**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 September 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**                                                                                                                                                                                                                                                                                                                                                    | ** ** |

 

**Power3 Medical Products, Inc.**

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

 
| **New York**                     | ** ** | **65-0565144**       |
|----------------------------------|------------|----------------------|
| (State or other  jurisdiction of |       | (I.R.S. Employer     |
| incorporation or  organization)  |       | 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 wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days. Yes  o  No  ý

 

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

 

As of September 30, 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                                                              |   |

 

2

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**RECENT DEVELOPMENTS**

 

*Scientific Developments – PfizerResearch Agreement*

 

On October 13, 2005, Power3 Medical Products, Inc. (“Power3”and “the Company”) executed a Research Agreement with Pfizer, Inc. tofurther evaluate the Company’s NuroProTM test capabilities and to test blind andunblended samples provided by Pfizer, under controlled conditions.

 

*MarketInformation*

 

On June 16, 2005, due to the Company’s continued failure to fileits Form 10-KSB for the year ended December 31, 2004, quotation ofPower3’s shares on the Over-the-Counter Bulletin Board (OTC BB) was suspended.The Company’s shares are currently quoted on the Pink Sheets.

 

On September 9,2005, the Company filed its Form 10-KSB for the year ended December 31,2004. The Company has been informed that a Form 211 application has beenfiled in order to resume quotation of the Company’s shares on the on the OTCBB.

 

*Legal Proceedings - Discontinuance of Lawsuit*

 

**On August 8, 2005,Industrial Enterprises of America, formerly Advanced BioChem, filed suit in theSupreme Court of the State of New York, New York County against Power3, StevenB. Rash and Ira Goldknopf claiming damages of at least $3,000,000. In thisaction, Advanced BioChem has asserted that Power3, Steven Rash and IraGoldknopf are responsible for all of the liabilities of Advanced BioChem, atthe date of the asset purchase transaction on May 18, 2004. On October 25,2005, this action was discontinued without prejudice by the Plaintiff,Industrial Enterprises of America.**

** **

***Appointment of ChiefFinancial Officer***

** **

On September 15,2005 the Company named John P. Burton as Chief Financial Officer, according toan Employment Agreement effective as of that date.

 

3

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**I.  FINANCIAL INFORMATION**

 

**Item 1.Financial Statements**

** **

**POWER3 MEDICAL PRODUCTS,INC. **

**(A Development Stage Enterprise)**

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

**(unaudited)**

 
| **ASSETS**                                                                                              |   |        |      |
|---------------------------------------------------------------------------------------------------------|--------|-------------|-----------|
| CURRENT ASSETS                                                                                          |   |        |      |
| Cash and cash  equivalents                                                                              |   | $           | 36,733    |   |
| All Other  Current Assets                                                                               |   | 15,509      |      |
| Total Current Assets                                                                                    |   | 52,242      |      |
| FIXED ASSETS                                                                                            |   |        |      |
| Furniture,  Fixtures and Equipment (Net of accumulated depreciation of $58,566)                         |   | 77,854      |      |
| Intellectual  Property                                                                                  |   | 267,774     |      |
| Total Fixed Assets                                                                                      |   | 345,628     |      |
| OTHER ASSETS                                                                                            |   |        |      |
| Debt Issuance  Cost (net of amortization of $14,590)                                                    |   | 37,243      |      |
| Deposits                                                                                                |   | 25,900      |      |
| Total Other Assets                                                                                      |   | 63,143      |      |
|                                                                                                    |   |        |      |
| **TOTAL  ASSETS**                                                                                       |   | $           | 461,013   |   |
|                                                                                                    |   |        |      |
| **LIABILITIES  AND STOCKHOLDER’S DEFICIT**                                                         |   |        |      |
| CURRENT  LIABILITIES                                                                                    |   |        |      |
| Accounts Payable  and accrued liabilities                                                               |   | $           | 1,015,982 |   |
| Note Payable                                                                                            |   | 1,138,150   |      |
| Other Current  Liabilities                                                                              |   | 426,524     |      |
| Total Current Liabilities                                                                               |   | 2,580,656   |      |
| LONG TERM  LIABILITIES                                                                                  |   |        |      |
| Convertible  Debentures                                                                                 |   | 1,400,000   |      |
| Accrued Interest  on Issued Debentures                                                                  |   | (1,005,554  | )         |
| Total Long Term Liabilities                                                                             |   | 394,446     |      |
|                                                                                                    |   |        |      |
| TOTAL  LIABILITIES                                                                                      |   | $           | 2,975,102 |   |
|                                                                                                    |   |        |      |
| STOCKHOLDER’S  DEFICIT                                                                             |   |        |      |
| Common Stock-$0.001  par value:150,000,000 shares authorized; 65,345,121 shares issued and  outstanding |   | 65,345      |      |
| Additional  Paid-In Capital                                                                             |   | 63,252,246  |      |
| Deferred  Compensation                                                                                  |   | (7,968,043  | )         |
| Deficit  accumulated before entering development stage                                                  |   | (11,681,500 | )         |
| Deficit accumulated during development stage                                                            |   | (46,182,137 | )         |
| Total  Stockholder’s Deficit                                                                       |   | (2,514,089  | )         |
| **TOTAL  LIABILITIES AND STOCKHOLDERS DEFICIT**                                                         |   | $           | 461,013   |   |

 

See notes to thecondensed financial statements.

 

4

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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 Nine**             | ** ** | **For the Nine**             | ** ** | **Development Stage**        | ** ** |
|-----------------------------------------------|------------|------------------------------|------------|------------------------------|------------|------------------------------|------------|------------------------------|------------|------------------------------|------------|
| ** **                                    | ** ** | **Months Ended**             | ** ** | **Months Ended**             | ** ** | **Months Ended**             | ** ** | **Months Ended**             | ** ** | **May 18, 2004 thru**   | ** ** |
| ** **                                    | ** ** | **September 30,  2005** | ** ** | **September 30,  2004** | ** ** | **September 30,  2005** | ** ** | **September 30,  2004** | ** ** | **September 30,  2005** | ** ** |
|                                          |       |                         |       |                         |       |                         |       |                         |       |                         |       |
| REVENUES                                      |       |                         |       |                         |       |                         |       | 25,091                       |       | 4,000                        |       |
|                                          |       |                         |       |                         |       |                         |       |                         |       |                         |       |
| COST OF GOODS SOLD                            |       |                         |       |                         |       |                         |       | 10,423                       |       |                         |       |
|                                          |       |                         |       |                         |       |                         |       |                         |       |                         |       |
| GROSS PROFIT                                  |       |                         |       |                         |       |                         |       | 14,667                       |       | 4,000                        |       |
|                                          |       |                         |       |                         |       |                         |       |                         |       |                         |       |
| OPERATING EXPENSES                            |       |                         |       |                         |       |                         |       |                         |       |                         |       |
|                                          |       |                         |       |                         |       |                         |       |                         |       |                         |       |
| Stock based compensation                      |       | 2,850,837                    |       | 1,717,600                    |       | 9,948,545                    |       | 9,052,649                    |       | 18,163,786                   |       |
|                                          |       |                         |       |                         |       |                         |       |                         |       |                         |       |
| Consulting Fees                               |       | 2,887                        |       | (455,633                     | )          | 103,262                      |       | 3,302,465                    |       | 7,235,002                    |       |
| Other operating expenses                      |       | 535,189                      |       | 362,397                      |       | 2,071,506                    |       | 376,742                      |       | 3,518,873                    |       |
|                                          |       |                         |       |                         |       |                         |       |                         |       |                         |       |
| Total Operating Expenses                      |       | 3,388,913                    |       | 1,624,364                    |       | 12,123,313                   |       | 12,731,856                   |       | 28,917,661                   |       |
|                                          |       |                         |       |                         |       |                         |       |                         |       |                         |       |
| LOSS FROM OPERATIONS                          |       | (3,388,913                   | )          |                         |       | (12,123,313                  | )          | (12,717,189                  | )          | (28,913,661                  | )          |
|                                          |       |                         |       |                         |       |                         |       |                         |       |                         |       |
| Interest and Financing Expense                |       | (237,364                     | )          |                         |       | (460,112                     | )          | (2,752                       | )          | (517,200                     | )          |
|                                          |       |                         |       |                         |       |                         |       |                         |       |                         |       |
| Other Income and Expense                      |       |                         |       |                         |       | 259                          |       |                         |       | 1,474                        |       |
|                                          |       |                         |       |                         |       |                         |       |                         |       |                         |       |
| NET LOSS                                      |       | (3,626,277                   | )          | (1,624,364                   | )          | (12,583,166                  | )          | (12,719,941                  | )          | (29,429,387                  | )          |
|                                          |       |                         |       |                         |       |                         |       |                         |       |                         |       |
| NET LOSS PER SHARE (basic and diluted)        |       | (0.06                        | )          | (0.05                        | )          | (0.19                        | )          | (0.37                        | )          | (0.46                        | )          |
|                                          |       |                         |       |                         |       |                         |       |                         |       |                         |       |
|                                          |       |                         |       |                         |       |                         |       |                         |       |                         |       |
| Weighted average number of shares outstanding |       | 65,289,640                   |       | 34,761,018                   |       | 65,289,640                   |       | 34,761,018                   |       | 64,126,503                   |       |

 

See notes to condensed financial statements.

 

5

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**POWER 3 MEDICAL PRODUCTS, INC**

**(A Development Stage Enterprise)**

**CONDENSED STATEMENTS OF CASHFLOWS**

**(unaudited)**

 
| ** **                                                                  | ** ** | ** **                   | ** ** | ** **                   | ** ** | **Development**              | ** ** |
|-----------------------------------------------------------------------------|------------|------------------------------|------------|------------------------------|------------|------------------------------|------------|
| ** **                                                                  | ** ** | **For the Nine**             | ** ** | **For the Nine**             | ** ** | **Stage Results**            | ** ** |
| ** **                                                                  | ** ** | **Months Ended**             | ** ** | **Months Ended**             | ** ** | **May 18, 2004 -**      | ** ** |
| ** **                                                                  | ** ** | **September 30,  2005** | ** ** | **September 30,  2004** | ** ** | **September 30,  2005** | ** ** |
| Operating  Activities:                                                      |       |                         |       |                         |       |                         |       |
| Net  Loss                                                                   |       | (12,583,166                  | )          | (12,719,941                  | )          | (29,429,387                  | )          |
| Adjustment to  reconcile net loss to net cash used in operating activities: |       |                         |       |                         |       |                         |       |
| Stock  based services and compensation                                      |       | 9,948,545                    |       | 12,355,114                   |       | 25,104,033                   |       |
| Stock  issued to retire preferred stock and debt                            |       |                         |       |                         |       | 4,236                        |       |
| Depreciation  and amortization                                              |       | 29,106                       |       | 212,677                      |       | 256,567                      |       |
| Decrease(increase)  in receivables                                          |       | 2,350                        |       | (2,244                       | )          |                         |       |
| Decrease(increase)  in deposits                                             |       |                         |       |                         |       | (25,900                      | )          |
| Decrease(increase)  in prepaids                                             |       | (11,157                      | )          |                         |       | (15,509                      | )          |
| Decrease(increase)  in inventory                                            |       |                         |       |                         |       |                         |       |
| Decrease(increase)  in intellectual property                                |       | (120,975                     | )          |                         |       | (120,975                     | )          |
| Decrease(increase)in  debt issuance costs                                   |       | 93,859                       |       |                         |       | 93,859                       |       |
| Increase(decrease)  in accrued interest                                     |       | (61,110                      | )          |                         |       | (61,110                      | )          |
| Increase(decrease)  in accounts payable and accrued liabilities and other   |       | 678,465                      |       | (417,237                     | )          | 1,221,762                    |       |
|                                                                        |       |                         |       |                         |       |                         |       |
| Net  cash used in Operating Activities                                      |       | (2,024,083                   | )          | (571,631                     | )          | (2,972,424                   | )          |
|                                                                        |       |                         |       |                         |       |                         |       |
| INVESTING  ACTIVITIES                                                       |       |                         |       |                         |       |                         |       |
| Capital  expenditures, net                                                  |       | (6,934                       | )          | 100,404                      |       | (337,995                     | )          |
|                                                                        |       |                         |       |                         |       |                         |       |
| Net  cash used in Investing Activities                                      |       | (6,934                       | )          | 100,404                      |       | (337,995                     | )          |
|                                                                        |       |                         |       |                         |       |                         |       |
| FINANCING  ACTIVITIES                                                       |       |                         |       |                         |       |                         |       |
| Proceeds  from long term debt, net of issuance costs                        |       | 338,890                      |       | 134,722                      |       | 1,324,671                    |       |
| Proceeds  from short-term debt and shareholder advances                     |       | 1,570,078                    |       |                         |       | 1,570,078                    |       |
| Proceeds  from sale of common stock, net                                    |       |                         |       | 349,000                      |       | 449,807                      |       |
|                                                                        |       |                         |       |                         |       |                         |       |
| Net  cash provided by financing activities                                  |       | 1,908,968                    |       | 483,722                      |       | 3,344,556                    |       |
|                                                                        |       |                         |       |                         |       |                         |       |
| Net increase  (decrease) in cash and cash equivalents                       |       | (122,049                     | )          | 12,495                       |       | 34,137                       |       |
|                                                                        |       |                         |       |                         |       |                         |       |
| Cash and cash  equivalents, beginning of period                             |       | 158,782                      |       | 547                          |       | 2,596                        |       |
|                                                                        |       |                         |       |                         |       |                         |       |
| Cash and cash  equivalents, end of period                                   |       | 36,733                       |       | 13,041                       |       | 36,733                       |       |

 

6

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| ** **                                                                    | ** ** | **For the Nine  months ended  September 30,  2005** | ** ** | **For the Nine  months ended  September 30,  2004** | ** ** | **Cumulative  during  Development  Stage  (May 18, 2004 to  Sept. 30, 2005** | ** ** |
|-------------------------------------------------------------------------------|------------|----------------------------------------------------------|------------|----------------------------------------------------------|------------|-----------------------------------------------------------------------------------|------------|
|                                                                          |       |                                                     |       |                                                     |       |                                                                              |       |
| Cash paid for:                                                                |       |                                                     |       |                                                     |       |                                                                              |       |
| Interest                                                                      |       | 91,500                                                   |       | 0                                                        |       | 91,500                                                                            |       |
| Income taxes                                                                  |       | 0                                                        |       | 0                                                        |       | 0                                                                                 |       |
|                                                                          |       |                                                     |       |                                                     |       |                                                                              |       |
| Non-cash transactions:                                                        |       |                                                     |       |                                                     |       |                                                                              |       |
| Conversion of convertible notes payable and accrued  interest to common stock |       |                                                     |       |                                                     |       |                                                                              |       |
| Conversion of accrued payroll to preferred stock                              |       |                                                     |       |                                                     |       |                                                                              |       |
| Conversion of stockholder advances to notes payable                           |       |                                                     |       |                                                     |       | —                                                                            |       |
| Conversion of notes payable to equity                                         |       | —                                                   |       |                                                     |       |                                                                              |       |
| Conversion of preferred stock to common stock                                 |       |                                                     |       |                                                     |       |                                                                              |       |
| Conversion of other liabilities to stockholder advances                       |       |                                                     |       |                                                     |       |                                                                              |       |
| Exchange of convertible preferred stock for common  stock 3,000,324 shares    |       |                                                     |       |                                                     |       | 3,380,975                                                                         |       |
| Common stock issued for services (At market, date of  effective agreement):   |       | —                                                   |       |                                                     |       |                                                                              |       |
| For consulting contracts                                                      |       |                                                     |       | 10,277,102                                               |       | 10,156,775                                                                        |       |
| For asset acquisition 15,000,000 shares                                       |       |                                                     |       | 13,500,000                                               |       | 13,500,000                                                                        |       |
| For compensation contracts                                                    |       |                                                     |       | 25,451,500                                               |       | 25,451,500                                                                        |       |
| Issuance of warrants in connection with services                              |       | —                                                   |       | 430,100                                                  |       | 626,100                                                                           |       |
| Issuance of warrants in connection with convertible  debentures               |       | —                                                   |       | —                                                   |       | 4,556,666                                                                         |       |

 

Seenotes to the condensed financial statements.

 

7

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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.  During this period, the Company was in aprior development stage, marketing devices to aid surgical procedures.  In early 2004, Power3 became aware of abiotech company that appeared to have a set of assets and intellectualproperties that it required to more effectively pursue its business model.  That company, named Advanced BioChem, doingbusiness as ProteEx, provided contract-for-fee lab services analyzing proteinbiomarkers. At the conclusion of negotiations with Advanced BioChem, Power3entered into an Asset Purchase Agreement dated May 18, 2004, whereby itpurchased substantially all the assets and intellectual properties of AdvancedBioChem, and assumed certain liabilities, as scheduled in the agreement, fromAdvanced BioChem. After the transaction, certain employees from AdvancedBioChem became employees of Power3 and were later issued Employment Agreementsby Power3.  As consideration in the AssetPurchase Agreement, Power3 issued 15,000,000 shares of common stock to AdvancedBioChem.

 

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.

 

Previouslythe Company was the sole shareholder in a subsidary, TenthGate, Inc., aNevada corporation, although it was not active in Power3’s current line ofbusiness activity.  As part of theacquisition of the assets of Advanced BioChem, it was contemplated that Power3would distribute shares of TenthGate to its shareholders of record prior to theAdvanced BioChem transaction.  Previousmanagement of Power3 and TenthGate, have been independently operating TenthGatesince the Advanced BioChem transaction. The Company feels that its business focus and strategy is significantlydifferent from that of TenthGate, and the disposition of TenthGate will allowthe Company’s management to focus exclusively on its business objectives andoperation and allow the market to separately identify and evaluate eachbusiness.  Current management ofTenthGate has advised the Company that TenthGate has issued a significantnumber of shares of its common stock, thereby reducing the Company’s ownershipinterest to less than 1%.  In addition,counsel for TenthGate has advised the Company that, on August 19, 2005,TenthGate, Inc. was merged with and into Edmonds 5, Inc.  The Company is considering its alternativeswith respect to these action and still desires to complete a divestiture of anyinterest it may have remaining in TenthGate, Inc.

 

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.

 

8

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Restatement of Financial Statements

 

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 initially reported 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 ofrecapitalization, as 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, shouldhave been accounted for as a purchase transaction, in a related partytransaction.  As a result, all financialstatements of the Company have been reported under the revised accountingtreatment since the date of the Advanced BioChem transaction on May 18,2004.

 

Specifically,on August 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 31, 2005, which had been presentedunder the previous accounting treatment. On September 9, 2005, the Company filed amended Form 10-QSB’sfor the quarterly periods ending June 30, 2004, September 30, 2004and March 31, 2005.  In addition, onSeptember 9, 2005, the Company filed its Form 10-KSB for the yearended December 31, 2004, under the restated accounting treatment discussedabove.

 

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 been established.  The Company has been in its currentdevelopmental stage since its acquisition of its set of intellectual propertieson May 18, 2004.

 

Deemed Distribution

 

Duringthe 2nd Quarter of 2004, the Company issued 15,000,000 shares ofcommon stock as consideration for a set of assets and liabilities purchasedfrom Advanced BioChem in the asset purchase transaction of May 18,2004.  Because this transaction wasbetween individuals and entities considered to be related parties, under the rules ofthe SEC, the assets are recorded at historical cost and the amount in excess ofhistorical cost is considered to be a deemed distribution to the shareholders.As part of that transaction, the Company recorded a deemed distribution of $13,371,776 as the difference between the market value of the stock at $0.90 pershare on the date of the agreement ($13,500,000) and $128,224, debt in excessof the assets received in the transaction.

 

Duringthe 4th Quarter of 2004, the Company converted Series APreferred Stock owned by former management of the Company to common shares, perthe terms of the Series A Preferred Stock held by these individuals(Novak, Gray and Leonard.)  As part ofthat transaction the Company recorded a deemed distribution of $3,380,975, themarket value of the common shares issued at the date of issue of the commonshares.  Since both of these deemeddistributions occurred after May 18, 2004, the date the Company enteredthe development stage, the total of these two deemed distributions($16,752,750) is included in the deficit accumulated during the developmentstage in the Balance Sheet of the Company as presented for December 31,2004.  The total presented in the BalanceSheet for deficit accumulated during development stage of ($46,182,137) is thecombined deemed distributions of ($16,752,750) and the net loss duringdevelopment stage of ($29,429,387).

 

(1) SUMMARYOF SIGNIFICANT ACCOUNTING POLICIES

 

Principles of Consolidation

 

Theaccompanying consolidated financial statements include only the accounts ofPower3.  TenthGate’s statement ofcondition and operating results are not consolidated, since the Company nowowns less than

 

9

----

 

1%of TenthGate’s common stock outstanding and its financial results would not beconsolidated, nor are they material to the financial statements of Power3.

 

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 beenincluded.

 

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, 2004 and 2003, including notesthereto, and/or the consolidated financial statements of the Company as of December 31,2004 and 2003, including notes thereto included in the Company’s Form 10-KSBfor the respective periods.

 

ProfessionalFees have been classified in the enclosed Statement of Operations as OtherOperating Expenses.

 

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 contingenciesand the amortization periods for the debt issuance costs and warrant expenserelative to the convertible debentures as well as estimating depreciation andamortization periods of tangible and intangible assets, and long-livedimpairments, among others.  Estimates andassumptions are reviewed periodically and the effects of revisions arereflected in the financial statements in the period they are determined to benecessary.

 

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 and notes because of the lack of similar type arrangements in themarketplace.

 

Financial instruments,which potentially subject the Company to significant concentrations of creditrisk, consist primarily of cash and cash equivalents.  We occasionally maintain cash and cashequivalents balances in excess of federally insured limits.  We have not experienced any losses in suchaccounts.

 

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 September 30, 2005, certain lab equipment having a net bookvalue of approximately $37,500 serves as security for certain liabilities.

 

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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 on Convertible Debenturesand Warrants associated with this Issue

 

Unamortized discount resulting from the allocation ofvalue to warrants and the beneficial conversion feature embedded in theconvertible debentures is being amortized to interest expense over thecontractual lives of the debentures using the interest method.

 

Amortization of Warrant Expense not related toConvertible Debentures

 

Unamortized warrant expense resulting from the issuanceof warrants to consultants and allocation of value to these warrants is beingamortized to stock compensation expense over the contractual lives of thewarrants.

 

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 September 30,2005 and determined that certain impairment losses were necessary. As a result,operations have been charged for $74,131 during the period May 18, 2004(date of acquisition) to September 30, 2005.  Management believes that the remainingbalances of the Company’s long-lived assets are recoverable at September 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 by dividing the net loss for theperiod by the number of common and common equivalent shares outstanding duringthe period.  In periods in which theywould be anti-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 fair market value of the equity instruments issued and accounts forequity instruments issued to those other than employees based on the fair valueof the consideration received or the fair value of the equity instruments,whichever is more reliably measurable. Fair value is measured herein as the closing market price of the commonstock on the effective date of the agreement or Board resolution, rather thanimputed value of the agreement or imputed services.

 

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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 Based Compensation”.It provides alternative methods of transition for an entity that voluntarilychanges to the fair value based method of accounting for employee stock basedcompensation. It also amends the disclosure provision of FASB statement No. 123to require prominent disclosure about the effects on reported net income of anentity’s accounting policy decisions with respect to stock-based employeecompensation. As permitted by SFAS No. 123 and amended by SFAS No. 148,the Company continues to apply the intrinsic value method under AccountingPrinciples Board (“APB”) Opinion No. 25, “Accounting for Stock Issued toEmployees,” to account for its stock-based employee compensation 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 September 30,2005.

 

Research and Development 

 

Research and development costs, whichapproximated $342,531 for the nine months ended September 30, 2005 and the$200,001 for the nine months ended September 30, 2004, are expensed asincurred.

 

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 value of Power3’sinvestment in Tenthgate is considered to be minimal since the Company now ownsless than 1% of the common stock and Power3 does not consider that inclusion ofthis minimal amount would significantly effect 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 September 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 operationalactivities before it will have any anticipated revenue generating products. Theactual amount of funds that the Company will need will be determined by manyfactors, some of which are beyond the Company’s control.  These factors include:

 

•                  Theextent to which the Company enters into licensing arrangements or jointventures;

•                  Theprogress and results of research and product development;

•                  Thecosts and timing of obtaining new patent rights;

 

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•                  Theextent to which the Company requires or licenses other technologies; and

•                  Regulatorychanges and competition and technological 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 $451,000 of bridge financing received in April andSeptember, 2005, the $446,500 of bridge loan financing and Officer Advancesthat are to be repaid upon the receipt of the $1,600,000. The Company is inimmediate need of capital to continue its operations and as such its ability tocontinue as a going concern is subject to its ability to generate a profit orobtain necessary funding from outside sources. Management believes that eventhough the Company currently has limited cash resources and liquidity, assumingfunding of the additional $1,600,000 available from the existing convertibledebenture holders as specified in the Agreement, that the net funds availablefrom the final closing under such Agreement will allow the Company to continueoperations through December 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 January, 2006 to meet its operating costs.However, the Company is currently in default under the conditions set forth inthe Agreement as well as the debentures and registration rights agreement andconsequently, there is no assurance that the Company will be successful incompleting the sale and issuance of the remaining $1,600,000 aggregateprincipal amount of debentures and/or the additional investments rightspursuant to the Agreement.  If theCompany is unsuccessful in the closing of the sale and issuance of the$1,600,000 aggregate principal amount of debentures at the final closing, theCompany will be required to obtain alternative financing, sell or license someof its technology, or curtail or cease its operations. Any such funding maysignificantly further dilute existing shareholders or may limit the Company’srights to its technology.  Moreover, theincrease in the number of shares available in the public marketplace may reducethe market price for the Company’s common stock, and consequently, the priceinvestors may receive at the time of sale. The financial statements do not include any adjustments to reflect thepossible future effects on the recoverability and classification of assets orthe amounts and classification of liabilities that may result from the possibleinability of the Company to continue as a going concern.

 

(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;

 

•                  2,500,000warrants and additional investment rights which were issued to certainaccredited investors on October 28, 2004 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.

 

•                  333,333warrants which were issued to certain accredited investors on January 26,2005 under the Agreement. In addition, pursuant to the Agreement, the investorspurchased certain convertible debentures that if exercised, will result in theissuance of an indeterminate number of shares of common stock.

 

•                  580,000shares of warrants which were issued to members of the Company’s ScientificAdvisory Board and various other consultants in 2004 (including 100,000 to theagent that placed the convertible debentures discussed above).  The warrants, which expire five years fromthe dates of the respective grants and were issued at no cost to suchpersonnel, may be converted to a like number of shares of the Company’s commonstock 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 basedcompensation as a result of the issuance of these warrants, which amountsrepresent the fair value of the warrants on the dates

 

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they 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.

 

AtSeptember 30, 2005 the Company had net operating loss carryforwards forincome tax purposes of approximately $12,957,858 arising primarily from stockbased expenses that are considered to be permanent differences.  These net operating loss carryforwards expireat various times through the period ended December 31, 2010, howeverbecause the Company has experienced changes in control and has incurredsignificant operating losses, utilization of the income tax loss carryforwardsare not assured. As a result, the non-current deferred income tax asset arisingfrom these 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 assetrecognition standard established by SFAS 109.

 

(5) RELATEDPARTY TRANSACTIONS

 

 During the three months ended March 31,2005 the chief financial officer at the time advanced $35,000 to theCompany.  The advance, which is due ondemand and unsecured, bears interest at 6% per annum.  At September 30, 2005, the balance ofthe advance is included in Officer Advances in the accompanying condensed balancesheet.

 

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

 

During September, 2005, the Company received Officer Advances in theamount of $100,000.  These advances werein the form of a short-term Note Payable, to the Officer, and are payable on March 6,2006.  Should the principal not be repaidas of March 6, 2006, interest of 6% per year on any unpaid principalamount will be earned by the Payee until such time as all of the principalamount is repaid.

 

(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%.   The due date forthis note has now been extended to November 15, 2005, by amendment asdiscussed in the 8-K filed by the Company on September 9, 2005.

 

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On June 17, 2005, the Company received abridge loan in the amount of $396,500. This bridge loan is in the form of a promissory note, payable on the soonerof August 15, 2005, or the fifth day following the effective date of theCompany’s registration statement on Form SB-2.  The note is secured by a Stock PledgeAgreement, entered into on June 17, 2005, by the CEO of Power3, whereinthe Pledger agreed to pledge 6,000,000 shares of common stock as security forthe performance of the Company under the note.  The note bears no interest, other than in case of default, in which casethe note shall bear interest at the rate of 18% per annum from the date such interestwould be due.  On September 6, 2005, the parties tothis promissory note agreed to amend the original note, thereby changing theamount to be repaid, by Power3, to $446,500 and changing the due date of thenote to October 31, 2005.  All otherprovisions of the note remain in effect, as originally stated in the NotePayable and shown as an exhibit to the 8-K filed by the Company on September 9,2005.  This note remains outstanding andunpaid at this time.

 

On September 5, 2005, the Company received a bridge loan in theamount of $200,000.  This bridge loan isdue and payable within one business day following the closing of the Company’ssale and issuance of the $1,600,000 aggregate principal amount of debenturespursuant to the Securities Purchase Agreement dated October 28, 2004, asamended.  If that closing, which is tooccur within five trading days of the effectiveness of the Company’s pendingregistration statement on Form SB-2, does not occur on or before October 31,2005, the entire unpaid principal balance will be due on October 31,2005.  Interest is due on the noteaccording to certain provisions as described in the note documents, shown as anexhibit to the 8-K filed by the Company on September 9, 2005.  This note remains outstanding and unpaid atthis time.

 

(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 $17,447 and $75,233, for the nine months ended September 30,2004 and the period September 30, 2005 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

 

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theopportunity to receive cash bonuses based on performance upon the discretion ofthe board of directors.   The agreementalso includes participation in employee benefit plans offered to employees, aswell as a grant of 13,250,000 shares of restricted common stock and 1,500,000shares of restricted Series B preferred stock (the Series B preferredshares have not yet been issued).  Eitherparty may terminate the chief scientific officer’s employment under thecontract, either with or without cause upon giving the other party at leastthirty days notice.  If the Companyterminates the Chief Scientific Officer’s employment at any time during theinitial term without cause, he will be entitled to receive compensationprovided under the agreement 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.

 

Chief Financial Officer – The amended and restated employment agreementis effective as of September 15, 2005 and has an initial term of threeyears, subject to each party’s termination rights.  The agreement provides for a base salary of$100,000 per year and the opportunity to receive cash bonuses based onperformance upon the discretion of our board of directors.  The agreement also includes participation inemployee benefit plans offered by us to our employees, as well as a grant of140,000 shares of restricted common stock. Either party may terminate the Chief Financial Officer’s employmentunder the contract, either with or without cause upon giving the other party atleast thirty days notice.  If the Companyterminates the chief financial officer’s employment at any time during theinitial term without cause, he will be entitled to receive compensationprovided under the agreement 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 granted to him.

 

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 one-three years, the Companyrecorded a total of $27,850,500 of deferred compensation upon the dates of theemployee stock grants (which amount was determined based on the total number ofshares granted times the trading values of the shares on the dates the stockgrants were made).  This amount is beingamortized to stock based compensation 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 the securitiesissued by the Company for such indebtedness), the shares have not yet beenissued.  The Company intends to issuesuch 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.

 

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

 

| **Periods Ending  December 31,** | ** ** | **Amounts** | ** ** |
|---------------------------------------|------------|-------------|------------|
|                                  |       |        |       |
| 2005  (three months)                  |       | $           | 112,500    |   |
| 2006                                  |       | 450,000     |       |
| 2007                                  |       | 450,000     |       |
| 2008                                  |       | 425,000     |       |
| 2009                                  |       | 350,000     |       |
|                                  |       |        |       |
| Total                                 |       | $           | 1,787,500  |   |
|                                       |            |             |            |  |  |

 

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Contingencies

 

**On August 8, 2005,Industrial Enterprises of America, formerly Advanced BioChem, filed suitagainst Power3, Steven B. Rash and Ira Goldknopf claiming damages of at least$3,000,000 including the costs of litigation and of addressing the claims ofthe creditors of Advanced BioChem that remain unpaid.  Advanced BioChem has, in its public reports,announced their assertion that the parties to the law suit are responsible forall of the liabilities of Advanced BioChem, at the date of the asset purchasetransaction on May 18, 2004.   Theterms of the Asset Purchase Agreement are not clear and are subject todifferent interpretations.  While webelieve that we have properly interpreted the provisions of the Agreement,fulfilled our obligations thereunder and reflected the terms of the transactionin our financial statements and previous filings, we have previously haddiscussions and negotiations with Advanced BioChem in an effort to resolve thisdisagreement and the alleged liabilities. Recently as a result of Advanced BioChem’s refusal to further negotiateto settle the question, management has reviewed the liabilities in question andhas determined that we are not liable for any of the aforementioned liabilitiesand these liabilities have not been included in the financial statements of theCompany.  We intend to file an answerdenying all claims in the lawsuit.  Webelieve that Advanced BioChem’s claims are without merit, however we cannot beassured we will prevail or if the outcome of the action will adversely affectour financial position or results of operations.**

** **

**On September 30, 2005, theCompany received a communication from an attorney representing formermanagement of Power3, requesting a clarification of statements made in Form 10-QSB/Afor the period ended June 30, 2004 and for the period ended September 30,2004.  Based on the Company’s knowledgeand reports it received from the Company’s stock transfer agent, the Companypreviously stated that shares of stock were issued to Emeritus Group LP,Southshore Harbor Group LLP and Arborcrest Assets LLP on May 17, 2004,based on authorization from Power3 Medical Products, Inc’s management at thetime.  After further investigation andprovision of documents by previous management,, it appears that the Company’sprevious management authorized issuance of shares to three individuals, ratherthan to the limited partnership entities previously named, for consultingagreements, although no such consulting agreements were provided by previousmanagement.  Based on copies provided,and prior to the actual issuance of shares to these individuals, these threeindividuals notified the stock transfer agent, by letter, to issue their sharesto the limited partnership entities, Emeritus Group LP, Southshore Harbor GroupLLP and Arborcrest Assts LLP.  The commonshares of Power3 were later issued to these three limited partnership entitiesand have been reported in the outstanding common shares of the Company.**

** **

(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,the purchasers agreed to purchase from the Company convertible debentures duethree (3) years from the date of issuance in the aggregate principalamount of $3,000,000. The Agreement also provides for the issuance to thepurchasers, at no additional cost to the purchasers, warrants to purchaseshares of the Company’s common stock and additional investment rights topurchase additional convertible debentures. In connection with the Agreement, the Company also entered into aregistration rights agreement with the purchasers, which requires that theCompany file a registration statement with the SEC registering, on behalf ofthe purchasers, the resale of the shares of common stock issuable uponconversion of the debentures and the exercise of the warrants.  On October 6, 2005, the

 

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Companyfiled an amended registration statement for the resale of the shares issuableupon conversion of the debentures.

 

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 Agreement werenot satisfied or otherwise met on a timely basis. As stated, the Company hasnow filed the aforementioned registration statement, however it has not beendeclared effective yet.  Consequently,there are no assurances that the investors will purchase all or any portion ofthe remaining $1,600,000 aggregate principal amount of debentures. The$1,000,000 aggregate principal amount of debentures issued in the initialclosing 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 anaggregate of up to 2,500,000 shares of common stock and additional investmentrights to purchase additional amounts of convertible debentures.  Pursuant to the Amendment to the agreement,concurrent with the Company’s issuance of the $400,000 aggregate principalamount of debentures on January 26, 2005, the Company issued additionalwarrants to purchase an aggregate of up to 333,333 shares of common stock.  All the issued 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).

 

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

 

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deliver certificates toholders upon conversion and a default by the Company in any obligations underany indebtedness of at least $150,000 which results in such indebtedness beingaccelerated. Upon the occurrence of an event of default, each debenture maybecome immediately due and payable, either automatically or by declaration ofthe holder of such debenture. The aggregate amount payable upon an accelerationby reason of an event of default shall be equal to the greater of 130% of theprincipal amount of the debentures to be prepaid or the principal amount of thedebentures to be prepaid, divided by the conversion price on the date specifiedin the debenture, multiplied by the closing price on the date set forth in thedebenture.

 

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 September 30, 2005, the Companyhas recorded $232,000 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.  Thatamount has not been paid as of the date of filing this report.

 

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 ten percent (10%) of the exercise price paid uponexercise of the additional investment rights divided by ninety percent (90%) ofthe market price as of the initial closing.

 

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 these 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

 

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Company’s stock option committee foroptions granted to officers, directors, and consultants. Options expire tenyears from the 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.

 

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 beincreased.  The number of shares of suchincrease shall be an amount such that immediately following such increase, thetotal number of shares issuable under this plan and reserved for issuance uponexercise of options, warrants, or conversion of shares of preferred stock willequal 15% of the total number of issued and outstanding shares of the Company’scommon stock.

 

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”)  under the fair value method of thatStatement. The fair value for the Warrants was estimated at the date of grantusing a Black-Scholes option pricing model with the following assumptions forWarrants granted in 2000: risk-free interest rate of 6.03%; dividend yield of0%; volatility factor of the expected market price of the Company’s commonstock of .34; and a weighted-average expected life of the options of 2.7 years.The following assumptions were used for Warrants granted in 2004: risk-freeinterest rate of 5.0%; dividend yield of 0%; volatility factor of the expectedmarket price of the Company’s common stock of 1.86 and a weighted-averageexpected life of the options of -0- years (as all were immediately vested). TheBlack-Scholes option valuation model was developed for use in estimating thefair value of traded Warrants that have no vesting restrictions and are fullytransferable. In addition, option valuation models require the input of highlysubjective assumptions including the expected stock price volatility. Becausethe Company’s Warrants have characteristics significantly different from thoseof traded Warrants, 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 and warrant expense actually recorded and stock basedcompensation and warrant expense that would be recorded using a fair valuebased method are identical.   A summaryof the Company’s warrant activity and related information for the period January 1,2004 to December 31, 2004 is as follows:

 

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| ** **                             | ** ** | ** **   | ** ** | **Weighted** | ** ** |
|----------------------------------------|------------|--------------|------------|--------------|------------|
| ** **                             | ** ** | ** **   | ** ** | **Average**  | ** ** |
| ** **                             | ** ** | **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       |   |

 

The following table summarizes informationabout the Company’s Warrants outstanding at December 31, 2004:

 

| **Exercise  Price** | ** ** | **Number  Outstanding** | ** ** | **Weighted Average  Remaining Contractual  Life (in years from  December 31, 2004)** | ** ** | **Weighted  Average  Exercise  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       |   |

 

(11) RECENT PRONOUNCEMENTS

 

*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 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-basedpayments such as stock options granted to employees. The Company will berequired to apply FAS 123 (R) on a modified prospective method. Under thismethod, the Company is required to record compensation expense (as previous awardscontinue to vest) for the

 

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unvested portion ofpreviously granted awards that remain outstanding at the date of adoption. Inaddition, 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 period beginningafter June 15, 2005. The Company does not believe the impact of adoptingthis Statement will be material as there are no unvested options and warrantsat December 31, 2004.

 

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

 

In December 2004, FASB StatementNo. 153 was issued amending APB Opinion No. 29 to eliminate theexception allowing non-monetary exchanges of similar productive assets to bemeasured based on the carrying value of the assets exchanged as opposed to attheir fair values.  This exception wasreplaced with a general exception for exchanges of non-monetary assets that donot have commercial substance.  Anon-monetary exchange has commercial substance if the future cash flows of theentity are expected 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 June 15, 2005.  Theadoption of this statement did not have a material impact on the Company’sfinancial statements.

 

(12)SUBSEQUENT EVENTS

 

OnOctober 3, 2005, Power3 was notified that it has been sued by Kamy A.Behzadi, a former employee and a stockholder of Power3.  The suit claims breach of contract and askthat all restrictions on stock issued to the Plaintiff be removed or that therestrictions be declared null and void. Previously on May 11, 2005, the Company filed suit against Mr. Behzadiand Search Alliance for misrepresentation of professional credentials,deceptive trade practices and breach of contract regarding his employment withPower3.

 

OnOctober 6, 2005, Power3 filed Amendment #1 to its previously filed SB-2 toregister the stock related to the Securities Purchase Agreement, dated October 28,2004, as amended.

 

On October 17, 2005, the Company executed apromissory note in the principal amount of $39,231 payable to Dr. Ira L.Goldknopf (the “Payee”) who is the Chief Scientific Officer, a Director and aPrincipal Stockholder of the Company.  Under the terms of the note, theprincipal amount of thirty nine thousand, two hundred and thirty one dollars($39,231), (the “Principal”) shall be due and payable on or before March 6,2006 (the “Maturity Date”).  Should the Principal not be repaid as of March 6,2006, interest of 6 % per year on any unpaid Principal amount will be earned bythe Payee until such time as all of the Principal amount is repaid.  ThisNote may be repaid at any time prior to March 6, 2006, without interest orpenalty.

 

***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, withoutlimitation:

 

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•                  The Company’s history of operatinglosses;

 

•                  The Company’s need and ability toraise significant capital and obtain adequate financing for its developmentefforts;

 

•                  The Company’s ability to successfullydevelop and complete validation studies for its products;

 

•                  The Company’s dependence upon and theuncertainties associated with obtaining and enforcing patents and intellectualproperty rights important to its business;

 

•                  The uncertainties associated with thelengthy regulatory approval process, including uncertainties associated withthe United States Food and Drug Administration (“FDA”) decisions and timing ofproduct development or approval;

 

•                  Development by competitors of new orcompetitive products or services;

 

•                  The Company’s ability to retainmanagement, implement its business strategy, assimilate and integrate anyacquisitions;

 

•                  The Company’s lack of operatingexperience and present commercial production capabilities; and

 

•                  The increasing emphasis oncontrolling healthcare costs and potential legislation or regulation ofhealthcare 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 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 the Company’s acquisition of the assets of Advanced BioChem, Inc.on May 18, 2004, the Company was primarily engaged in the production anddistribution of surgical safety devices through the operations of itssubsidiary, Power3 Medical, Inc.  OnMay 18, 2004, the Company completed its acquisition of the assets ofAdvanced BioChem.  The Company acquiredall assets and intellectual properties of Advanced BioChem and assumed certainliabilities in exchange for the issuance of 15,000,000 shares of the Company’scommon stock. Subsequent to the transaction, the Company

 

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established the newbusiness direction described above. After the acquisition of the assets and certain liabilities of AdvancedBioChem, the Company transformed into an advanced proteomics company applyingexisting proprietary methodologies to commercialize the intellectual propertyit acquired 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 theinternal control procedures that will be necessary when the Company moves out ofthe developmental stage are not developed at this time.  Our ongoing operations consist of researchand development operations and activities directed toward commercializing theintellectual 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 willcontinue to incur substantial operating losses in future years as it progressesin its research and development activities as well as the commercializing ofits technologies.  The Company does notexpect to produce revenues from operations in the near term and expects thatits revenues will be limited to research grants, collaboration agreements, andother strategic alliances which the Company is able to obtain.  The Company has an immediate need for capitalto continue its current operations

 

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 Houston.Under the trade name of NuroProTM, the Company is continuing development of asuite of four tests to differentiate individuals with no known neurologicaldisorders from those with Alzheimer’s disease, Parkinson’s disease, ALS, andother disorders that have similar clinical symptoms as these diseases. Eachtest involves monitoring the concentration of a group of differentiallyexpressed proteins selected from a panel of 34 biomarkers that have beenidentified as indicators of the different disorders. Each test employs adifferent combination of 4 to 10 biomarkers to achieve the desired diagnosticcapability for the specific disease discrimination designed for any individualtest.  The Company has just received aNotice of Allowance for the trademark NuroProTM from the United States Patentand Trademark Office.

 

At the end of thefirst nine months of 2005, the number of unique samples in our collection usedfor constructing our NuroProTM 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 4 of the diagnostic tests in the NuroProTM 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.  The fourth test is designed to aidneurologists and internists in differentiating individuals with Parkinson’sdisease from those with similar disorders and from normal individuals of thesame age.

 

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Since January, 2005, theCompany has converted six provisional patents to utility patent applications, 1focusing on the Company’s biomarker discovery technologies, 1 on antibody basedtest designs for the company’s biomarkers, and 4 on biomarkers forneurodegenerative diseases. The company has filed a provisional patentapplication for the Company’s first generic, blood based diagnostic test forneuromuscular disorders on May 9, 2005 and second and third provisionalpatent applications on July 21, 2005 and August 17, 2005 for theCompany’s ALS specific test and Alzheimer’s 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. A fourth provisionalpatent application has been submitted, on August 24, 2005, for afunctionally-related group of biomarkers that distinguish between ALS andParkinson’s disease. Theseapplications are included in the 9 utility patents pending, 15 provisionalpatent applications, and 1 issued patent, owned and/or licensed by Power3 fordeveloping disease specific diagnostic tests for neurodegenerative disease,breast cancer, and drug resistance.

 

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 exclusive license agreement withBaylor College of Medicine, Houston, TX to commercialize the neurodegenerativedisease biomarkers and tests co developed and patents filed jointly with thatinstitution. Further, on June 6, 2005, the Company entered into a researchagreement with The Methodist Hospital Neurological Research Institute, HoustonTX, to be effective March 17, 2005, to continue the search for biomarkersand development of the NuroPro suite of tests that directly impact thediagnosis of neurodegenerative diseases. Power3, in collaboration with StanAppel, M.D., Chair of Neurology at the Methodist Hospital Neurological ResearchInstitute, has completed clinical validation, testing serum proteins from over600 patients, normal and neurodegenerative disease controls, including patientswith Lou Gehrig’s (ALS), Alzheimer’s and Parkinson’s diseases.

 

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.

 

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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.  Althoughthe form and amounts of any consideration to be paid have not been agreed upon,the parties have agreed to be reasonable in negotiating such consideration.

 

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 biomarkersproposed by Power3.  If the antibodiesand diagnostic assays are found to have diagnostic and/or therapeuticpotential, BioSite will develop and commercialize BioSite products for thedetection and/or treatment of breast cancer and/or neurological diseases.  Under the agreement, BioSite will makemilestone payments to the Company, as well as pay royalties on the sale of anyBioSite products containing antibodies to any selected target biomarker claimedin a patent application 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 continues with promising results.  The current enrollment status includes 162patients, including all categories of normal, benign and cancer samples.  The three clinical sites include Mercy Women’sCenter in Oklahoma City, OK, Obstetrical and Gynecology Associates in Houston,TX, and NYU School of Medicine in NY, NY. It is anticipated that the enrollment will continue without changes tothe sites or Primary Investigators.  TheCompany is pleased with the continual progress of the validation study and theadvice received from the study’s principal investigator.  The Company has received a Notice ofAllowance for its NAFTestTM trademark for breast cancer from the United StatesPatent and Trademark Office.

 

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 144 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 was

 

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developedthrough joint collaboration between the scientific team of Power3 Medical andThe University of Texas M. D. Anderson Cancer Center.

 

TheCompany has accumulated an intellectual property portfolio in which the Companyowns or has licensed a total of 24 patent applications, 1 issued U.S. patentand 2 License agreements, covering its biomarker discovery and diagnosticplatforms and the breakthrough diagnostic and drug targeting discoveries it hasobtained with its platforms.  Thediscoveries the Company has made include biomarkers and tests for breastcancer, gastrointestinal cancer, leukemia, drug resistance andneurodegenerative diseases.  The Companyis also preparing several manuscripts for scientific publication covering thesediscoveries.

 

OnOctober 13, 2005, the Company executed a Research Agreement with Pfizer, Inc.to further evaluate its NuroProTM test capabilities and to test blind andunblended samples provided by Pfizer, under controlled conditions.

 

*Resultsof Operations*

 

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

 

Revenues for the threemonths ending September 30, 2005 were $-0- and $-0- for the same period in2004.  Due to the Company’s focus ondisease diagnosis, protein and biomarkers identification, and research on drugresistance 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 expenses were$3,388,913 during the three months ended September 30, 2005 as compared to$1,624,364 for the three months ended September 30, 2004, an increase of$1,764,549.  The increase in operatingexpenses was primarily attributable to an increase of $1,133,237 in stock basedcompensation expense and to the amortized costs of the warrants issued toconsultants and to the convertible debenture holders.  Other operating expenses were $535,189 in thefirst three months of 2005 as compared to $362,397 during the first threemonths of 2004, an increase of $172,792.

 

Interest expense thus farin 2005 has amounted to $368,612 as compared to $2,752 during the same ninemonth period of 2004.  The increase ininterest expense is primarily attributable to the monthly amortization of theaccrued interest on the convertible debentures issued.

 

The above matters resultin our Net Loss being slightly less during the first nine months in 2005 ascompared to the first nine months of 2004.

 

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.  From the date of the Advanced BioChemtransaction through September 30, 2005, the Company has raisedapproximately $2,538,150 in debt capital. As described in “Recent Financing” below, the Company may sell anadditional $1,600,000 in aggregate principal amount of convertible debenturesfollowing the effectiveness of the Registration Statement on Form SB-2filed by the Company for the resale of certain shares of the Company’s stock bythe purchasers of the Company’s convertible debentures.  The Company is in default under the terms ofthe Securities Purchase Agreement, the previously issued debentures and relatedregistration rights agreement and there can be no assurance that the existinginvestors will purchase all or any portion of the additional $1,600,000 aggregateprincipal amount of debentures.  Ifadditional debentures are issued and sold by the Company, the Company will usea portion of the proceeds from the sale and issuance of such debentures to paythe $451,000 principal balance owing under the promissory notes dated April andSeptember, 2005,

 

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the $ 446,500 principalbalance owing under the promissory note dated June 17, 2005 and amended inSeptember, 2005 and the $240,650 in Officer Advances.

 

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 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 Companywas obligated to pay the second installment of $20,000 in August of 2005.That payment is now due and payable and has not been paid.  The Company has an immediate need for capitalto continue its current operations.  Inaddition to seeking additional capital, the Company will seek revenues fromresearch grants, collaboration agreements, and other strategic alliances.

 

In the event the sale and issuance of the $1,600,000aggregate principal amount of debentures occurs and the investors exercisetheir warrants and additional investment rights, the Company anticipates itwill have adequate cash to meet its funding requirements through the firstquarter of 2006.  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 ($210,471) for the nine months ended September 30,2005, compared to ($970,366) for the nine months ended September 30,2004.  The decrease in net cash used inoperating activities during 2005 was primarily due to a smaller charge tostock-based compensation during the first nine months of 2005, as compared tothe first nine months of 2004.

 

Net cash provided byfinancing activities approximated $338,890 for the nine months of 2005 ascompared to $882,457 for the nine months ended September 30, 2004.  As of September 30, 2005, the Company’sprincipal source of liquidity was approximately $36,733 in cash.

 

*RecentFinancing*

 

On September 5, 2005, the Company received a bridge loan in theamount of $ 200,000.  This bridge loan isdue and payable within one business day following the closing of the Company’s saleand issuance of the $1,600,000 aggregate principal amount of debenturespursuant to the Securities Purchase Agreement dated October 28, 2004, asamended.  If that closing, which is tooccur within five trading days of the effectiveness of the Company’s pendingregistration statement on Form SB-2, does not occur on or before October 31,2005, the entire unpaid principal balance will be due on October 31,2005.  The due date for this note hasbeen extended to November 15, 2005 and interest is due on the noteaccording to certain provisions as described in the note documents, shown as anexhibit to the 8-K filed by the Company on September 9, 2005.

 

The Company’s earlier $251,000 bridge loan, received in the quarterending June 30, 2005, bears interest at a rate of 10% per annum which, atthe holder’s option, may be paid in (a) cash, or (b) that number ofshares of the Company’s common stock determined by dividing $ 251,000 by thecommon stock price on the date of payment and multiplying the quotient so obtainedby 20%.  This note is still outstandingand remains unpaid at this time.

 

On September 6, 2005, the Company received an Officer Advance inthe amount of $ 80,000.  This advance isin the form of a short-term Note Payable, to the Officer, and is payable on March 6,2006.

 

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Should the principal not be repaid as of March 6, 2006, interestof 6% per year on any unpaid principal amount will be earned by the Payee untilsuch time as all of the principal amount is repaid.

 

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.

 

On September 6, 2005, the parties to this promissory note agreedto amend the original note, thereby changing the amount to be repaid, byPower3, to $446,500 and changing the due date of the note to October 31,2005.  All other provisions of the noteremain in effect, as originally stated in the Note Payable and shown as anexhibit to the 8-K filed by the Company on September 9, 2005.  This note remain unpaid and still outstandingat this time.

 

On September 29, 2005 the Company received an Officer Advance inthe amount of $20,000.  This advance isin the form of a short-term Note Payable to the Officer and is payable on March 6,2006.  Should the principal not be repaidas of March 6, 2006, interest of 6% per year on any unpaid principal amountwill be earned by the Payee until such time as all of the principal amount isrepaid.

 

*Plan ofOperations and Cash Requirements*

 

The Company currentlydoes not have operating revenues from product sales or the performance ofservices and it continues to experience net operating losses.  The Company is actively pursuing third partylicensing agreements, collaboration agreements and similar businessarrangements in order to establish a revenue base utilizing its capabilities indisease diagnosis based on protein and biomarker identification, and drugresistance in the areas of cancers, neurodegenerative and neuromusculardiseases.  The Company has undertakenclinical validation 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 $200,000 per month and the Company anticipates that it willrequire approximately $2,400,000 for the twelve months ended September 30,2006 to continue its development activities, undertake and perform clinicalvalidation studies, continue its marketing efforts and maintain itsadministrative infrastructure, broken down as follows:

 

Estimated Expenditures RequiredDuring Next Twelve Months

 
| General and Administrative                |   | $      | 1,850,000 |   |
|-------------------------------------------|--------|--------|-----------|--------|
| Patent filings  and intellectual property |   | $      | 200,000   |   |
| NAF clinical  validation studies          |   | $      | 350,000   |   |
|                                      |   |   |      |   |
| Total                                     |   | $      | 2,400,000 |   |

 

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

 

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Company has no significant capital expenditurerequirements and does not plan to increase its monthly expenditure rate absentan increase in revenues or additional funding.

 

Asnoted previously, 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.  Assuming the completion ofthe remaining closing and sale and issuance of the remaining $1,600,000 inaggregate principal amount of the convertible debentures, the Company estimatesthat, after repayment of the bridge loans immediately following the sale andissuance of such debentures, the Company will have adequate cash to allow it tomeet its current funding requirements through the first 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 end of 2006.  The foregoing is based upon current estimatedcash requirements and may be affected by the Company’s current dispute withAdvanced BioChem regarding the liabilities assumed under the May 2004transaction.

 

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.

 

*Off-BalanceSheet Arrangements*

 

At September 30,2005, with the exception of the lease for its operating facility, andemployment agreements entered with its three principal officers, the Companydid not have any significant off balance sheet commitments.

 

On November 1, 2005,the Company executed an agreement with Dallas Jones Associates to providefinancial services and receive compensation of 8 per cent of debt funds orequity funds raised for the Company, payable upon completion of any suchtransaction.

 

*CriticalAccounting Policies*

 

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 employees.  TheCompany will be required to apply FAS 123 (R) on a modifiedprospective method.  Under this method,the Company will be required to record compensation expense (as previous awardscontinue to vest) for the unvested portion of previously granted awards thatremain outstanding at the date of adoption. In addition, the Company may elect to adopt FAS 123 (R) byrestating previously issued

 

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financial statements,basing the amounts on the expense previously calculated and reported in the proforma disclosures that had been required by FAS 123, FAS 123 (R)is effective for the first reporting period beginning after June 15,2005.  The Company has not yet determinedthe impact that FAS 123 (R) will have on its financial statements;however, it does not believe the impact of adopting this Statement will bematerial as there are no unvested options and warrants at September 30,2005.

 

On May 18, 2004,Power3 executed an Asset Purchase Agreement with Advanced BioChem, doingbusiness as ProteEx.   In thetransaction, Power3 purchased substantially all of the assets and intellectualproperties of Advanced BioChem and assumed certain liabilities in exchange forthe issuance of 15,000,000 shares of its common stock pursuant to an AssetPurchase Agreement.  For financialstatement purposes, 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, arein complete agreement as to the accounting treatment of purchase accounting asthe appropriate treatment to account for its acquisition of a set of assets anda 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 Financial 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 September 30,2005.

 

Management has identifiedcertain deficiencies which have caused it to conclude that the Company’sdisclosure controls are ineffective.  Certainof these deficiencies such as late filing of the Company’s 10-K for the yearended December 31, 2004, the Company’s inability to hire outsideprofessionals and consultants and the unexpected issues with the AdvancedBioChem transaction, were previously reported in the Company’s Quarterly Reporton Form 10-QSB for the quarterly period ended June 30, 2005.

 

The Company hasundertaken steps and implemented actions as disclosed in its previous Form 10-QSBin an effort to resolve these deficiencies.

 

While the actionsidentified in the previously filed Form 10-QSB and the actions identifiedbelow have addressed many of these deficiencies, the Company continued to havedeficiencies with respect to its disclosure controls and procedures at September 30,2005 including the following:

 

•                  Although the Company has hiredaccounting personnel as reported in its previous Form 10-QSB, the Company’slimited financing and available capital have restricted the Company’s abilityto fully implement its procedures for the improvement of its internal controlover financial reporting and to engage certain outside professionals andadvisors 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.

 

•                  The Company continues to faceunexpected issues relating to the integration of the Advanced BioChemtransaction such as the dispute described in this quarterly report over theAdvanced BioChem liabilities that Power3 is ultimately responsible for and suchissues have caused the Company’s accounting personnel to devote significant andunanticipated time and attention to these matters.

 

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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 toimprove the Company’s infrastructure, personnel, processes and controls to helpensure that the Company is able to produce accurate financial statements on atimely basis.

 

*Changes in Internal Control Over FinancialReporting*

* *

During the first threequarters of 2005, the Company has 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 September 30,2005 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.  On June 3, 2005, the Companynamed John P. Burton as its Chief Accounting Officer and Controller.  On September 15, 2005 the Company named Mr. Burtonas Chief Financial Officer, according to an Employment Agreement effective asof that date.

 

# **PART II. OTHER INFORMATION**

# ** **

*Item 1.Legal Proceedings*

 

InNovember 2004, Chapman Spira & Carson, LLC (“Chapman Spira”), aninvestment banking firm, filed a lawsuit in the Supreme Court of the State ofNew York for the County of New York against Advanced BioChem (the Predecessor),Power3 and Steven Rash.  The suit allegesthat Advanced BioChem and Power3 are liable to Chapman Spira for damagesallegedly resulting from the breach of a letter agreement between Chapman Spiraand Advanced BioChem relating to the performance of strategic and investmentbanking services.  The suit furtheralleges that Mr. Rash made false statements regarding the performance ofservices by Chapman Spira. Chapman Spira is seeking damages in the amount of$1,522,000 plus interest.  We have filedan answer in the lawsuit.  We believethat Chapman Spira’s claims are without merit; however, we cannot be assured wewill prevail or if the outcome of the action will adversely affect ourbusiness, financial position or results of operations.  Inquiries to resolve this matter have beenundertaken by the attorneys representing each party in this matter, but noresolution has been achieved thus far.

 

An equipment vendor filed a complaint, regarding equipment which theCompany acquired in its May 18, 2004 transaction with Advanced BioChem,against Advanced BioChem in April of 2002 in a California court allegingbreach of contract and seeking damages. Advanced BioChem reached a settlement agreement in April of 2003under which Advanced BioChem would pay the vendor $40,000 in installmentsthrough August, 2003.  At December 31,2003, Advanced BioChem had a balance remaining of $20,000.   In April, 2005, the equipment vendor filed alawsuit against Advanced BioChem, certain former officers of Advanced BioChemand against Power3 in order to enforce its claim for the remaining balancewhich is past due and may be assumed by the Company as part of the settlementof the dispute with Advanced BioChem.

 

On May 17, 2005, the Law Offices of Jerry Scheff filed suitagainst us seeking recovery of fees billed to us for legal fees invoiced inNovember, 2004.  We believe that we arenot liable for the specific dollar amounts claimed in the lawsuit, however thedollar amounts are included in the accounts payable section

 

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of the Company’s balance sheet. We cannot be assured we will prevail or if the outcome of this actionwill adversely affect our financial position or results of operations.

 

On May 19, 2005, Quinn Capital Consulting, Inc. filed suitagainst Power3 and Steven B. Rash claiming breach of contract regarding paymentfor services claimed to be issued to Power3, with payment to have been made byissue of 500,000 shares to Quinn Capital, for which Power3 later cancelled orotherwise converted the shares from Quinn Capital.  We believe that we are not liable for theissuance of any shares to Quinn Capital regarding the service performed underany such agreement, however we cannot be assured we will prevail or if theoutcome of this action will affect our financial position or results ofoperations.

 

In June, 2005, Charles Caudle et al filed a lawsuit in Harris County,Texas, against Advanced BioChem, Power3 and the officers and directors of bothcompanies.  The suit alleges thatAdvanced BioChem, Power3 and the officers and directors of Power3, are liableto Charles Caudle et al for damages resulting from funds loaned to AdvancedBioChem and which were subsequently converted into common stock of AdvancedBioChem.  It is unclear as to thespecific dollar amount of the claim.  We,and our officers and directors, have filed an answer denying all claims in thelawsuit.  We believe that Charles Caudleet al’s claims are without merit, however we cannot be assured we will prevailor if the outcome of the action will adversely affect our financial position orresults of operations.

 

**On June 27, 2005, the Company received asubpoena for documents regarding the SEC’s Division of Enforcementinvestigation In The Matter of Maui General Store, Inc.  It is our understanding that the Maui GeneralStore matter relates to a promotional scheme by certain individuals to promotethe stock and stock price of certain companies, during 2004.  We provided all documents in our possessionpursuant to the subpoena and complied fully with the subpoena on July 11,2005.  We have received no furthercorrespondence from the Enforcement Division of the SEC.  We have not been notified that we are asubject of this investigation.**

 

**On August 8, 2005,Industrial Enterprises of America, formerly Advanced BioChem, filed suit in theSupreme Court of the State of New York, New York County against Power3, StevenB. Rash and Ira Goldknopf claiming damages of at least $3,000,000. In thisaction, Advanced BioChem has asserted that Power3, Steven Rash and IraGoldknopf are responsible for all of the liabilities of Advanced BioChem, atthe date of the asset purchase transaction on May 18, 2004.   On October 25, 2005, this action wasdiscontinued without prejudice by the Plaintiff, Industrial Enterprises ofAmerica.**

** **

OnAugust 29, 2005, Power3 was notified that it had been sued by CarlottaLansford for non-payment of services rendered to Advanced BioChem.  Plaintiff claims that the liability for theseservices now rests with Power3 due to Power3’s assumption of liabilities in theMay 18, 2004 transaction with Advanced BioChem.  While Power3 believes that it will eventuallybe determined to be not liable for these claims, this liability has beenincluded in the accounts payable of the Company.

 

OnOctober 3, 2005, Power3 was notified that it has been sued by Kamy A.Behzadi, a former employee and a stockholder of Power3.  The suit claims breach of contract and askthat all restrictions on stock issued to the Plaintiff be removed or that therestrictions be declared null and void.  Previously on May 11, 2005, the Company had filed suit against Mr. Behzadiand Search Alliance for misrepresentation of professional credentials,deceptive trade practices and breach of contract regarding his employment withPower3.

 

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

 

(a)                Notapplicable.

 

(b)               Underthe terms of the $400,000 aggregate principal amount of convertible debenturesissued by the Company as of January 26, 2005, as well as the terms of the$1,000,000 aggregate principal amount of convertible debentures issued by theCompany as of October 28, 2004, the Company is prohibited

 

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fromtaking certain actions without the approval of the holders of a two-thirdsmajority of the then-outstanding principal amount of the debentures.  Specifically, the Company has agreed not to,so long as any portion of the debentures are outstanding, (1) amend itcertificate of incorporation, bylaws or other charter documents so as toadversely affect any rights of the holders of the debentures, or (2) repurchasemore than a de minimis number of shares of its common stock or other equitysecurities other than as to the shares of common stock issuable upon conversionof the debentures described above.

 

(c)                Notapplicable.

 

(d)               Notapplicable.

 

**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 on September 9, 2005,filed its Form 10-KSB for the year ended December 31, 2004.

 

Although the Companyintends to seek waivers or forbearance agreements from the holders of itsdebentures, there is no assurance that the Company will receive suchconcessions.  If the Company is unable toobtain such concessions, the aggregate amount payable under the outstandingdebentures due to the acceleration thereof by reason of the default is equal tothe “Mandatory Prepayment 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.  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.  That amount is outstandingand has not been paid by the Company.

 

The Company has now filedits Amendment #1 to SB-2 and as soon as it is declared effective, will endeavorto resolve the issue of the monthly debenture penalty payments immediatelythereafter or at time of purchase of the remaining $1,600,000 of convertibledebentures.

 

**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.

 

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**Item 5.Other Information**

 

Filing Status ofReports

 

On October 6, 2005,Power3 filed Amendment #1 to SB-2, originally filed in February, 2005, toregister securities underlying a Securities Purchase Agreement dated October 28,2004, as amended.

 

Related Party PromissoryNote

 

OnOctober 17, 2005, the Company executed a promissory note in the principalamount of $39,231 payable to Dr. Ira L. Goldknopf (the “Payee”) who is theChief Scientific Officer, a Director and a Principal Stockholder of theCompany.  Under the terms of the note, the principal amount of thirty ninethousand, two hundred and thirty one dollars ($39,231), (the “Principal”) shallbe due and payable on or before March 6, 2006 (the “Maturity Date”). Should the Principal not be repaid as of March 6, 2006, interest of 6 %per year on any unpaid Principal amount will be earned by the Payee until suchtime as all the Principal amount is repaid.  This Note may be repaid atany time prior to March 6, 2006, without interest or penalty.

 

$150,000 Promissory Note

 

On November 3, 2005, Power3 MedicalProducts, Inc. (“the Company” or “Power3”) executed a promissory note (“theNote”) in the principal amount of $150,000 payable to Trinity FinancingInvestments Corporation (“the Holder”). Pursuant to the Note, the Company promises to pay to the Holder $150,000in cash on March 2, 2006. The Note bears interest at the rate of 11% perannum until the maturity date. After the maturity date, the default rate ofinterest increases to 18% per annum on any portion of the principal amount ofthe Note remaining outstanding.

 

Payment of the Note is secured by personalUnconditional and Continuing Guarantees from both Steven B. Rash, the Company’sChairman and CEO, and Dr. Ira Goldknopf, the Company’s Chief ScientificOfficer and a Director. In addition, Mr. Rash and Mr. Goldknopfexecuted a Stock Pledge Agreement, as security for the Note, in the amount of2,000,000 shares of Power3 common stock. Further, as part of the consideration provided to the Holder for theNote, Trinity Financing Investments Corporation also received seven yearwarrants for the purchase of up to 1,000,000 shares of the Company’s commonstock at an exercise price of $.25 per share, subject to adjustment.   The warrants are exercisable, in whole or inpart, any time from and after the date of issuance of the warrant and prior tothe expiration of seven years following the date of issuance of the warrant.

 

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**Item 6.  Exhibits**

 
| **EXHIBIT NO.** | ** ** | **DESCRIPTION**                                                                                                                                                                                                                                                                                                                                     |
|----------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** **           | ** ** | ** **                                                                                                                                                                                                                                                                                                                                          |
| 10.1                 |       | Form 10-QSB for quarter ended June 30, 2005 as filed on August 22,  2005                                                                                                                                                                                                                                                             |
| 10.2                 |       | Form 8-K/A, as filed on August 29, 2005                                                                                                                                                                                                                                                                                                   |
| 10.3                 |       | Form 10-QSB/A for quarter ended June 30, 2004 as filed on September 9,  2005                                                                                                                                                                                                                                                         |
| 10.4                 |       | Form 10-QSB/A  for quarter ended September 30, 2004 as filed on September 9, 2005                                                                                                                                                                                                                                                    |
| 10.5                 |       | Form 10-QSB/A  for quarter ended March 31, 2005 as filed on September 9, 2005                                                                                                                                                                                                                                                        |
| 10.6                 |       | Form 10-KSB  for year ended December 31, 2004 as filed on September 9, 2005                                                                                                                                                                                                                                                          |
| 10.7                 |       | Amendment #1 to  SB-2 filed October 6, 2005 as filed on October 6, 2005                                                                                                                                                                                                                                                                   |
| 10.8                 |       | Promissory Note,  dated September 5, 2005, executed by Power3 and Cordillera Fund, in the  amount of $200,000 (incorporated by reference to Exhibit 10.3 to the  Company’s Form 8-K filed on September 9, 2005                                                                                                             |
| 10.9                 |       | Promissory Note,  dated September 6, 2005, executed by Power3 and Dr. Ira Goldknopf  in the amount of $80,000 (incorporated by reference to Exhibit 10.2 to  the Company’s Form 8-K filed on September 9, 2005                                                                                                        |
| 10.10                |       | Promissory Note  (Amended version), dated August 29, 2005, executed by Power3 and John  Fife in the amended amount of $446,500 (incorporated by reference to Exhibit 10.1  to the Company’s Form 8-K filed on September 9, 2005                                                                                            |
| 10.11                |       | Collaborative  Research Agreement, dated October 13, 2005 by and between Power3 and  Pfizer Inc. with Pfizer Inc.(incorporated by reference to the Company’s Form 8-K  filed on October 19, 2005.)                                                                                                                              |
| 10.12                |       | Employment  Agreement with John Burton dated September 15, 2005 (incorporated by  reference to Exhibit 10.1 to the Company’s Form 8-K filed on September 21,  2005                                                                                                                                                         |
| 10.13                |       | Exclusive  License Agreement dated effective June 28, 2005, by and between Power3  and Baylor College of Medicine (incorporated by reference to Exhibit 10.1  to the Company’s Form 10-QSB for the quarter ended September 30,  2004                                                                                       |
| 10.14                |       | Patent and  Technology License Agreement dated August 1, 2004, by and between Power3  and The University of Texas System, on behalf of The University of Texas M.D.  Anderson Cancer Center (incorporated by reference to Exhibit 10.2 to the  Company’s Form 10-QSB for the quarter ended September 30, 2004              |
| 10.15                |       | Patent and  Technology License Agreement dated September 1, 2003 by and between The  University of Texas System, on behalf of The University of Texas M.D.  Anderson Cancer Center and Advanced BioChem (incorporated by reference to Exhibit 10.3  to the Company’s Form 10-QSB for the quarter ended September 30,  2004 |
| 10.16                |       | Securities  Purchase Agreement dated October 28, 2004 among the Company and each  purchaser identified therein (incorporated by reference to Exhibit 10.1  to the Company’s Form 8-K filed on November 3, 2004                                                                                                             |
| 10.17                |       | Amendment to  Securities Purchase Agreement dated January 19, 2005, between the  Company and each purchaser identified therein (incorporated by reference to Exhibit 10.8  of the Company’s Registration Statement on Form SB-2 (File No. 122227)                                                                          |
| 10.18                |       | Power3’s  Registration Statement (incorporated by reference to the SB-2 (File No. 122227)  as filed on January 21, 2005                                                                                                                                                                                                              |
| 10.19                |       | Amended and  Restated Employment Agreement for Steven B. Rash (incorporated by reference  to Exhibit 10.1 to the Company’s Form 8-K filed January 5,  2005                                                                                                                                                                      |
|                 |       | Amended and  Restated Employment Agreement for Ira L. Goldknopf, PhD (incorporated by  reference to Exhibit 10.2 to the Company’s Form 8-K filed on January 5,  2005)                                                                                                                                                      |
| 10.20                |       | Collaborative  Research Agreement dated March 21, 2005, by and between New Horizons  Diagnostics and Power3 (incorporated by reference to Exhibit 10.1 to the  Company’s Form 8-K filed on March 28, 2005                                                                                                                  |
| 10.21                |       | Collaborative  Research and Licensing Agreement dated May 17, 2005, by and between  BioSite Incorporated and Power3 (incorporated by reference to Exhibit 10.13  to the Company’s Form 10-KSB filed on September 9, 2005                                                                                                   |

 

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| 31.1*  |   | Certification                              |
|--------|--------|--------------------------------------------|
| 31.2*  |   | Certification                              |
| 32.1** |   | Certification Pursuant to Section 906 |
| 32.2** |   | Certification Pursuant to Section 906 |

 

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  * Filed with this report.** Furnished with this report.

 

(1)          Filed with this report

 

 

**SIGNATURES**

 

Pursuantto the requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.

 
|                          | Power3 Medical  Products, Inc. (Registrant) |
|-------------------------------|--------------------------------------------------|
|                          |                                             |
|                          |                                             |
| Date: November 14,  2005 | By:                                              | /s/ Steven B.  Rash |   |
|                          | Steven B. Rash                                   |
|                          | Chairman and  Chief Executive Officer            |
|                               |                                                  |  |  |  |

 

 

Pursuantto the requirements of the Exchange Act, this report has been signed by thefollowing persons in the capacities and on the dates indicated.

 
| **Signature**      | ** ** | **Title**                | ** **                | **Date** |
|--------------------|------------|--------------------------|---------------------------|----------|
|               |       |                     |                      |     |
| /s/ Steven B. Rash |       |                     | Chairman and              |     | November 14, 2005 |
| Steven B. Rash     |       | Chief Executive  Officer |                      |     |
|               |       |                     |                      |     |
| /s/ John P. Burton |       |                     | Chief Accounting  Officer |     | November 14, 2005 |
| John P. Burton     |       | and Controller           |                      |     |

 

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