005.  As a result, the Company has an immediateneed for capital to continue its operations, and it will need to raisesignificant additional funds to implement its business plan.  This cash will have to come from equity salesand/or borrowings as management has projected that the Company will needsignificant additional capital for development and other ongoing operational

 

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activitiesbefore it will have any anticipated revenue generating products. The actualamount of funds that the Company will need will be determined by many factors,some of which are beyond the Company’s control. These factors include:

 

•      The extent to which the Company enters intolicensing arrangements, collaborations or joint ventures;

•      The progress and results of research andproduct development;

•      The costs and timing of obtaining new patentrights;

•      The extent to which the Company requires orlicenses other technologies; and

•      Regulatory changes and competition andtechnological developments in the market.

 

Acurrent possibility available to the Company is to raise the remaining funds of$1,600,000 potentially available to them pursuant to the Securities PurchaseAgreement dated October 28, 2004 (the “Agreement”). These funds will beimmediately reduced by the payment of certain delinquent payables ofapproximately $251,000 of certain bridge financing received in April 2005,the $396,500 of bridge loan financing and the two Officer Advances that are tobe repaid upon the receipt of the $1,600,000. The Company is in immediate needfor capital to continue its operations and as such its ability to continue as agoing concern is subject to its ability to generate a profit or obtainnecessary funding from outside sources. . Management believes that even thoughthe Company currently has limited cash resources and liquidity, assumingexercise of the warrants and additional investment rights specified in theAgreement, that the net funds available from the final closing under suchAgreement will allow the Company to continue operations through December 2005.  In the event the final closing and sale of$1,600,000 in aggregate principal amount of debentures occurs, but the warrantsand additional investment rights are not exercised, the Company anticipatesthat it will need to raise additional capital prior to December 2005 tomeet its operating costs. However, the Company is currently in default underthe conditions set forth in the Agreement as well as the debentures andregistration rights agreement and consequently, there is no assurance that theCompany will be successful in completing the sale and issuance of the remaining$1,600,000 aggregate principal amount of debentures and/or the additionalinvestments rights pursuant to the Agreement. If the Company is unsuccessful in the closing of the sale and issuanceof the $1,600,000 aggregate principal amount of debentures at the finalclosing, the Company will be required to obtain alternative financing, sell orlicense some of its technology, and/or to curtail or cease its operations. Anysuch funding may significantly further dilute existing shareholders or maylimit the Company’s rights to its technology. Moreover, the increase in the number of shares available in the publicmarketplace may reduce the market price for the Company’s common stock, andconsequently, the price investors may receive at the time of sale.  The financial statements do not include anyadjustments to reflect the possible future effects on the recoverability andclassification of assets or the amounts and classification of liabilities thatmay result from the possible inability of the Company to continue as a goingconcern.

 

(3)  Loss Per Share

 

Thefollowing common equivalent shares have been excluded from the fully dilutedloss per share calculations because the effects would be anti-dilutive;

 

•      2,500,000 warrants, and additional investmentrights having a value of $2,500,000, which were issued to certain accreditedinvestors on October 28, 2004 under the Agreement. In addition, pursuantto the Agreement, the investors purchased certain convertible debentures thatif exercised, will result in the issuance of an indeterminate number of sharesof common stock.

 

•      333,333 warrants which were issued to certainaccredited investors on January 26, 2005 under the Agreement. In addition,pursuant to the Agreement, the investors purchased certain convertibledebentures that if exercised, will result in the issuance of an indeterminatenumber of shares of common stock

 

•      580,000 shares of warrants which were issuedto members of the Company’s Scientific

 

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Advisory Board and various other consultants in 2004(including 100,000 to the agent that placed the convertible debenturesdiscussed above).  The warrants, whichexpire three to five years from the dates of the respective grants and were issuedat no cost to such personnel, may be converted to a like number of shares ofthe Company’s common stock at any time prior to their expiration(s).  As a result, during the period May 18,2004 (date of acquisition) to December 31, 2004, the Company recorded$626,100 of stock based compensation as a result of the issuance of thesewarrants, which amounts represent the fair value of the warrants on the datesthey were granted.

 

(4) Income Taxes

 

TheCompany recognized losses for both financial and tax reporting purposes duringeach of the periods in the accompanying statements of operations.  Accordingly, no provisions for income taxesand/or deferred income taxes payable have been provided for in the accompanyingfinancial statements.

 

AtJune 30, 2005 the Company had net operating loss carryforwards for incometax purposes of approximately $9,551,000 arising primarily from stock basedexpenses that are considered to be permanent differences.  These net operating loss carryforwards expireat various times through the period ended June 30, 2005 however becausethe Company has experienced changes in control and has incurred significantoperating losses, utilization of the income tax loss carryforwards are notassured. As a result, the non-current deferred income tax asset arising fromthese net operating loss carryforwards is not recorded in the accompanyingbalance sheet because the Company established a valuation allowance to fullyreserve such assets as their realization did not meet the required asset recognitionstandard established by SFAS 109.

 

(5) RelatedParty Transactions

 

 During the three months ended March 31,2005 the chief financial officer advanced $35,000 to the Company.  The advance, which is due on demand andunsecured, bears interest at 6% per annum. At June 30, 2005, the balance of the advance is included inaccounts payable and accrued and other liabilities in the accompanyingcondensed balance sheet.

 

OnMay 31, 2005, the Company received an Officer Advance in the amount of $55,000.  This advance is in the form of ashort-term Note Payable to the Officer, is payable on June 30, 2005, andbears interest at a rate of 6 % per annum until paid.

 

OnJune 3, 2005, the Company received an Officer Advance in the amount of $50,000.  This advance is in the form of ashort-term Note Payable to the Officer, is payable on June 30, 2005, andbears interest at a rate of 6 % per annum until paid.

 

(6) Notes Payable

 

Certainnotes payable existing at March 31, 2005 bear interest at a fixed rate of6% and were scheduled to mature on December 31, 2004. However, the Companyhas entered into agreements with the note holders to extend the maturity of thenotes through June 30, 2005.  Inaddition, the Company has the option to convert 75% of the notes into itscommon stock at a mutually agreeable conversion ratio.

 

OnApril 5, 2005, the Company received a bridge loan in the amount of $251,000.  This bridge loan is due andpayable on the sooner of August 15, 2005 or one business day following theclosing of the Company’s sale and issuance of the $1,600,000 aggregateprincipal amount of debentures which come due on August 15, 2005.  This bridge loan bears interest at a rate of10% per annum which, at the holder’s option may be paid in (a) cash or (b) thatnumber of shares of the Company’s common stock determined by dividing $ 251,000by the common stock price on the date of payment and multiplying the quotientso obtained by 20%.

 

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OnJune 17, 2005, the Company received a bridge loan in the amount of $396,500.  This bridge loan is in the formof a promissory note, payable on the sooner of August 15, 2005, or thefifth day following the effective date of the Company’s registration statementon Form SB-2.  The note is securedby a Stock Pledge Agreement, entered into on June 17, 2005, by the CEO ofPower3, wherein the Pledger agreed to pledge 6,000,000 shares of common stockas security for the performance of the Company under the note.  The note bears no interest, other than incase of default, in which case the note shall bear interest at the rate of 18%per annum from the date such interest would be due.

 

(7) OtherCommitments and Contingencies

 

Operating Lease

 

InAugust 2004, the Company entered into a new lease which expires on August 31,2009, has an initial term of sixty-three months, and requires base monthlyminimum lease payments ranging from approximately $6,000 to $9,600 (plusutilities and operating expenses) over the lease term.  The lease contains a provision which allowsthe Company to extend the lease for two additional terms of sixty months.  Rent expense, including utilities,approximated $18,000 and $62,800, for the six months ended June 30, 2005and the period June 30, 2004  respectively.

 

Employment Agreements 

 

TheCompany is obligated under amended and restated employment agreements with itsChief Executive Officer, Chief Scientific Officer and Chief FinancialOfficer.  The significant terms of theagreements are as follows:

 

ChiefExecutive Officer – The amended and restated employment agreement is effectiveas of May 18, 2004 and has an initial term of five years, subject to eachparty’s termination rights.  Theagreement provides for a base salary of $250,000 per year and the opportunityto receive cash bonuses based on performance upon the discretion of the boardof directors.  The agreement alsoincludes participation in employee benefit plans offered to employees, as wellas a grant of 13,250,000 shares of restricted common stock and 1,500,000 sharesof restricted Series B preferred stock (the Series B preferred shareshave not yet been issued).  Either partymay terminate the Chief Executive Officer’s employment under the contract,either with or without cause upon giving the other party at least thirty daysnotice.  If the Company terminates thechief executive officer’s employment at any time during the initial termwithout cause, he will be entitled to receive compensation provided under theagreement for the remaining initial term of employment.  In addition, in the event of a change incontrol as defined in the agreement, the Company may waive, in whole or inpart, any and all remaining restrictions on the restricted shares of commonstock and Series B preferred stock granted to him.

 

ChiefScientific Officer – The amended and restated employment agreement is effectiveas of May 18, 2004 and has an initial term of five years, subject to eachparty’s termination rights.  Theagreement provides for a current base salary of $125,000 through December 18,2004 and $100,000 thereafter and the opportunity to receive cash bonuses basedon performance upon the discretion of the board of directors.  The agreement also includes participation inemployee benefit plans offered to employees, as well as a grant of 13,250,000shares of restricted common stock and 1,500,000 shares of restricted Series Bpreferred stock (the Series B preferred shares have not yet beenissued).  Either party may terminate thechief scientific officer’s employment under the contract, either with orwithout cause upon giving the other party at least thirty days notice.  If the Company terminates the ChiefScientific Officer’s employment at any time during the initial term withoutcause, he will be entitled to receive compensation provided under the agreementfor the remaining initial term of employment. In addition, in the event of a change in control as defined in theagreement, the Company may waive, in whole or in part, any and all remainingrestrictions on the restricted shares of common stock and Series Bpreferred stock granted to him.

 

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Chief Financial Officer – The amended and restated employment agreementis effective as of July 2, 2004 and has an initial term of three years,subject to each party’s termination rights. The agreement provides for a base salary of $120,000 per year and theopportunity to receive cash bonuses based on performance upon the discretion ofour board of directors.  The agreementalso includes participation in employee benefit plans offered by us to ouremployees, as well as a grant of 140,000 shares of restricted commonstock.  Either party may terminate theChief Financial Officer’s employment under the contract, either with or withoutcause upon giving the other party at least thirty days notice.  If the Company terminates the chief financialofficer’s employment at any time during the initial term without cause, he willbe entitled to receive compensation provided under the agreement for the remaininginitial term of employment.  In addition,in the event of a change in control as defined in the agreement, the Companymay waive, in whole or in part, any and all remaining restrictions on therestricted shares of common stock granted to him.

 

On June 3, 2005, Mr. Michael Rosinski, Chief FinancialOfficer of Power3, resigned and terminated his employment at the Company as ofthat date.  In accordance with hisresignation, the employment agreement with Mr. Rosinski has terminated on June 5,2005, and the stock grant of 140,000 shares of Restricted Stock to Mr. Rosinskiis terminated.  The stock shares coveredin this agreement have been returned to the Company.

 

OnJune 3, 2005, the Company named John P. Burton as Chief Accounting Officerand Controller.  Previously Mr. Burtonwas Chief Financial Officer of Affiniscape, Inc. and served as ChiefFinancial Officer and Controller for Bob Johnson & Associates, Inc.from 1999 to 2003.

 

Other Common Stock Grants

 

Inaddition to the above common stock grants, the Company granted 1,305,000 sharesof its common stock to various other employees. Because all of the shares were granted at no cost to the employees, andbecause the shares generally vest over a period of two years, the Companyrecorded $27,850,500 of deferred compensation upon the date of the grant (whichamount was determined based on the total number of shares granted times thetrading values of the shares on the dates the stock grants were made).  This amount is being amortized to stock basedcompensation expense over the vesting period.

 

Asmentioned above, the Company has agreed to issue a total of 3,000,000 shares ofSeries B Preferred Stock to two of its officers.  However, for various reasons, includingcertain restrictions required by the indebtedness (which preclude the sharesfrom being issued for at least 90 days after the effective date of theregistration statement that has been filed to cover the resale of the shares ofcommon stock that will be issued upon the conversion or exercise of thesecurities issued by the Company for such indebtedness), the shares have notyet been issued.  The Company intends toissue such shares of the Series B Preferred Stock at such time as it ispermitted. The shares will be convertible into a like number of common sharesas vesting occurs over a period which is expected to be two years. Because ofthis and because all of the shares were granted at no cost to the officers, theCompany recorded $2,700,000 of deferred compensation upon the date of therespective employment contracts (which amount was determined based on the3,000,000 common shares that may ultimately be issued as a result of theconvertible feature times the trading values of the shares on the dates thestock grants were made).  This amount isbeing amortized to stock based compensation expense over the anticipatedvesting period.

 

Futurerequired payments for base compensation under all of the employment agreementsdiscussed above are approximately as follows:

 

| **Periods Ending  December 31,** | ** ** | **Amounts** | ** ** |
|---------------------------------------|------------|-------------|------------|
|                                  |       |        |       |
| 2005 (six months)                     |       | $           | 235,000    |   |
| 2006                                  |       | 470,000     |       |
| 2007                                  |       | 410,000     |       |
| 2008                                  |       | 350,000     |       |
| 2009                                  |       | 175,000     |       |
|                                  |       |        |       |
| Total                                 |       | $           | 1,640,000  |   |

 

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Contingencies

 

Inthe normal course of business, the Company is involved in certain litigation,including one matter in which the plaintiff is seeking $1,522,000 indamages.  Management believes the claimis without merit, and intends to vigorously contest such claim.  This matter is currently in the discoverystage and accordingly its ultimate resolution cannot presently bedetermined.  As such, no effect has beengiven to any loss that might result from the outcome of this litigation in theaccompanying financial statements.

 

Inaddition, an equipment vendor filed a complaint against Advanced BioChem (whichrelated to equipment acquired by Power3 in the May 18, 2004 transaction)in April of 2002 in a California court alleging breach of contract andseeking damages. Advanced BioChem reached a settlement agreement in April of2003 under which Advanced BioChem agreed to pay the vendor $40,000 ininstallments through August of 2003. At December 31, 2003, Advanced BioChem had a balance remaining of$20,000. In April 2005 the equipment vendor filed a lawsuit againstAdvanced BioChem and certain former officers of Advanced BioChem, and againstPower3, in order to enforce its claim for the remaining balance which is pastdue and may be assumed by the Company as part of the settlement of the disputewith Advanced BioChem as to liabilities assumed in the May 18, 2004transaction.

 

*Disputewith Advanced BioChem*

 

Advanced BioChem recentlyadvised the Company, and publicly announced, that it was reviewing the terms ofthe Company’s acquisition of substantially all of the assets and assumption ofcertain liabilities of Advanced BioChem pursuant to the Asset PurchaseAgreement. Advanced BioChem has asserted that the Company did not assume all ofthe liabilities for which it was obligated under the terms of the purchaseagreement. The terms of the Asset Purchase Agreement are not clear and aresubject to different interpretations. While the Company believes that it hasproperly interpreted the provisions of the agreement, fulfilled its obligationsthereunder and reflected the terms of the transaction in its financialstatements and previous filings, the Company has had discussions andnegotiations with Advanced BioChem in an effort to resolve this disagreement. Atthis time, Advanced BioChem has ceased discussions with Power3 and has statedin its 8-K and Form 10-QSB that they will take action to enforce anyrights and remedies it may have with respect to the Power3 sale and theliabilities.  Notwithstanding this,because the Company had previously offered to assume certain additional liabilitiesof approximately $425,000 in connection with their efforts to resolve thedispute, the Company had previously recorded $425,000 in contingent liabilitieson its balance sheet.  In accordance withFinancial Accounting Standards Board Statement Number 5, “Accounting forContingencies”, the Company was prepared to increase the purchase price by$425,000 (which amount represents the minimum amount of the range of additionalliabilities that may ultimately be assumed upon the resolution of thismatter).  Recently, as a result ofAdvanced BioChem’s refusal to further negotiate to settle the question,management has reviewed the liabilities in question and has determined thatPower3 is not liable for any of the aforementioned liabilities and thesecontingent liabilities have been removed from the Company’s balance sheet.  However, the Company remains contingentlyliable for the claimed liabilities of $2,575,000.  The purchase price and related financialstatements have not been adjusted for these liabilities as the fair value ofthis contingency cannot be reasonably estimated at this time.

 

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(8) SecuritiesPurchase Agreement

 

Convertible Debentures 

 

TheCompany entered into a Securities Purchase Agreement, dated October 28,2004 (the “Agreement”) with certain accredited investors, and an Amendment tosuch Securities Purchase agreement on January 19, 2005 in which fourinvestors accelerated the purchase of debentures in exchange for additionalwarrants.  Pursuant to the Agreement, thepurchasers agreed to purchase from the Company convertible debentures due three(3) years from the date of issuance in the aggregate principal amount of$3,000,000. The Agreement also provides for the issuance to the purchasers, at noadditional cost to the purchasers, warrants to purchase shares of the Company’scommon stock and additional investment rights to purchase additionalconvertible debentures.  In connectionwith the Agreement, the Company also entered into a registration rightsagreement with the purchasers, which requires that the Company file aregistration statement with the SEC registering on behalf of the purchasers theresale of the shares of common stock issuable upon conversion of the debenturesand the exercise of the warrants. The Company will also file an additionalregistration statement for the resale of the shares issuable upon conversion ofthe debentures issuable upon exercise of the additional investment rightspreviously issued by the Company.

 

EffectiveOctober 28, 2004, the Company issued and sold to the purchasers the first$1,000,000 in aggregate principal amount of such debentures at the initialclosing under the Agreement. Effective January 26, 2005, the Companyissued and sold to certain investors $400,000 aggregate principal amount ofdebentures.  Subject to the conditionsset forth in the Agreement, as amended, the purchasers are required to purchasethe remaining $1,600,000 in aggregate principal amount of such debentures atthe final closing, which is to occur on or before the fifth trading day afterthe effective date of the registration statement. The Company is currently indefault under the Agreement and the previously issued debentures and relatedregistration rights agreement, and therefore the conditions of the Agreementwill not be satisfied or otherwise met on a timely basis. Consequently, thereare no assurances that the investors will purchase all or any portion of theremaining $1,600,000 aggregate principal amount of debentures. The $1,000,000aggregate principal amount of debentures issued in the initial closing and the$400,000 aggregate principal amount of debentures issued on January 26,2005 are due and payable in accordance with their original terms in full threeyears after the date of issuance and will not bear interest. The debentureswhich may be issued at the final closing will be due and payable in full three (3) yearsafter the date of their issuance, and will not bear interest. The aggregatecash purchase price for the debentures will be $3,000,000, which is equal tothe full face amount of the debentures. At any time from the closing date untilthe maturity date of the debentures, the purchasers have the right to convertthe debentures, in whole or in part, into common stock of the Company at thethen effective conversion price. The conversion price for the previously issued$1,400,000 aggregate principal amount of debentures and the 1,600,000 aggregateprincipal amount of debentures issuable at the final closing is equal to thelesser of (1) $0.90, (2) the 75% average of the daily volume weightedaverage price of the common stock for the five (5) consecutive dayspreceding the effective date of the registration statement or (3) thedaily volume weighted average price of the common stock on the effective dateof the registration statement. The conversion price shall be subject toadjustment under circumstances set forth in the debentures.

 

Under the Agreement, thePurchasers also received at the first closing warrants to purchase an aggregateof up to 2,500,000 shares of common stock and additional investment rights topurchase up to an additional $2,500,000 principal amount of convertibledebentures.  Pursuant to the Amendment tothe agreement, concurrent with the Company’s issuance of the $400,000 aggregateprincipal amount of debentures on January 26, 2005, the Company issuedadditional warrants to purchase an aggregate of up to 333,333 shares of commonstock.  The warrants are exercisable at aprice of $1.44 per share (subject to adjustment), for a period of five (5) yearsfrom October 28, 2004.

 

Theadditional investment rights are exercisable at a price equal to the principalamount of the debentures to be purchased, for (1) a period of nine monthsfollowing the effective date of the registration statement to be filed pursuantto the registration rights agreement, or (2) a period of 18 months fromthe date of issuance of the additional investment rights, whichever is shorter.The debentures to be purchased upon the exercise of the additional investmentrights will have the same terms as the debentures described above, except thatthe conversion price will be equal to $1.08 (subject to adjustment).

 

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The debentures contain covenants that will limit the Company’s abilityto, among other things: incur or guarantee additional indebtedness; incur orcreate liens; amend the Company’s certificate of incorporation, bylaws or othercharter documents so as to adversely affect any rights of the holders of thedebentures; and repay or repurchase more than a de minimus number of shares ofcommon stock other than as permitted in the debentures and other documentsexecuted with the purchasers.

 

The debentures include customary default provisions and an event ofdefault includes, among other things, a change of control of the Company, thesale of all or substantially all of the Company’s assets, the failure to havethe registration statement declared effective on or before the 180th day afterthe initial closing date, and the lapse of the effectiveness of theregistration statement for more than 30 consecutive trading days during any 12-monthperiod (with certain exceptions), the Company’s failure to timely deliver certificatesto holders upon conversion and a default by the Company in any obligationsunder any indebtedness of at least $150,000 which results in such indebtednessbeing accelerated. Upon the occurrence of an event of default, each debenturemay become immediately due and payable, either automatically or by declarationof the holder of such debenture. The aggregate amount payable upon anacceleration by reason of an event of default shall be equal to the greater of130% of the principal amount of the debentures to be prepaid or the principalamount of the debentures to be prepaid, divided by the conversion price on thedate specified in the debenture, multiplied by the closing price on the dateset forth in the debenture.

 

As mentioned above, theCompany is in default under the provisions of the Agreement, registrationrights agreement and previously issued debentures.  The events of default now principally relatesto the Company’s inability to have its registration statement declaredeffective within the time period required by the agreements.  Although the Company intends to seek waiversor forbearance agreements from the holders of its debentures, there is noassurance that the Company will receive such concessions.  As such, the indebtedness has been classifiedas a current liability in the accompanying balance sheet.  If the Company is unable to obtain suchconcessions, the aggregate amount payable under the outstanding debentures dueto the acceleration thereof by reason of the default is equal to the “MandatoryPrepayment Amount” as specified in the debentures.  The Mandatory Prepayment Amount equals thesum of (i) the greater of:  (a) 130%of the principal amount of the debentures to be prepaid, or (b) theprincipal amount of the debentures to be prepaid, divided by the conversionprice on (x) the date the payment is demanded or otherwise due, or(y) the date the payment is paid in full, whichever is less, multiplied bythe closing price of the Company’s common stock on (x) the date thepayment is demanded or otherwise due, or (y) the date the payment is paidin full, whichever is greater, and (ii) all other amounts, costs, expensesand liquidated damages due in respect of the debentures.  In addition to the foregoing, pursuant to theterms of the registration rights agreement, the Company is required to pay eachholder of the debentures liquidated damages since the registration statementwas not declared effective on or before February 25, 2005.  The amount of liquidated damages shall equaltwo percent (2%) of the aggregate purchase price paid by the holders for thedebentures and shall be payable on each monthly anniversary of such date untilthe registration statement is declared effective.  As of June 30, 2005, the Company hasrecorded $188,000 of expense and accrued liabilities as a result of thisprovision.

 

The Company has receivednotice from one of the purchasers of the debentures informing the Company thatit is in default under the debentures and demanding payment of the MandatoryPrepayment Amount, together with the liquidated damages, to which it isentitled pursuant to the agreement.

 

Upon filing its Form 10-KSBfor 2004, the Company intends to file an amendment to its previously filedregistration statement and will endeavor to have it declared effective as soonas practicable.  The Company is indiscussion with its debenture holders regarding a resolution of this matter.

 

Inconnection with such financing, the Company became obligated to issue to itsplacement agent a warrant to purchase 100,000 shares of common stock at anexercise price of $3.00. If any investor exercises their additional investmentrights and purchases additional debentures, the placement agent will beentitled to receive additional warrants to purchase up to a number of shares ofcommon stock equal to

 

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ten percent (10%) of the exercise price paid upon exercise of theadditional investment rights divided by ninety percent (90%) of the marketprice as of the initial closing.

 

Inaccordance with the provisions of Emerging Issues Task Force Issue 98-5 (“EITF98-5”), discounts have been recorded for the entire face amount of theconvertible debentures on the dates the debentures were sold (i.e. October 28,2004 and January 25, 2005) of the first closing to allocate value to theembedded beneficial conversion feature and the 2,500,000 warrants.

 

Similarly,a discount for the entire face amount of the convertible debentures wasrecorded on the date of the first closing to allocate value to the embeddedbeneficial conversion feature and the 2,500,000 warrants.

 

Sincethere is no assurance that the Company will receive the remaining funds due atthe time of the final closing and/or through the exercise of additionalinvestment rights, no effect has been given to any value that may result fromthe issuance of securities in the accompanying financial statements.

 

(9) OtherSignificant Equity Transactions

 

(10) Stock Option Plans

 

The Company has various stock option andwarrant plans outstanding.  Optionsgranted under the 1998 stock option plans are exercisable only after therespective vesting period, which is determined by the Company’s stock optioncommittee. Options expire seven years from the date of grant. Under the 1999stock option plan, options granted to employees vest ratably over three years;vesting is determined by the Company’s stock option committee for optionsgranted to officers, directors, and consultants. Options expire ten years fromthe date of grant.

 

On March 31, 2003, the Companyapproved the 2003 Stock Compensation Plan, which provides for the granting ofcommon stock, options and/or warrants to officers, directors and employees ofthe Company, as well as consultants and attorneys who provide services to theCompany.  Under this plan the Company isauthorized to issue up to 8,000,000 shares of common stock, options orwarrants. The options and warrants shall expire according to terms asdetermined by a committee on the date of grant, which will not exceed ten yearsfrom the date of grant, or five years in cases of a grantee who owns more than10% of the total combined voting power of all classes of stock (10%Stockholder). The exercise period of any options or warrants granted will alsobe determined by this committee at the date of grant. The exercise price shallbe determined by the committee at the time of grant except that in the case ofincentive stock options, the exercise price shall not be less than 100% of thefair market value of the shares on the date of grant, and in cases of a 10%Stockholder, for which the exercise price shall not be less than 110% of fairmarket value on the date of grant.  At March 31,2005 no warrants or options are outstanding under this plan.

 

In addition to the above, in January 2004,the Company’s Board of Directors approved the 2004 Directors, Officers andConsultants Stock Option, Stock Warrant, and Stock Award Plan (the 2004Plan).  Pursuant to the 2004 Plan,initially 10,000,000 shares of common stock, warrants, options, preferred stockor any combination thereof may be optioned. After the grant of any option, warrant or share of preferred stock, thenumber of shares that may be optioned under the 2004 Plan will be increased.  The number of shares of such increase shallbe an amount such that immediately following such increase, the total number ofshares issuable under this plan and reserved for issuance upon exercise ofoptions, warrants, or conversion of shares of preferred stock will equal 15% ofthe total number of issued and outstanding shares of the Company’s commonstock.  At December 31, 2004 nowarrants or options are outstanding under this plan.

 

Pro forma information regarding net income andearnings per share is required by SFAS 123, and has been determined as if theCompany had accounted for all of its options and warrants (the “Warrants”)

 

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under the fair value method of that Statement. Thefair value for the Warrants was estimated at the date of grant using a Black-Scholesoption pricing model with the following assumptions for Warrants granted in2000: risk-free interest rate of 6.03%; dividend yield of 0%; volatility factorof the expected market price of the Company’s common stock of .34; and aweighted-average expected life of the options of 2.7 years. The followingassumptions were used for Warrants granted in 2004: risk-free interest rate of5.0%; dividend yield of 0%; volatility factor of the expected market price ofthe Company’s common stock of 1.86 and a weighted-average expected life of theoptions of -0- years (as all were immediately vested). The Black-Scholes optionvaluation model was developed for use in estimating the fair value of tradedWarrants that have no vesting restrictions and are fully transferable. Inaddition, option valuation models require the input of highly subjectiveassumptions including the expected stock price volatility. Because the Company’sWarrants have characteristics significantly different from those of tradedWarrants, and because changes in the subjective input assumptions canmaterially affect the fair value estimate, in management’s opinion, theexisting models do not necessarily provide a reliable single measure of thefair value of its Warrants.

 

Allof the Company’s warrants were recorded at their fair values; accordingly stockbased compensation actually recorded and stock based compensation that would berecorded using a fair value based method are identical.

 

Asummary of the Company’s warrant activity and related information for theperiod January 1, 2004 to December 31, 2004 is as follows:

 
| ** **                             | ** ** | ** **   | ** ** | **Weighted** | ** ** |
|----------------------------------------|------------|--------------|------------|--------------|------------|
| ** **                             | ** ** | ** **   | ** ** | **Average**  | ** ** |
| ** **                             | ** ** | ** **   | ** ** | **Exercise** | ** ** |
| ** **                             | ** ** | **Warrants** | ** ** | **Price**    | ** ** |
|                                   |       |         |       |         |       |
| Outstanding at  January 1, 2004   |       | 6,360        |       | $            | 12.50      |   |
|                                   |       |         |       |         |       |
| Cancelled                              |       | —       |       | $            | —     |   |
|                                   |       |         |       |         |       |
| Granted                                |       | 3,080,000    |       | $            | 1.44       |   |
|                                   |       |         |       |         |       |
| Exercised                              |       | —       |       | $            | —     |   |
|                                   |       |         |       |         |       |
| Outstanding at  December 31, 2004 |       | 3,086,360    |       | $            | 1.46       |   |
|                                   |       |         |       |         |       |
| Exercisable at  the end of the year    |       | 3,086,360    |       | $            | 1.46       |   |

 

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Thefollowing table summarizes information about the Company’s Warrants outstandingat December 31, 2004:

 
| ** **   | ** ** | ** **      | ** ** | ** **                | ** ** | **Weighted** | ** ** |
|--------------|------------|-----------------|------------|---------------------------|------------|--------------|------------|
| ** **   | ** ** | ** **      | ** ** | **Weighted Average**      | ** ** | **Average**  | ** ** |
| **Exercise** | ** ** | **Number**      | ** ** | **Remaining Contractual** | ** ** | **Exercise** | ** ** |
| **Price**    | ** ** | **Outstanding** | ** ** | **Life (in years)**       | ** ** | **Price**    | ** ** |
| $            | .98        |            | 300,000    |                      | 2.4        |         | $          | .98 |   |
| $            | 1.00       |            | 100,000    |                      | 2.4        |         | $          | 1.00 |   |
| $            | 1.43       |            | 50,000     |                      | 2.8        |         | $          | 1.43 |   |
| $            | 1.44       |            | 2,500,000  |                      | 4.8        |         | $          | 1.44 |   |
| $            | 2.77       |            | 30,000     |                      | 2.6        |         | $          | 2.77 |   |
| $            | 3.00       |            | 100,000    |                      | 4.8        |         | $          | 3.00 |   |
| $            | 6.50       |            | 5,460      |                      | 6.0        |         | $          | 6.50 |   |
| $            | 50.00      |            | 900        |                      | 3.0        |         | $          | 50.00 |   |
|         |       |            |       |                      |       |         |       |
|         |       | 3,086,360       |       |                      |       | $            | 1.46       |   |

 

Inaddition to the Warrants discussed above, during the six months ended June 30,2005, the Company issued 333,333 warrants to certain holders of the convertibledebentures (see Note 8).

 

(11) Recent Pronouncements

 

*FIN 46 – Consolidation ofVariable Interest Entities*

 

InJanuary 2003, the FASB issued FIN 46, (revised in December 2003 asFIN46R) “Consolidation of Variable Interest Entities,” which clarifies theapplication of Accounting Research Bulletin (“ARB”) 51, Consolidated FinancialStatements, to certain entities (called variable interest entities) in whichequity investors do not have the characteristics of a controlling financialinterest or do not have sufficient equity at risk for the entity to finance itsactivities without additional subordinated financial support from otherparties. The disclosure requirements of this Interpretation are effective forall financial statements issued after January 31, 2003. The consolidationrequirements apply to all variable interest entities created after January 31,2003. In addition, public companies must apply the consolidation requirementsto variable interest entities that existed prior to February 1, 2003 andremain in existence as of the beginning of annual or interim periods beginningafter June 15, 2003. The adoption of FIN 46R had no impact on thefinancial statements of the Company as the Company has no variable interests invariable interest entities.

 

*SFAS 150 - Accounting forCertain ‘Financial Instruments with Characteristics of Both Liabilities andEquity*

 

In May 2003, SFAS No. 150“Accounting for Certain Financial Instruments with Characteristics of BothLiabilities and Equity,” was issued to establish new standards for how anentity classifies and measures certain financial instruments withcharacteristics of both liabilities and equity. It requires that an entity classify a financial instrument that iswithin its scope as a liability (or an asset in some circumstances).  Many of these instruments were previouslyclassified as equity.  This statement waseffective when issued for financial instruments entered into or modified after May 31,2003, and otherwise is effective for calendar year public companies for thethird quarter of 2003.  The adoption ofSFAS 150 had no impact on the financial statements of the Company.

 

*SFAS 132 - Employers’Disclosures about Pensions and Other Postretirement Benefits*

 

In December 2003, FASBStatement No. 132 (revised) was issued which prescribes the requiredemployers’ disclosures about pension plans and other postretirement benefitplans; but it does not change the measurement or recognition of thoseplans.  The Statement retains and revisesthe disclosure requirements contained in the original Statement 132.  It also requires additional disclosures aboutthe assets, obligations, cash flows, and net periodic benefit cost of definedbenefit pension plans and other

 

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postretirement benefit plans.  The Statement generally is effective forfiscal years ending after December 15, 2003.  Since the Company does not have any types ofpension plans or other postretirement benefits, the adoption of this Statementdid not have an effect on the Company’s financial statements.

 

*SFAS 123(R)‘Share-Based Payments’*

 

In December 2004, theFinancial Accounting Standards Board issued Statement Number 123 (“FAS 123 (R)”),Share-Based Payments. FAS 123 (R) requires all entities to recognizecompensation expense in an amount equal to the fair value of shared-based paymentssuch as stock options granted to employees. The Company will be required toapply FAS 123 (R) on a modified prospective method. Under this method, theCompany is required to record compensation expense (as previous awards continueto vest) for the unvested portion of previously granted awards that remainoutstanding at the date of adoption. In addition, the Company may elect toadopt FAS 123 (R) by restating previously issued financial statements, basingthe amounts on the expense previously calculated and reported in the pro formadisclosures that had been required by FAS 123. FAS 123 (R) is effective for thefirst reporting period beginning after June 15, 2005. The Company does notbelieve the impact of adopting this Statement will be material as there are nounvested options and warrants at December 31, 2004.

 

*SFAS 153 -Exchanges of Non-monetary Assets an Amendment of APB Opinion No. 29*

 

In December 2004, FASBStatement No. 153 was issued amending APB Opinion No. 29 to eliminatethe exception allowing non-monetary exchanges of similar productive assets tobe measured based on the carrying value of the assets exchanged as opposed toat their fair values.  This exception wasreplaced with a general exception for exchanges of non-monetary assets that donot have commercial substance.  A non-monetaryexchange has commercial substance if the future cash flows of the entity areexpected to change significantly as a result of the exchange.  The provisions of this statement areeffective for non-monetary asset exchanges occurring in fiscal periodsbeginning after the June 15, 2005. The adoption of this statement did not have a material impact on theCompany’s financial statements.

 

*FIN- 45 Guarantor’s Accounting and Disclosure Requirements forGuarantees, Including Indirect Guarantees of Indebtedness of Others*

 

InNovember 2002, the FASB issued FASB Interpretation (“FIN”) 45 “Guarantor’sAccounting and Disclosure Requirements for Guarantees, Including IndirectGuarantees of Indebtedness of Others,” which elaborates on the disclosures tobe made by a guarantor in its interim and annual financial statements about itsobligations under certain guarantees that it has issued. It also clarifies thata guarantor is required to recognize, at the inception of the guarantee, aliability for the fair value of the obligation undertaken in issuing theguarantee. The initial recognition and initial measurement provisions of thisInterpretation are applied prospectively to guarantees issued or modified afterDecember 31, 2002. The adoption of these recognition provisions willresult in recording liabilities associated with certain guarantees provided byus. The disclosure requirements of this Interpretation are effective forfinancial statements of interim or annual periods ending after December 15,2002. FIN 45 has no impact on the Company’s financial statements

 

(12)Subsequent Events

 

OnJuly 28, 2005, the management of Power3 decided upon a change in itsindependent public accounting firm and decided to no longer engage Kingery &Crouse, P.A. as its independent public accounting firm.  On that same date, the Company engaged theservices of John A. Braden & Company, P.C. as its independent publicaccounting firm.

 

OnAugust 12, 2005, Power3 issued an 8-K indicating that it was restating itsfinancial statements previously presented for the three month periods ending June 30,2004, September 30, 2004 and 

 

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March 31,2005.  In addition, the Company willamend its 8-K filed to report the asset purchase transaction with AdvancedBioChem on May 18, 2004.

 

OnAugust 15, 2005, Power3 issued a 12b-25 indicating that it would be filingits 10-QSB for June 30, 2005 late, within the 5 day grace period for latefiling.

 

*Item 2.**MANAGEMENT’SDISCUSSION AND ANALYSIS OR PLAN OF OPERATION*

 

Forward LookingStatements

 

This report containscertain forward-looking statements of the intentions, hopes, beliefs,expectations, strategies, and predictions of the Company or its management withrespect to future activities or other future events or conditions within themeaning of Section 27A of the Securities Act of 1933, as amended, and Section 21Eof the Securities Exchange Act of 1934, as amended.  These statements are usually identified bythe use of words such as “believes,” “will,” “anticipates,” “estimates,” “expects,”“projects,” “plans,” “intends,” “should,” “could,” or similar expressions.  These statements are based on certainassumptions and analyses made by the Company in light of its experience and itsperception of historical trends, current conditions, expected futuredevelopments and other factors it believes are appropriate.  Investors are cautioned that allforward-looking statements involve risks and uncertainties, including, without limitation:

 

•      TheCompany’s history of operating losses;

 

•      TheCompany’s need and ability to raise significant capital and obtain adequatefinancing for its development efforts;

 

•      TheCompany’s ability to successfully develop and complete validation studies forits products;

 

•      TheCompany’s dependence upon and the uncertainties associated with obtaining andenforcing patents and intellectual property rights important to its business;

 

•      Theuncertainties associated with the lengthy regulatory approval process,including uncertainties associated with the United States Food and DrugAdministration (“FDA”) decisions and timing of product development or approval;

 

•      Developmentby competitors of new or competitive products or services;

 

•      TheCompany’s ability to retain management, implement its business strategy,assimilate and integrate any acquisitions;

 

•      TheCompany’s lack of operating experience and present commercial productioncapabilities; and

 

•      Theincreasing emphasis on controlling healthcare costs and potential legislationor regulation of healthcare pricing.

 

Although theCompany believes that the assumptions underlying the forward-looking statementscontained in this report are reasonable, any of the assumptions could beinaccurate, and, therefore, there can be no assurance that the forward-lookingstatements included in this report will prove to be accurate.  In light of the significant uncertaintiesinherent in the forward-looking statements included in this report, theinclusion of such information should not be regarded as a representation by theCompany or any other person that the objectives and plans of the Company willbe achieved.  Except for its ongoingobligation to disclose material information as required by the federalsecurities laws, the Company undertakes no obligation to release publicly anyrevisions to any forward-looking statements to reflect events or

 

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circumstancesafter the date of this report or to reflect the occurrence of unanticipatedevents.  Accordingly, the reader shouldnot rely on forward-looking statements, because they are subject to known andunknown risks, uncertainties, and other factors that may cause our actualresults to differ materially from those contemplated by the forward-lookingstatements.

 

Overview

 

The Company is anearly stage development company engaged in the early detection, monitoring, andtargeting of diseases through the analysis of proteins.  The Company’s business objective is tocommercialize its intellectual property by focusing on disease diagnosis,protein and biomarkers identification and drug resistance in the areas ofcancers, neurodegenerative and neuromuscular diseases.  The Company has established a scientificadvisory board to assist in the research and development of its products. Themembers of the scientific advisory board are recognized leaders in their chosenfields, and the Company is working with them in the development of effectiveearly diagnosis and drug targets for early treatment of cancers,neurodegenerative and neuromuscular diseases.

 

Prior to theCompany’s acquisition of the assets of Advanced BioChem, Inc. on May 18,2004, the Company was primarily engaged in the production and distribution ofsurgical safety devices through the operations of its subsidiary, Power3Medical, Inc.  On May 18, 2004,the Company completed its acquisition of the assets of Advanced BioChem.  The Company acquired all assets andintellectual properties of Advanced BioChem and assumed certain liabilities inexchange for the issuance of 15,000,000 shares of the Company’s common stock.Subsequent to the transaction, the Company established the new businessdirection described above.

 

After theacquisition of the assets and certain liabilities of Advanced BioChem, theCompany transformed into an advanced proteomics company applying existingproprietary methodologies to commercialize the intellectual property itacquired in the Advanced BioChem transaction and subsequently developed newproprietary methodologies in the specific areas of discovery and identificationof protein biomarkers associated with diseases. The Company currently has no products for sale nor does it provide anyservice for hire.  The Company is focusedon research and development activities and initiating the “proof of concept” ofits technologies.

 

The Company is in thedevelopmental stage of its existence.  Assuch, it has not begun generating revenue from the sales of products orservices, nor has it produced such for sale at this time.  The Company is dependent on debt and equitycapital for its activities.  Many of the internal control procedures that will be necessary whenthe Company moves out of the developmental stage are not developed at thistime.  Our ongoing operationsconsist of research and development operations and activities directed towardcommercializing the intellectual property of the Company at this time.  The Company has been in its currentdevelopmental stage since its acquisition of its current set of intellectualproperties on May 18, 2004.

 

The Company hashad significant losses from its inception. The Company anticipates that it will continue to incur substantialoperating losses in future years as it progresses in its research anddevelopment activities as well as the commercializing of its technologies.  The Company does not expect to producerevenues from operations in the near term and expects that its revenues will belimited to research grants, collaboration agreements, and other strategicalliances which the Company is able to obtain. The Company has an immediate need for capital to continue its currentoperations

 

Recent Developments

 

*Scientific Developments*

 

The members of theCompany’s scientific team have developed a method for the differentialdiagnosis of neurodegenerative diseases utilizing blood serum, which wasco-developed with neurologist, Dr. Stan Appel, Chair of Neurology and histeam at The Methodist Hospital Neurological Research Institute in

 

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Houston. Under thetrade name of NuroProTM, the Company is continuing development of a group oftests to differentiate individuals with no known neurological disorders fromthose with Alzheimer’s disease, Parkinson’s disease, ALS, and other disordersthat have similar clinical symptoms as these diseases. Each test involvesmonitoring the concentration of a group of differentially expressed proteinsselected from a panel of 34 biomarkers that have been identified as indicatorsof the different disorders. Each test employs a different combination of 4 to10 biomarkers to achieve the desired diagnostic capability for the specificdisease discrimination designed for any individual test.

 

At the end of thefirst six months of 2005, the number of unique samples in our collection usedfor constructing our NuroPro tests has increased from 435 to over 600. During this time, the Company has determined the protein identities for 31 ofthe 34 differentially expressed proteins in the pool of biomarkers targetingneurodegenerative diseases and has focused its efforts on commercializing thefirst 3 of the diagnostic tests in the NuroPro series. The first test is a “General”test designed to aid the general practitioner in differentiating individualswith no known neurological disorders from those with neuromuscular diseasesincluding Parkinson’s disease, ALS, and other disorders with similar clinicalsymptoms. The second test is designed to aid the neurologist in differentiatingindividuals with ALS from those disorders with similar clinical symptoms asALS. The third test is designed to aid neurologists in differentiatingindividuals with Alzheimer’s disease from those with similar disorders and fromnormal non demented individuals of the same age.

 

Since the first of theyear, the Company has converted six provisional patents to utility patentapplications, 1 focusing on the Company’s biomarker discovery technologies, 1on antibody based test designs for the company’s biomarkers, and 4 onbiomarkers for neurodegenerative diseases. The company has filed a provisionalpatent application for the Company’s first generic, blood based diagnostic testfor neuromuscular disorders on May 9, 2005 and a second provisional patentapplication on July 21 for the Company’s ALS specific test to distinguishpatients with ALS from those with other diseases that have the same symptoms asALS but with more treatment options and better prognosis. These applications are included in the 9utility patents pending, 12 provisional patent applications, and 1 issuedpatent, owned and/or licensed by Power3 for developing disease specificdiagnostic tests for neurodegenerative disease, breast cancer, and drugresistance.

 

Following the provisional patent applications, the Company submitted apre-market IDE (InvestigationalDevice Exemption) application with the Division of Hematology of the U.S. Foodand Drug Administration (FDA) for the first diagnostic test in theNuroProTM series. Currently, there are no other diagnostic tests available tothe physician to assist in the diagnosis of these disorders and the Companybelieves the FDA is highly interested in evaluating this technology. In a meeting with the FDA on June 1,2005, guidance was offered regarding requirements for study design, patientrisk assessment and intended use. In addition, based on the FDA’s advice inpreliminary discussions, Power3 presented optimized results with an increase inspecificity to more than 92% and an increase in Positive Predicted Value tomore than 96%. The FDA concurred with how the Company had approached thebiostatistics analysis utilized to optimize the test results. Now, the Companyis proceeding to make preparations for FDA applicable multiple site clinicalstudies for the NuroPro(TM) suite of blood serum tests. The company has sincesubmitted its second pre-IDE application on June 22 with the FDA for theCompany’s NuroPro(TM) Blood Tests for the early detection and differentiationof the neurodegenerative disease, ALS from the ALS-like disorders that havesimilar symptoms but different treatments and prognoses. The basis forsubmission is the analysis of blood serum from over 600 patients.

 

Onjune 28, 2004, Power3 entered into an exclusivelicense agreement with Baylor College of Medicine, Houston, TX to commercializethe neurodegenerative disease biomarkers and tests co developed and patentsfiled jointly with that institution. More recently on June 6, 2005, theCompany entered into a research agreement with The Methodist HospitalNeurological Research Institute, Houston TX to continue the search forbiomarkers and development of the NuroPro suite of tests that directly impactthe diagnosis of neurodegenerative diseases. Power3, in collaboration with StanAppel, M.D., Chair of Neurology at the Methodist Hospital Neurological ResearchInstitute, has completed clinical validation,

 

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testingserum proteins from over 600 patients, normal and neurodegenerative diseasecontrols, including patients with Lou Gehrig’s (ALS), Alzheimer’s and Parkinson’sdiseases.

 

Theresults from recently completed studies measuring levels of biomarkers fromblood serum to diagnose and follow patients with neurological disordersinvolving muscle control have provided further scientific evidence in supportof the Company’s biomarker program. These studies were done with serum samplesfrom more than 600 patients and normal controls. They revealed that 21 of 34blood serum protein biomarkers are useful in distinguishing patients with ALS(Lou Gehrig’s disease) and Parkinson’s diseases. These studies have providednew and surprising results, revealing for the first time that 3 blood serumprotein biomarkers useful in distinguishing patients with ALS (Lou Gehrig’sdisease) and Parkinson’s diseases are actually different forms of the sameprotein, where the disease specific difference involves an important regulatorymechanism, the attachment of a chemical tag to the protein. The finding of aprotein tagging difference between two distinct diseases which are members ofthe same type of neurological disorder, motor control, provides highly valuableclues about these specific diseases, biochemical differences that can point totargeted therapies exploiting them. New results of studies of Alzheimer’sdisease by the Company have found that 15 of the 34 biomarkers appear toprovide indication of disease severity and 6 provide indication of earlydisease. These findings offer the hope of developing specific tests for earlydetection of Alzheimer’s disease, for monitoring of disease progression andresponse to treatment, and valuable clues for drug targeting for development ofearly treatments.

 

The Company hasentered into a collaborative research agreement with New Horizons Diagnosticeffective March 21, 2005 for the development of antibody based diagnostictests for neurodegenerative disease utilizing the Company’s identifiedbiomarkers.  The research agreement isbased on groups of biomarkers whose profiles are relatively sensitive andspecific in distinguishing patients with ALS, Alzheimer’s disease and Parkinson’sdisease from each other, as well as from normal patients and patients withother neuromuscular and neurological disorders. The purpose of the agreement isto tailor monoclonal and polyclonal antibodies to the biomarkers, which will beincorporated into immunoassays.  Once theassays are available, they will be developed to validate diagnostic testsspecifically designed to detect and discriminate among the neurodegenerativediseases.  The research agreementprovides that the parties will develop an agreed upon schedule and budgetfor the work contemplated there under within sixty (60) days of the effectivedate.  The agreement provides that in theevent the parties are able to achieve specified goals relating to thedevelopment of a diagnostic kit as contemplated by the research agreement, NewHorizons would be compensated in any one of the following manners with respectto such diagnostic kit:  (i) acontract to manufacture at least one key component of such diagnostic kit; (ii) royaltieson the sale of such diagnostic kit; (iii) the opportunity to form a jointventure with the Company for the commercialization of such diagnostic kit; or (iv) areasonable percentage of any cash consideration that the Company receives froma third party for such diagnostic kit. Although the form and amounts of any consideration to be paid have notbeen agreed upon, the parties have agreed to be reasonable in negotiating suchconsideration.

 

On May 24, 2005, theCompany entered into a collaboration agreement with BioSite Inc.  The agreement provides that Power3 andBioSite will engage in a research program in which BioSite will attempt todevelop antibodies and diagnostic assays for selected target biomarkers proposedby Power3.  If the antibodies and diagnosticassays are found to have diagnostic and/or therapeutic potential, BioSite willdevelop and commercialize BioSite products for the detection and/or treatmentof breast cancer and/or neurological diseases. Under the agreement, BioSite will make milestone payments to theCompany, as well as pay royalties on the sale of any BioSite productscontaining antibodies to any selected target biomarker claimed in a patentapplication or an issued patent.

 

Power3’s DiscoveryPlatform of patents pending and trade secrets for identifying proteinbiomarkers, which signal early stages of breast cancer (pre-mammography) haveled to what the Company believes to be the first test of its type that detectsbreast cancer earlier than current technology allows.  These discoveries establish the basis of avery sensitive, non-invasive, early detection breast cancer-screening test.With regard to the NAF test for breast cancer, the M.D. Anderson utilitiespatent licensed by Power3 has issued, as of February 15, 2005.  The Company’s breast Cancer NAFTestTM ClinicalValidation Study

 

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continues with promisingresults.  The current enrollment statusincludes 156 patients, including all categories of normal, benign and cancersamples.  The three clinical sitesinclude Mercy Women’s Center in Oklahoma City, OK, Obstetrical and GynecologyAssociates in Houston, TX, and NYU School of Medicine in NY, NY.  It is anticipated that the enrollment willcontinue without changes to the sites or Primary Investigators.  The Company is pleased with the continualprogress of the validation study and the advice received from the study’sprincipal investigator.

 

The Company hasextended its breast cancer diagnostic technology with a newly discovered groupof 12 blood serum biomarkers found in studies of serum samples collected atMercy Women’s Center from 150 high risk women. Preliminary biostatisticalanalysis of these biomarkers indicate that monitoring their concentrations hasutility in distinguishing between women with breast cancer, women with benignbreast disease, and normal women.

 

Power3has obtained the exclusive worldwide license to a joint utility patentapplication and jointly developed technologies for early detection screeningtests, identified protein biomarkers and drug targets to predict which cancerpatients will be sensitive or resistant to drug therapy. The technology wasdeveloped through joint collaboration between the scientific team of Power3Medical and The University of Texas M. D. Anderson Cancer Center.

 

*Delay inFiling Annual Report on Form 10-KSB*

 

As previously reported, the Company was unable to fileits 2004 Form 10-KSB within the extended filing deadline ending April 15,2005.  Under the previous accountingtreatment, the Company was required to include in its Form 10-KSB for2004, audited financial statements from Advanced BioChem, Inc., the entityfrom which the Company purchased certain assets during 2004.  The Company was unable to file its 2004 Form 10-KSBbecause the former auditors of Advanced BioChem, refused to give their consentto the inclusion, in the Company’s 2004 Form 10-KSB, of their auditopinion on the financial statements of Advanced BioChem for fiscal year 2003.As previously reported by the Company, Fitts Roberts, the auditors of AdvancedBioChem for 2003 informed the Company that they refused to furnish theirconsent due to different concerns, including concerns with the previousaccounting treatment of the May 18, 2004 transaction with AdvancedBioChem.  This refusal to give theirconsent was only communicated to Power3 as Power3 was preparing to file the2004 Form 10-KSB.  Power3 is nowpreparing its Form 10-KSB for the year ended December 31, 2004 andwill file this form contemporaneously with amended quarterly financialstatements for the periods ended June 30, 2004, September 30, 2004and March 31, 2005.

 

*Disputewith Advanced BioChem*

 

Advanced BioChem recentlyadvised the Company, and publicly announced, that itwas reviewing the terms of the Company’s acquisition of substantially all of theassets and assumption of certain liabilities of Advanced BioChem pursuant tothe Asset Purchase Agreement. Advanced BioChem has asserted that the Companydid not assume all of the liabilities for which it was obligated under theterms of the purchase agreement. The terms of the Asset Purchase Agreement arenot clear and are subject to different interpretations. While the Companybelieves that it has properly interpreted the provisions of the agreement,fulfilled its obligations thereunder and reflected the terms of the transactionin its financial statements and previous filings, the Company has haddiscussions and negotiations with Advanced BioChem in an effort to resolve thisdisagreement. At this time, Advanced BioChem has ceaseddiscussions with Power3 and has stated in its 8-K and Form 10-QSB thatthey will take action to enforce any rights and remedies it may have withrespect to the Power3 sale and the liabilities. Notwithstanding this, because the Company had previously offeredto assume certain additional liabilities of approximately $425,000 inconnection with their efforts to resolve the dispute, the Company hadpreviously recorded $425,000 in contingent liabilities on its balance sheet.  In accordance with Financial AccountingStandards Board Statement Number 5, “Accounting for Contingencies”, the Companywas prepared to increase the purchase price by $425,000 (which amountrepresents the minimum amount of the range of additional liabilities that mayultimately be assumed upon the resolution of this matter).  Recently, as a

 

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resultof Advanced BioChem’s refusal to further negotiate to settle the question,management has reviewed the liabilities in question and has determined thatPower3 is not liable for any of the aforementioned liabilities and thesecontingent liabilities have been removed from the Company’s balance sheet.  However, the Company remains contingentlyliable for the claimed liabilities of $2,575,000.  The purchase price and related financialstatements have not been adjusted for these liabilities as the fair value ofthis contingency cannot be reasonably estimated at this time.

 

*Resultsof Operations*

 

*ThreeMonths Ended June 30, 2005 as Compared to Three Months Ended June 30,2004*

 

Revenues for the threemonths ending June 30, 2005 were $ -0- compared to $ 13,600 for the sameperiod in 2004.  Due to the Company’sfocus on disease diagnosis, protein and biomarkers identification, and researchon drug resistance in the areas of cancer, neurodegenerative and neuromusculardiseases, it is unlikely that the Company will receive any revenues fromcommercial operations in the immediate future.

 

Total Operating expenseswere $4,558,754 during the three months ended June 30, 2005 as compared to$14,083,841 for the three months ended June 30, 2004, a decrease of$9,525,087.  The decrease in operatingexpenses was primarily attributable to a decrease of $2,580,215 in stock basedcompensation expense due to the issuance of shares of common stock and warrantsto management and other employees as well as consultants and advisors whichwere issued in 2004 immediately after the asset purchase transaction, duringthe 2nd quarter of 2004. Other operating expenses were $949,316 in the first three months of 2005as compared to $7,894,187 during the first three months of 2004, a decrease of$6,944,871, attributed primarily to $7,089,015 in consulting fees that werepaid with issued stock, but which are required to be expensed to the statementof operations during the 2nd quarter of 2004.

 

Interest expense thus farin 2005 has amounted to $117,085 as compared to $1,238 during the same sixmonth period of 2004.  The increase ininterest expense is primarily attributable to the non-cash interest expenserecorded as a result of fair valuing certain warrants issued to purchasers ofconvertible debentures.

 

The above matters resultin net loss decreasing from ($14,075,491) in 2004 to $4,558,754 for the firstsix months of 2005.

 

Liquidity andCapital Resources

 

The Company has financedits operations since the date of the Advanced BioChem transaction primarilythrough the net proceeds generated from the sale of common stock, the sale ofconvertible debentures and the issuance of notes payable as bridge loans.  Since the date of the Advanced BioChemtransaction, the Company has raised approximately $2,590,900.  As described in “Recent Financing” below, theCompany may sell an additional $1,600,000 in aggregate principal amount ofconvertible debentures following the effectiveness of the RegistrationStatement on Form SB-2 filed by the Company for the resale of certainshares of the Company’s stock by the purchasers of the Company’s convertibledebentures.  The Company is in defaultunder the terms of the Securities Purchase Agreement, the previously issueddebentures and related registration rights agreement and there can be noassurance that the existing investors will purchase all or any portion of theadditional $1,600,000 aggregate principal amount of debentures.  If additional debentures are issued and soldby the Company, the Company will use a portion of the proceeds from the saleand issuance of such debentures to pay the $251,000 principal balance owingunder the promissory note dated April 5, 2005 and $ 396,500 principalbalance owing under the promissory note dated June 17, 2005.

 

The Company’s liquidity and capital needs relateprimarily to working capital, development and other general corporaterequirements.  The Company has notreceived any cash from operations.  Underthe terms of the license agreement with M.D. Anderson, which the Companyacquired from Advanced BioChem, the Company is required to pay a nonrefundablelicense documentation fee of $40,000, payable

 

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in two installments.  The first $20,000 installment was previouslypaid following the execution of the license agreement and the secondinstallment was paid in February 2005. A similar license documentation fee is payable under the terms of thelicense agreement the Company entered into with M.D. Anderson and the Companywill be obligated to pay the second installment of $20,000 in August of2005. The Company has an immediate need for capital to continue its currentoperations.  In addition to seekingadditional capital, the Company will seek revenues from research grants,collaboration agreements, and other strategic alliances.  If the Company is successful in completingthe sale and issuance of the remaining $1,600,000 aggregate principal amount ofdebentures, of which no assurances can be given due to the Company’s defaultunder the Securities Purchase Agreement and related documents, managementbelieves that the net funds available, after repayment of the bridge note of$251,000 immediately following the sale and issuance of such debentures, willprovide adequate cash to satisfy this obligation to M.D. Anderson and to allowthe Company to meet its funding requirements through the third quarter of 2005.  In the event the sale and issuance of the$1,600,000 aggregate principal amount of debentures occurs and the investorsexercise their warrants and additional investment rights, the Companyanticipates it will have adequate cash to meet its funding requirements throughthe first quarter of 2007.  The foregoingprojections are based upon the Company’s existing obligations.  Advanced BioChem has asserted that theCompany has not assumed or recognized all liabilities for which it is obligatedunder the terms of the Securities Purchase Agreement.  The resolution of this dispute, including apossible settlement thereof, could result in an increase in the Company’sliabilities.  If the Company’sobligations are increased, the Company will require additional funding soonerthan is currently anticipated.  (See “RecentDevelopments – Dispute with Advanced BioChem.”)

 

Net cash used inoperating activities approximated ($586,347) for the six months ended June 30,2005, compared to ($1,004,299) for the six months ended June 30,2004.  The decrease in net cash used inoperating activities during 2005 was primarily due to a decrease in consultingfees, attorney fees and stock issue costs that were particular high during thequarter including the May 18, 2004 purchase transaction with AdvancedBioChem.

 

Net cash provided byfinancing activities approximated $628,041 for the six months ended June 30,2005, as compared to $1,246,322 for the six months ended June 30,2004.  The decrease in net cash providedby financing activities in 2005 is primarily due to a reduced rate of activityin in equity financing and debt financing during 2005, compared to the firstsix months of 2004, which included the May 18, 2004 transaction and allthe stock issues associated with that transaction.  As of June 30, 2005, the Company’sprincipal source of liquidity was approximately $36,722 in cash.  The Company received a bridge loan of$251,000 on April 5, 2005, a bridge loan in the amount of $396,500 on June 17,2005 and two Officer Advances in the aggregate amount of $105,000.  If the Company is successful in completingthe sale and issuance of the remaining $1,600,000 aggregate principal amount ofdebentures, of which no assurances can be given due to the Company’s defaultunder the Securities Purchase Agreement and related documents, managementbelieves that the net funds available, after repayment of the bridge note of$251,000 and the $ 396,500 and the Officer Advances immediately following thesale and issuance of such debentures, will provide adequate cash to allow theCompany to meet its current funding requirements through the third quarter of2005.

 

Recent Financing

 

The Company entered intoa securities purchase agreement, dated as of October 28, 2004, withcertain investors.  Pursuant to the securitiespurchase agreement, the investors agreed to purchase from the Companyconvertible debentures due three (3) years from the date of issuance inthe aggregate principal amount of $3,000,000. Effective January 19, 2005, the Company entered into an amendmentto the securities purchase agreement with each of the investors.  The securities purchase agreement, asamended, also provides for the issuance to the investors of warrants topurchase shares of the Company’s common stock and additional investment rightsto purchase additional convertible debentures. In connection with thesecurities purchase agreement, the Company entered into a registration rightsagreement which requires the Company to file a registration statementregistering on behalf of the investors the resale of the shares of common stockissuable upon conversion of the debentures and the exercise of the warrants.

 

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The Company will alsofile a registration statement registering on behalf of the investors the resaleof shares of common stock issuable upon conversion of the debentures issuedupon exercise of the additional investment rights previously issued by theCompany.

 

Effective October 28,2004, the Company issued and sold to the investors the first $1,000,000 inaggregate principal amount of such debentures at the initial closing under thesecurities purchase agreement.  Pursuantto the securities purchase agreement, as amended, effective January 26,2005 the Company issued and sold to certain investors$400,000 aggregate principal amount of convertible debentures.  Subject to the Company’s satisfaction of theconditions set forth in the securities purchase agreement, as amended, theinvestors are required to purchase the remaining $1,600,000 in aggregateprincipal amount of such debentures at the final closing, which is to occur onor before the fifth trading day after the effective date of the registrationstatement. The Company is currently in default under the Securities PurchaseAgreement, the previously issued debentures and related registration rightsagreement and therefore the conditions of the Securities Purchase Agreementwill not be satisfied or otherwise met on a timely basis.  Consequently, there are no assurances thatthe investors will purchase all or any portion of the remaining $1,600,000aggregate principal amount of debentures. The securities purchase agreementprovides that the $1,000,000 aggregate principal amount of debentures issued onOctober 28, 2004 and the $400,000 aggregate principal amount of debenturesissued January 26, 2005 are due and payable in accordance with theiroriginal terms in full three (3) years after issuance and do not bearinterest. The $1,600,000 aggregate principal amount of debentures, or portionthereof, which may be issued at the final closing will be due and payable infull three (3) years after the date of their issuance, and will not bearinterest. The aggregate cash purchase price for the debentures will be$3,000,000, which is equal to the full face amount of the debentures. At anytime from the closing date until the maturity date of the debentures, thepurchasers have the right to convert the debentures, in whole or in part, intocommon stock at the then effective conversion price. The conversion price forthe previously issued $1,400,000 aggregate principal amount of debentures is$0.90 but is subject to adjustment if either (1) 75% of the average of thedaily volume weighted average price of the Company’s common stock for the five (5) consecutivetrading days preceding the date that the registration statement is declaredeffective by the SEC or (2) the daily volume weighted average price of thecommon stock on such date is less than $0.90 per share. In such event, theconversion price will be adjusted down to equal the lower of (1) the 75%average of the daily volume weighted average price of the common stock for thefive (5) consecutive days preceding the effective date of the registrationstatement or (2) the daily volume weighted average price of the commonstock on the effective date of the registration statement. The $1,600,000aggregate principal amount of debentures issuable at the final closing willhave a conversion price equal to the lesser of (1) $0.90, (2) the 75%average of the daily volume weighted average price of the common stock for thefive (5) consecutive days preceding the effective date of the registrationstatement of which this prospectus forms a part, or (3) the daily volumeweighted average price of the common stock on the effective date of theregistration statement. It is anticipated that the conversion price of thepreviously issued $1,400,000 aggregate principal amount of debentures, as wellas the conversion price of any remaining debentures issued by the Company, willbe adjusted and reduced below the current adjustment price of $0.90.

 

The debentures containcovenants that will limit the Company’s ability to, among other things: incuror guarantee additional indebtedness; incur or create liens; amend the Company’scertificate of incorporation, bylaws or other charter documents so as toadversely affect any rights of the holders of the debentures; and repay orrepurchase more than a de minimus number of shares of common stock other thanas permitted in the debentures and other documents executed with thepurchasers.

 

The debentures includecustomary default provisions and an event of default includes, among otherthings, a change of control of the Company, the sale of all or substantiallyall of the Company’s assets, the failure to have the registration statementdeclared effective on or before the 180th day after the initial closing date,and the lapse of the effectiveness of the registration statement for more than30 consecutive trading days during any 12-month period (with certainexceptions), the Company’s failure to timely deliver certificates to holdersupon conversion and a default by the Company in any obligations under anyindebtedness of at least $150,000 which results in such indebtedness beingaccelerated. Upon the

 

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occurrenceof an event of default, each debenture may become immediately due and payable,either automatically or by declaration of the holder of such debenture. Theaggregate amount payable upon an acceleration by reason of an event of defaultshall be equal to the greater of 130% of the principal amount of the debenturesto be prepaid or the principal amount of the debentures to be prepaid, dividedby the conversion price on the date specified in the debenture, multiplied bythe closing price on the date set forth in the debenture.

 

The Company is in defaultunder the provisions of the Securities Purchase Agreement; registration rightsagreement and previously issued debentures. The event of default now relates only to the Company’s inability to haveits registration statement declared effective. Although the Company intends to seek waivers or forbearance agreementsfrom the holders of its debentures, there is no assurance that the Company willreceive such concessions.  If the Companyis unable to obtain such concessions, the aggregate amount payable under theoutstanding debentures due to the acceleration thereof by reason of the defaultis equal to the “Mandatory Prepayment Amount” as specified in the debentures.

 

The Mandatory PrepaymentAmount equals the sum of (i) the greater of:  (a) 130% of the principal amount of thedebentures to be prepaid, or (b) the principal amount of the debentures tobe prepaid, divided by the conversion price on (x) the date the payment isdemanded or otherwise due, or (y) the date the payment is paid in full,whichever is less, multiplied by the closing price of the Company’s commonstock on (x) the date the payment is demanded or otherwise due, or(y) the date the payment is paid in full, whichever is greater, and (ii) allother amounts, costs, expenses and liquidated damages due in respect of thedebentures.  In addition to theforegoing, pursuant to the terms of the registration rights agreement, theCompany is required to pay each holder of the debentures liquidated damagessince the registration statement was not declared effective on or before February 25,2005.  The amount of liquidated damagesshall equal two percent (2%) of the aggregate purchase price paid by theholders for the debentures and shall be payable on each monthly anniversary ofsuch date until the registration statement is declared effective.

 

Concurrent with theissuance of the initial $1,000,000 aggregate principal amount of debentures datedOctober 28, 2004, the purchasers also received warrants to purchase anaggregate of up to 2,500,000 shares of common stock and additional investmentrights to purchase up to an additional $2,500,000 principal amount ofconvertible debentures.  Pursuant to theterms of the amendment to the securities purchase agreement, concurrent withthe issuance of the $400,000 aggregate principal amount of convertibledebentures, the Company issued additional warrants to purchase an aggregate ofup to 333,333 shares of its common stock. The warrants are exercisable at a price of $1.44 per share (subject toadjustment), for a period of five (5) years from October 28, 2004.The additional investment rights are exercisable at a price equal to theprincipal amount of the debentures to be purchased, for (1) a period ofnine months following the effective date of the registration statement, or (2) April 28,2006.

 

The debentures to bepurchased upon the exercise of the additional investment rights will have thesame terms as the debentures described above, except that the conversion pricewill be equal to $1.08 (subject to adjustment).

 

Each selling shareholderhas contractually agreed to restrict its ability to convert the debentures,exercise the warrants and additional investment rights and receive shares ofthe Company’s common stock such that the number of shares of common stock heldby them and their affiliates after such conversion or exercise does not exceed4.99% of the number of shares of the Company’s common stock outstandingimmediately after giving effect to such conversion or exercise.

 

In accordance withgenerally accepted accounting principles, the difference between the total costof the debentures on October 28, 2004 (the date of the securities purchaseagreement) and the total fair value of the common shares that will be receivedby the debenture holders at the time of conversion (which amount cannot bedetermined until the conversion price is established) will be reflected as adebt discount and amortized to stock based interest expense over the lesser ofthree years or the period of time the debentures are outstanding.  With respect to the warrants, the differencebetween the fair value of the

 

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shares of the Company’scommon stock on the date the respective warrants are issued and the amountdetermined by multiplying the exercise price of the warrants by the number ofshares issuable under the warrants will also be reflected as a debt discountand amortized to interest expense over the lesser of five years or the periodof time the warrants are outstanding. Similar treatment will be accorded to benefits accruing to the debentureholders as a result of any purchase of the additional investment rights discussedabove.

 

On April 5, 2005,the Company received a bridge loan in the amount of $251,000.  This bridge loan is due and payable on thesooner of August 15, 2005 or one business day following the closing of theCompany’s sale and issuance of the $1,600,000 aggregate principal amount ofdebentures.  The Company expects to useproceeds from the sale and issuance of such debentures to repay such bridgeloan.  The bridge loan bears interest ata rate of 10% per annum which, at the holder’s option, may be paid in (a) cash,or (b) that number of shares of the Company’s common stock determined bydividing $251,000 by the common stock price on date of payment and multiplyingthe quotient so obtained by 20%.

 

On May 31, 2005, theCompany received an Officer Advance in the amount of $55,000.  This advance is in the form of a short-termNote Payable, to the Officer, and is payable on June 30, 2005, and bearsinterest at a rate of 6 % per annum until paid.

 

On June 3, 2005, theCompany received an Officer Advance in the amount of $50,000.  This advance is in the form of a short-termNote Payable, to the Officer, and is payable on June 30, 2005, and bearsinterest at a rate of 6 % per annum until paid.

 

On June 17, 2005,the Company received a bridge loan in the amount of $396,500.  This bridge loan is in the form of apromissory note, payable on the sooner of August 15, 2005, or on the fifthday following the effective date of the Company’s registration statement on Form SB-2.  The note is secured by a Stock Pledge Agreement,entered into on June 17, 2005, by the CEO of Power3, wherein the Pledgeragreed to pledge 6,000,000 shares of common stock as security for theperformance of the Company under the note.

 

Plan of Operationsand Cash Requirements

 

The Company currently doesnot have operating revenues from product sales or the performance of servicesand it continues to experience net operating losses.  The Company is actively pursuing third partylicensing agreements, collaboration agreements and similar business arrangementsin order to establish a revenue base utilizing its capabilities in diseasediagnosis based on protein and biomarker identification, and drug resistance inthe areas of cancers, neurodegenerative and neuromuscular diseases.  The Company has undertaken clinicalvalidation studies to demonstrate the diagnostic capabilities of itstechnologies. However, there can be no assurances that revenue-generatingagreements will be in place in the next twelve months.

 

Absent a source ofrevenues, the Company will require funding in order to carry out its businessplan until such time as it is able to generate sustained revenues.  The Company’s current cash requirements areapproximately $250,000 per month and the Company anticipates that it willrequire approximately $3,500,000 for the twelve months ended March 31,2006 to continue its development activities, undertake and perform clinicalvalidation studies, continue its marketing efforts and maintain itsadministrative infrastructure, broken down as follows:

 

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Estimated Expenditures RequiredDuring Next Twelve Months

 
| General and  Administrative               |   | $      | 2,550,000 |   |
|-------------------------------------------|--------|--------|-----------|--------|
| Capital  Expenditures                     |   | $      | 400,000   |   |
| Patent filings  and intellectual property |   | $      | 200,000   |   |
| NAF clinical  validation studies          |   | $      | 350,000   |   |
|                                      |   |   |      |
| Total                                     |   | $      | 3,500,000 |   |

 

The foregoing is based upon the Company’s currentestimated cash requirements.  Theresolution of the Company’s current dispute with Advanced BioChem regarding theliabilities assumed by the Company in the parties’ transaction may result in anincrease in the Company’s liabilities and cash requirements. The Company has nosignificant capital expenditure requirements and does not plan to increase itsmonthly expenditure rate absent an increase in revenues or additional funding.

 

As noted in “RecentFinancing” above, the Company entered into a securities purchase agreement andan amendment to the securities purchase agreement pursuant to which certaininvestors agreed to purchase, subject to the satisfaction of certainconditions, convertible debentures in the aggregate principal amount of$3,000,000.

 

The securities purchaseagreement, as amended, also provides for the issuance of warrants to purchaseshares of the Company’s common stock and additional investment rights topurchase additional convertible debentures. On the initial closing under thesecurities purchase agreement, which was effective as of October 28, 2004,the investors purchased the first $1,000,000 in aggregate principal amount ofthe convertible debentures of which the Company received approximately $860,000after payment of fees and expenses. Pursuant to the securities purchase agreement, as amended, certaininvestors have purchased an additional $400,000 aggregate principal amount of convertibledebentures on January 26, 2005. Subject to the Company’s satisfaction of the conditions set forth in thesecurities purchase agreement (which includes the effectiveness of theregistration statement), the investors are required to purchase the remaining$1,600,000 in aggregate principal amount of such convertible debentures on orbefore the fifth trading day after the effective date of the registrationstatement. The Company is currently in default under the Securities PurchaseAgreement, the previously issued debentures and related registration rightsagreement and therefore the conditions of the Securities Purchase Agreementwill not be satisfied or otherwise met on a timely basis.  Consequently, there are no assurances thatthe investors will purchase all or any portion of the remaining $1,600,000aggregate principal amount of debentures.

 

Assuming the completion of the remaining closing andsale and issuance of the remaining $1,600,000 in aggregate principal amount ofthe convertible debentures, the Company estimates that, after repayment of thebridge note of $251,000 immediately following the sale and issuance of suchdebentures, the Company will have adequate cash to allow it to meet its currentfunding requirements through the third quarter of 2005.  In the event the sale and issuance of suchdebentures occurs and the investors exercise their warrants and additionalinvestment rights, the Company anticipates it will have adequate cash to meetits current funding requirements through the first quarter of 2007. Theforegoing is based upon current estimated cash requirements and may be affectedby the Company’s current dispute with Advanced BioChem regarding theliabilities assumed under the May 2004 transaction.

 

In addition to theconvertible debentures, the Company also issued warrants to purchase up to2,500,000 shares of common stock, with an exercise price equal to $1.44.  The Company issued additional warrants topurchase up to 333,333 shares of common stock concurrent with its issuance ofthe $400,000 aggregate principal amount of debentures.  Full exercise of the warrants would generatefunds in excess of $4,000,000.  TheCompany also issued additional investment rights, which give the investors theright to purchase up to an aggregate of $2,500,000 of convertible debentureswith a conversion price of $1.08.

 

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However, the exercise ofthese warrants and additional investment rights is at the discretion of thepurchasers and there are no assurances that the purchasers will exercise theirrights under such securities.

 

The Company will continue to require additional debtor equity financing for its operations, which may not be readilyavailable.  The Company’s ability tocontinue as a going concern is subject to its ability to generate a profit orobtain necessary funding from outside sources. If the Company is successful incompleting the sale and issuance of the remaining $1,600,000 aggregateprincipal amount of debentures, of which no assurances can be given due to theCompany’s default under the Securities Purchase Agreement and relateddocuments, management believes that the net funds available, after repayment ofthe bridge note of $251,000 immediately following the sale and issuance of suchdebentures, will provide adequate cash to allow the Company to meet its fundingrequirements through the third quarter of 2005. In the event the final closing and sale of $1,600,000 in aggregateprincipal amount of debentures occurs but the warrants and additionalinvestment rights are not exercised, the Company anticipates that it will needto raise additional capital prior to October 2005 to meet its operatingcosts. The foregoing projections are based upon current estimated cashrequirements and may be affected by the Company’s current dispute with AdvancedBioChem.  In addition to theuncertainties resulting from the Company’s dispute with Advanced BioChem, theCompany’s actual results may differ materially from these estimates, and noassurance can be given that additional funding will not be required sooner thananticipated or that such additional funding will be available when needed or onterms acceptable to the Company. Insufficient funding will require the Company to curtail or terminateoperations.

 

Off-Balance SheetArrangements

 

At June 30, 2005,with the exception of the lease for its operating facility, and employmentagreements entered with its two principal officers, the Company did not haveany significant off balance sheet commitments.

 

CriticalAccounting Policies

 

In accordance with theEmerging Issues Task Force (EITF) Issue 98-5, the Company allocates theproceeds received from convertible instruments to the instrument, and to theintrinsic value, if any, of the imbedded conversion option.  Under this approach, the proceeds received inthe financing transaction are allocated to the convertible instrument and anydetachable instruments on a fair value basis. The Issue 98-5 model is thenapplied to the amount allocated to convertible instrument and the intrinsicvalue of the embedded conversion option is then measured.

 

The Company accounts forequity instruments issued to employees for services based on the intrinsicvalue of the equity instruments issued. Equity instruments issued to non-employees that are fully vested andnon-forfeitable are measured at fair value at the issuance date and expensed inthe period over which the benefit is expected to be received.

 

The Company has adoptedStatement of Financial Accounting Standards No. 148 “Accounting forStock-Based Compensation - Transition and Disclosure” (SFAS No. 148). Thisstatement amends FASB statement No. 123, “Accounting for Stock BasedCompensation”. It provides alternative methods of transition for an entity thatvoluntarily changes to the fair value based method of accounting for employeestock based compensation. It also amends the disclosure provision of FASBstatement No. 123 to require prominent disclosure about the effects onreported net income of an entity’s accounting policy decisions with respect tostock-based employee compensation. As permitted by SFAS No. 123 andamended by SFAS No. 148, the Company continues to apply the intrinsicvalue method under Accounting Principles Board (“APB”) Opinion No. 25, “Accountingfor Stock Issued to Employees,” to account for its stock-based employeecompensation arrangements.

 

In December 2004,the Financial Accounting Standards Board issued Statement Number 123 (“FAS 123 (R)”),Share-Based Payments. FAS 123 (R) requires all entities to recognize compensationexpense in an amount equal to the fair value of share-based payments such asstock options granted to

 

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employees.  The Company will be required to applyFAS 123 (R) on a modified prospective method.  Under this method, the Company will berequired to record compensation expense (as previous awards continue to vest)for the unvested portion of previously granted awards that remain outstandingat the date of adoption.  In addition,the Company may elect to adopt FAS 123 (R) by restating previouslyissued financial statements, basing the amounts on the expense previouslycalculated and reported in the pro forma disclosures that had been required byFAS 123, FAS 123 (R) is effective for the first reporting periodbeginning after June 15, 2005.  TheCompany has not yet determined the impact that FAS 123 (R) will haveon its financial statements; however, it does not believe the impact ofadopting this Statement will be material as there are no unvested options andwarrants at June 30, 2005.

 

On May 18, 2004,Power3 executed an Asset Purchase Agreement with Advanced BioChem, doingbusiness as ProteEx.  In the transaction,Power3 purchased substantially all of the assets and intellectual properties ofAdvanced BioChem and assumed certain liabilities in exchange for the issuanceof 15,000,000 shares of its common stock pursuant to an Asset PurchaseAgreement.  For financial statementpurposes, the transaction had previously been accounted for as arecapitalization, as in a reverse acquisition. After review, the Company has concluded that a more appropriatecharacterization of the transaction would be purchase accounting.  Power3 has now completed a recharacterizationof the transaction as purchase accounting and has produced revised financialstatements for the quarterly periods ending June 30, 2004; September 30,2004 and for the 1st Quarter of 2005, ending March 31,2005.  The Company, and its auditors, are in complete agreement as to the accounting treatment ofpurchase accounting as the appropriate treatment to account for its acquisitionof a set of assets and a certain set of liabilities of Advanced BioChem on May 18,2004.

 

*Item 3.**CONTROLS AND PROCEDURES*

 

Under the supervision andwith the participation of the Company’s management, including its ChiefExecutive Officer and Chief Accounting Officer, the Company conducted anevaluation of its disclosure controls and procedures (as defined in Rules 13a-15(e) and15d-15(e) of the Exchange Act). Based on this evaluation and for the reasons set forth below, the ChiefExecutive Officer and Chief Financial Officer concluded that the Company’sdisclosure controls and procedures were ineffective as of June 30, 2005,the end of the period covered by this report.

 

Management has identifiedcertain deficiencies which have caused it to conclude that the Company’sdisclosure controls are ineffective. Many of these deficiencies were previously reported in the Company’sQuarterly Report on Form 10-QSB for the quarterly period ended September 30,2004. The Company has undertaken steps and implementedactions as disclosed in its previous Form 10-QSB in an effort to resolvethese deficiencies.  While theactions identified in the previously filed Form 10-QSB and the actionsidentified below have addressed many of these deficiencies, the Companycontinued to have deficiencies with respect to its disclosure controls andprocedures at March 31, 2005 including the following:

 

•      Aspreviously reported, the Company’s delay in filing its Form 10-KSB for2004, was caused by its inability to include the audit report of AdvancedBioChem’s previous auditor in the Company’s 2004 Form 10-KSB.  The Company has also encountered deficienciesarising from a lack of supporting documentation and records relating to periodsprior to the Advanced BioChem transaction and a lack of communication betweenthe Company, its auditors and the previous auditors of Advanced BioChem.  The lack of this supporting documentation andfailure either to obtain the prior auditor’s consent or make alternativearrangements for the 2003 Advanced BioChem audit report had previously resultedin the Company’s inability to file its Annual Report on Form 10-KSB. TheCompany has resolved its previously describeddifficulties and will be filing its 10-KSB for 2004, concurrent with otheramended 10-QSB’s immediately thereafter. Subsequently the Company’s efforts will be focused on filing its SB-2 assoon as possible.

 

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•      Althoughthe Company has hired accounting personnel as reported in its previous Form 10-QSB,the Company’s limited financing and available capital have restricted theCompany’s ability to fully implement its procedures for the improvement of itsinternal control over financial reporting and to engage outside professionalsand advisors to the extent the Company has desired to support the Company’saccounting personnel in the preparation and/or audit of financial statementsand reports to be filed with the SEC.

 

•      TheCompany continues to face unexpected issues relating to the integration of theAdvanced BioChem transaction such as the dispute described in this quarterlyreport and such issues have caused the Company’s accounting personnel to devotesignificant and unanticipated time and attention to these matters.

 

The Company continues to believe that the deficienciesare attributable to many factors including issues relating to the quality ofthe Company’s disclosure controls and procedures at the time of the AdvancedBioChem transaction and the transition following the transaction.  Management is committed to a sound disclosurecontrol and internal control environment and is continuing its efforts to improvethe Company’s infrastructure, personnel, processes and controls to help ensurethat the Company is able to produce accurate financial statements on a timelybasis.

 

*Changesin Internal Control Over Financial Reporting*

* *

During the firstquarter of 2005, the Company continued the implementation of more rigorouspolicies with respect to its disclosure and financial reporting review processincluding improvements of its infrastructure and processes to improve itsinternal control over financial reporting. The Company also is continuing its implementation of procedures toimprove its review and processing of non-accounting documentation andcontracts.  Other than the changesdescribed above, there were no changes in the Company’s internal control overfinancial reporting that occurred during the three months ended March 31,2005 that have materially affected, or are reasonably likely to materiallyaffect, the Company’s internal controls over financial reporting.

 

OnJune 3, 2005, Mr. Michael Rosinski, Chief Financial Officer ofPower3, resigned and terminated his employment at the Company as of thatdate.  In accordance with hisresignation, the employment agreement with Mr. Rosinski is terminated on June 5,2005, and the stock grant of 140,000 shares of Restricted Stock to Mr. Rosinskiis terminated.  The stock shares coveredin this agreement have been returned to the Company.  On June 3, 2005, the Company named JohnP. Burton as its Chief Accounting Officer and Controller.

 

# **PART II.** OTHER INFORMATION

 

Item 1.Legal Proceedings

 

In November 2004,Chapman Spira & Carson, LLC (“Chapman Spira”) filed a lawsuit in theSupreme Court of the State of New York for the County of New York againstAdvanced BioChem, Power3 and Steven Rash. The suit alleges that Advanced BioChem and Power3 are liable to ChapmanSpira for damages alledgedly resulting from the breachof a letter agreement between Chapman Spira and Advanced BioChem relating tothe performance of strategic and investment banking services.  The suit further alleges that Mr. Rashmade false statements regarding the performance of services by ChapmanSpira.  Chapman Spira is seeking damagesin the amount of $1,522,000 plus interest. The Company has filed an answer in the lawsuit.  The Company believes that Chapman Spira’sclaims are without merit; however, the Company does not know if it willultimately prevail or if the outcome of the action will adversely affect theCompany’s business, financial position or results of operations.

 

An equipment vendor fileda complaint against Advanced BioChem in April of 2002 in a Californiacourt alleging breach of contract and seeking damages. Advanced BioChem reacheda settlement agreement in

 

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April of2003 under which they would pay the vendor $40,000 in installments through August of2003.  AdvancedBioChem recorded a settlement cost of $40,000 in 2002 general andadministrative expenses. At December 31, 2003, Advanced BioChem had abalance remaining of $20,000. In April 2005 the equipment vendor filed alawsuit against Advanced BioChem, certain former officers of Advanced BioChemand the Company in order to enforce its claim for the remaining balance whichis past due and may be assumed by the Company as part of the settlement of thedispute with Advanced BioChem.

 

In June, 2005, CharlesCaudle et al, filed a lawsuit in Harris County, Texas, against AdvancedBioChem, Power3 and the officers and directors of both companies.  The suit alleges that Advanced BioChem,Power3 and the officers and directors of both companies, are liable to CharlesCaudle et al for damages resulting from funds loaned to Advanced BioChem andwhich were subsequently converted into common stock of Advanced BioChem.  It is unclear as to the specific dollaramount of the claim.  The Company, andits officers and directors, has filed an answer denying all claims in thelawsuit.  The Company believes thatCharles Caudle et al’s claims are without merit,however the Company does not know if it will ultimately prevail or if theoutcome of the action will adversely affect the Company’s business, financialposition or results of operations.

 

Item 2.Unregistered Sale of Equity Securities and use of Proceeds

 

(a)     Not applicable.

 

(b)     Under the termsof the $400,000 aggregate principal amount of convertible debentures issued bythe Company as of January 26, 2005, as well as the terms of the $1,000,000aggregate principal amount of convertible debentures issued by the Company asof October 28, 2004, the Company is prohibited from taking certain actionswithout the approval of the holders of a two-thirds majority of thethen-outstanding principal amount of the debentures.  Specifically, the Company has agreed not to,and not to permit its subsidiary to, so long as any portion of the debenturesare outstanding, (1) amend it certificate of incorporation, bylaws orother charter documents so as to adversely affect any rights of the holders ofthe debentures, or (2) repurchase more than a de minimus number of sharesof its common stock or other equity securities other than as to the shares ofcommon stock issuable upon conversion of the debentures described above.

 

(c)     Not applicable.

 

(d)     Not applicable.

 

Item 3.Defaults Upon Senior Securities

 

The Company is in defaultunder the provisions of the Securities Purchase Agreement, registration rightsagreement and previously issued debentures. The events of default principally relate to the Company’s inability totimely file its Annual Report on Form 10-KSB and the Company’s resultinginability to have the registration statement declared effective within the timeperiod required by the agreements.  Aspreviously disclosed, the Company had been unable to file its 2004 AnnualReport on Form 10-KSB.  The Companyhas now correctly recharacterized the May 18, 2004 transaction withAdvanced BioChem as a purchase transaction, and is completing its revisedfinancial statements for 2004 and intends to file its Form 10-KSB for 2004as soon as possible.  In addition, theCompany will issue revised financial statements for the quarterly periods sincethe May 18, 2004 transaction, including the 1st Quarter, 2005.

 

Although the Companyintends to seek waivers or forbearance agreements from the holders of itsdebentures, there is no assurance that the Company will receive such concessions.  If the Company is unable to obtain suchconcessions, the aggregate amount payable under the outstanding debentures dueto the acceleration thereof by reason of the default is equal to the “MandatoryPrepayment Amount” as specified in the debentures.  The Mandatory Prepayment Amount equals thesum of (i) the greater of:  (a) 130%of the principal amount of the debentures to be prepaid, or (b) theprincipal amount of the debentures to be prepaid, divided by the conversionprice on (x) the date the payment is demanded or

 

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otherwise due, or(y) the date the payment is paid in full, whichever is less, multiplied bythe closing price of the Company’s common stock on (x) the date thepayment is demanded or otherwise due, or (y) the date the payment is paidin full, whichever is greater, and (ii) all other amounts, costs, expensesand liquidated damages due in respect of the debentures.  In addition to the foregoing, pursuant to theterms of the registration rights agreement, the Company is required to pay eachholder of the debentures liquidated damages since the registration statementwas not declared effective on or before February 25, 2005.  The amount of liquidated damages shall equaltwo percent (2%) of the aggregate purchase price paid by the holders for thedebentures and shall be payable on each monthly anniversary of such date untilthe registration statement is declared effective.  The Company has received notice from one ofthe purchasers of the debentures informing the Company that it is in defaultunder the debentures and demanding payment of the Mandatory Prepayment Amount,together with the liquidated damages, to which it is entitled pursuant to theagreement.

 

The Company intends tofile its registration statement, for the common shares associated with theconvertible debentures, as soon as possible. Promptly thereafter, the Company intends to file an amendment to itspreviously filed registration statement and will endeavor to have it declaredeffective as soon as practicable.  TheCompany is in discussion with its debenture holders regarding a resolution ofthis matter.

 

Item 4.Submission of Matters to a Vote of Security Holders

 

No matters were submittedto the security holders for a vote during the quarter ended March 31,2004.

 

Item 5.Other Information

 

None

 

Item6.  Exhibits

 
| **EXHIBIT NO.** | ** ** | **DESCRIPTION**                                                                               |
|----------------------|------------|-----------------------------------------------------------------------------------------------|
| ** **           | ** ** | ** **                                                                                    |
| 10.1(1)              |       | Promissory Note to Cordillera Fund L.P., in the amount of $251,000,  dated April 5, 2005 |
|                 |       |                                                                                          |
| 10.2(1)              |       | Promissory Note to Steven B. Rash, in the amount of $55,000,dated  May 31, 2005          |
|                 |       |                                                                                          |
| 10.3(1)              |       | Promissory Note to Dr. Ira Goldknopf, in the amount of $50,000  dated June 3, 2005  |
|                 |       |                                                                                          |
| 10.4(1)              |       | Promissory Note  to John Fife in the amount of $396,500.00, dated June 13, 2005          |
|                 |       |                                                                                          |
| 31.1*                |       | Certification                                                                                 |
|                 |       |                                                                                          |
| 31.2*                |       | Certification                                                                                 |
|                 |       |                                                                                          |
| 32.1**               |       | Certification Pursuant to Section 906                                                    |
|                 |       |                                                                                          |
| 32.2**               |       | Certification Pursuant to Section 906                                                    |

 

----

    *Filed with this report.

  **Furnishedwith this report.

 

(1) Filed with this report

 

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**SIGNATURES**

 

Pursuant to the requirements of the SecuritiesExchange Act of 1934, the registrant has duly caused this report to be signedon its behalf by the undersigned thereunto duly authorized.

 
| Power3  Medical Products, Inc. (Registrant) |
|--------------------------------------------------|
|                                             |
|                                             |   |
| Date:  August 19, 2005                      | By: | s/s Steven B.  Rash |   |
|                                             | Steven B. Rash |
|                                             | Chairman and  Chief Executive Officer |

 

 

Pursuant to the requirements of the Exchange Act, thisreport has been signed by the following persons in the capacities and on thedates indicated.

 
| **Signature**       | ** ** | **Title**                 | ** ** | **Date**              |
|---------------------|------------|---------------------------|------------|-----------------------|
|                |       |                      |       |                  |
| /s/ Steven B.  Rash |       | Chairman and              |       | August 19,  2005 |
| Steven B. Rash      |       | Chief Executive  Officer  |       |                  |
|                |       |                      |       |                  |
|                |       |                      |       |                  |
| /s/ John P.  Burton |       | Chief Accounting  Officer |       | August 19,  2005 |
| John P. Burton      |       | and Controller            |       |                  |

 

 

**EXHIBIT INDEX**

 
| **EXHIBIT NO.** | ** ** | **DESCRIPTION**                                                                               |
|----------------------|------------|-----------------------------------------------------------------------------------------------|
|                 |       |                                                                                          |
| 10.1(1)              |       | Promissory Note to Cordillera Fund, L.P. in the amount of $251,000,  dated April 5, 2005 |
|                 |       |                                                                                          |
| 10.2(1)              |       | Promissory Note to Steven B. Rash, in the amount of $55,000, dated  May 31, 2005         |
|                 |       |                                                                                          |
| 10.3(1)              |       | Promissory Note to Dr. Ira Goldknopf, in the amount of $50,000,  dated June 3, 2005 |
|                 |       |                                                                                          |
| 10.4(1)              |       | Promissory Note  to John Fife, in the amount of $396,500, dated June 13, 2005            |
|                 |       |                                                                                          |
| 31.1*                |       | Certification                                                                                 |
|                 |       |                                                                                          |
| 31.2*                |       | Certification                                                                                 |
|                 |       |                                                                                          |
| 32.1**               |       | Certification Pursuant to Section 906                                                    |
|                 |       |                                                                                          |
| 32.2**               |       | Certification Pursuant to Section 906                                                    |

 

----

    *Filedwith this report.

  **Furnished with this report.

 

(1) Filed with this report

 

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