SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549



FORM 10-KSB/A

(Amendment Number 3)



ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES

EXCHANGE ACT OF 1934

For the Fiscal Year Ended September 30, 2007

Commission File No. 2-95626-D



SIONIX CORPORATION

(Name of small business issuer in its charter)



|                                                           |                       
|---------------------------------------------------------- | ----------------------
|Nevada                                                     | 87-0428526            
|(State or other jurisdiction of                            | (I.R.S. Employer      
|incorporation or organization)                             | Identification Number)
|                                                           |                       
|2801 Ocean Park Blvd., Suite 339, Santa Monica, California | 90405                 
|(Address of principal executive offices)                   | (Zip Code)            



Issuers Telephone Number:  (847) 235-4566

Securities registered under Section 12(b) of the Exchange Act: NONE

Securities registered under Section 12(g) of the Exchange Act:

COMMON STOCK, PAR VALUE $.001 PER SHARE

(Title of Class)

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

Check if there is no disclosure of delinquent filers in response to Item 405 of Regulation S-B is not contained in this form, and no disclosure will be contained, to the best of registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-KSB or any amendment to this Form 10-KSB. þ

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

The issuers revenues for the year ended September 30, 2007 were $0.

The aggregate market value of the voting stock held by non-affiliates as of January 16, 2009, computed based on the closing price reported on the OTC Bulletin Board, was $13,668,462.

As of January 16, 2009, there were 136,684,616 shares of Common Stock of the issuer outstanding.

Documents Incorporated by Reference: NONE

Transitional Small Business Disclosure Format (Check one): Yes  ̈ No þ















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EXPLANATORY NOTE

On August 28, 2009 we disclosed that on August 7, 2009, our board of directors, in consultation with its then independent registered public accounting firm, concluded that there were errors in our financial statements for the fiscal years ended September 30, 2007 and September 30, 2008, as well as errors in certain of the interim financial statements for those years, and that the financial statements needed to be restated. The errors include the following:

(i)

On May 28, 2008 we determined that, due to the oversubscription of common stock, the conversion feature of the convertible notes and all of the warrants and options that we issued required reclassification from equity to a liability for the fiscal year ended September 30, 2007 and the quarter ended December 31, 2007. These financial statements had been restated and included in Amendment No. 2 to the Annual Report on Form 10-K for the fiscal year ended September 30, 2007 and Amendment No. 1 to the Quarterly Report on Form 10-Q for the quarter ended December 31, 2007 that were filed with the Securities and Exchange Commission on February 3, 2009 and February 18, 2009, respectively. We have since performed additional analysis and determined that the conversion feature required liability classification using the fair value due to the anti-dilution term within the Secured Convertible Promissory Notes we issued from October 2006 to February 2007.

(ii)

On May 28, 2008 we determined that the conversion feature included in compensation to be paid to the members of our Advisory Board should have been calculated using the fair value method and restated our financial statements for the fiscal year ended September 30, 2007 and December 31, 2007 to include that information. Subsequently, we performed additional analysis and determined that the conversion feature required the use of the intrinsic value method.

The primary purpose of this Amendment No. 3 to our Annual Report on Form 10-K for the fiscal year ended September 30, 2007 (the Original Report) is to disclose the restatement of our financial statements. A complete discussion of the restatement is included in the section of this Amendment No. 3 titled Managements Discussion and Analysis of Financial Condition and Plan of Operation and in note 17 to our restated financial statements for the fiscal year ended September 30, 2007. As a result of the restatement, the following adjustments were made to our financial statements for the fiscal year ended September 30, 2007:





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|                                                                       |  |   |                      |   |   |                                |   |   |                       |   |   |                            |  
|---------------------------------------------------------------------- |  | - | -------------------- | - | - | ------------------------------ | - | - | --------------------- | - | - | -------------------------- | -
|                                                                       |  |   | As
Previously
Stated |   |   | Benficial
Conversion 
Features |   |   | Warrants
and
 Options |   |   | As Restated
June 30,
 2007 |  
|Balance Sheet                                                          |  |   |                      |   |   |                                |   |   |                       |   |   |                            |  
|Accrued expenses                                                       |  | $ | 2,068,114            |   | $ | 195,559                        |   | $ |                     |   | $ | 2,263,673                  |  
|Warrant and option liability                                           |  |   | 2,426,846            |   |   |                              |   |   | 703,885               |   |   | 3,130,731                  |  
|Beneficial conversion liability                                        |  |   | 2,006,812            |   |   | 30,210,100                     |   |   |                     |   |   | 32,216,912                 |  
|Additional paid-in capital                                             |  |   | 10,762,982           |   |   |                              |   |   | 334,746               |   |   | 11,097,728                 |  
|Deficit accumulated during developmental stage                         |  |   | (18,020,836          | ) |   | (30,405,659                    | ) |   | (1,038,631            | ) |   | (49,465,126                | )
|                                                                       |  |   |                      |   |   |                                |   |   |                       |   |   |                            |  
|Statement of Operations (for the year ended September 30, 2007)        |  |   |                      |   |   |                                |   |   |                       |   |   |                            |  
|Gain (loss) on change in fair value of warrant and option liability    |  | $ | 469,311              |   | $ |                              |   | $ | (140,838              | ) | $ | 328,473                    |  
|Gain (loss) on change in fair value of beneficial conversion liability |  |   | (4,044               | ) |   | 4,168,621                      |   |   |                     |   |   | 4,164,577                  |  
|General and administrative                                             |  |   | 1,045,725            |   |   | 4,037,578                      |   |   |                     |   |   | 5,083,303                  |  
|Interest and financing costs                                           |  |   | (942,243             | ) |   | (30,536,702                    | ) |   | (897,793              | ) |   | (32,376,738                | )
|                                                                       |  |   |                      |   |   |                                |   |   |                       |   |   |                            |  
|Statement of Operations (since inception)                              |  |   |                      |   |   |                                |   |   |                       |   |   |                            |  
|Gain (loss) on change in fair value of warrant and option liability    |  | $ | 469,311              |   | $ |                              |   | $ | (140,838              | ) | $ | 328,473                    |  
|Gain (loss) on change in fair value of beneficial conversion liability |  |   | (4,044               | ) |   | 3,918,075                      |   |   |                     |   |   | 3,914,031                  |  
|General and administrative                                             |  |   | 13,329,505           |   |   | 3,787,032                      |   |   |                     |   |   | 17,116,537                 |  
|Interest and financing costs                                           |  |   | (1,176,929           | ) |   | (30,536,702                    | ) |   | (897,793              | ) |   | (32,611,424                | )
|                                                                       |  |   |                      |   |   |                                |   |   |                       |   |   |                            |  
|Statement of Cash Flows (for the year ended September 30, 2007)        |  |   |                      |   |   |                                |   |   |                       |   |   |                            |  
|Net loss                                                               |  | $ | (2,168,226           | ) | $ | (30,405,659                    | ) | $ | (1,038,631            | ) | $ | (33,612,516                | )
|(Gain) loss on change in fair value of warrant and option liability    |  |   | (469,311             | ) |   |                              |   |   | 140,838               |   |   | (328,473                   | )
|(Gain) loss on change in fair value of beneficial conversion liability |  |   | 4,044                |   |   | (4,168,621                     | ) |   |                     |   |   | (4,164,577                 | )
|Change in accrued expenses                                             |  |   | 1,445,946            |   |   | 576,000                        |   |   |                     |   |   | 2,021,946                  |  
|Non-cash compensation expense                                          |  |   |                    |   |   | 3,461,578                      |   |   |                     |   |   | 3,461,578                  |  
|Non-cash financing costs                                               |  |   |                    |   |   | 30,536,702                     |   |   | 897,793               |   |   | 31,434,495                 |  
|                                                                       |  |   |                      |   |   |                                |   |   |                       |   |   |                            |  
|Statement of Cash Flows (since inception)                              |  |   |                      |   |   |                                |   |   |                       |   |   |                            |  
|Net loss                                                               |  | $ | (18,020,836          | ) | $ | (30,405,659                    | ) | $ | (1,038,631            | ) | $ | (49,465,126                | )
|(Gain) loss on change in fair value of warrant and option liability    |  |   | (469,311             | ) |   |                              |   |   | 140,838               |   |   | (328,473                   | )
|(Gain) loss on change in fair value of beneficial conversion liability |  |   | 4,044                |   |   | (4,168,621                     | ) |   |                     |   |   | (4,164,577                 | )
|Change in accrued expenses                                             |  |   | 2,006,812            |   |   | 576,000                        |   |   |                     |   |   | 2,582,812                  |  
|Non-cash compensation expense                                          |  |   |                    |   |   | 3,461,578                      |   |   |                     |   |   | 3,461,578                  |  
|Non-cash financing costs                                               |  |   |                    |   |   | 30,536,702                     |   |   | 897,793               |   |   | 31,434,495                 |  

Changes have also been made to the following items, either to correct, enhance or clarify information:

Part I

Item 1.

Description of Business, including the section titled Cautionary Factors that may Affect Future Results

Item 1A.

Risk Factors

Item 2.

Description of Property

Item 8A.

Controls and Procedures

This Amendment No. 3 includes information contained in the Original Report, and we have made no attempt in this Amendment No. 3 to modify or update the disclosures presented in the Original Report, except as identified above.

The disclosures in this Amendment No. 3 continue to speak as of the date of the Original Report, and do not reflect events occurring after the filing of the Original Report. Accordingly, this Amendment should be read in conjunction with our other filings made with the Securities and Exchange Commission subsequent to the filing of the Original Report, including any amendments to those filings. The filing of this Amendment No. 3 shall not be deemed to be an admission that the Original Report, when made, included any untrue statement of a material fact or omitted to state a material fact necessary to make a statement not misleading.



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PART I

ITEM 1

DESCRIPTION OF BUSINESS.

We design and develop turn-key stand-alone water treatment systems for: municipalities (both potable and wastewater), industrial (both make-up water and wastewater), emergency response, military and small residential communities. Sionix was initially incorporated in Utah in 1996, and reincorporated in Nevada in 2003. As of December 21, 2009, our executive offices and principal operations are located at 2801 Ocean Park Blvd., Suite 339, Santa Monica, California 90405. Our telephone number is (714) 678-1000, and our website is located at www.sionix.com.

The Water Purification Industry

INDUSTRY BACKGROUND. The water purification industry is highly fragmented, consisting of many companies involved in various capacities, including companies that design fully integrated systems for processing millions of gallons of water for municipal, industrial, and commercial applications. Demand for water purification has continued to grow due to economic expansion, population growth, scarcity of usable water, concerns about water quality and regulatory requirements. Drinking water, regardless of its source, may contain impurities that can affect the health of consumers. Although municipal agencies and water utilities in the United States are required to provide drinking water that complies with the U.S. Safe Drinking Water Act, the water supplied to homes and businesses from municipalities and utilities may contain high levels of bacteria, toxins, parasites and human and animal-health pharmaceuticals, as well as high levels of chlorine used to eliminate contaminants. The quality of drinking water outside the United States and other industrialized countries is generally much worse, with high levels of contaminants and often only rudimentary purification systems. In the industrialized world, water quality is often compromised by pollution, aging municipal water systems, and contaminated wells and surface water. In addition, the specter of terrorism directed at intentional contamination of water supplies has heightened awareness of the importance of reliable and secure water purification. The importance of effective water treatment is also critical from an economic standpoint, as health concerns and impure water can impair consumers' confidence in food products. Discharge of impaired waters to the environment can further degrade the earth's water and violate environmental laws, with the possibility of significant fines and penalties from regulatory agencies.

There are over 200,000 public rural water districts in the United States. The great majority of these are considered small to medium-sized public water systems, which support populations of fewer than 10,000 people. A substantial portion of these are in violation of the Safe Drinking Water Act at any given time. This problem is expected to worsen, as more stringent EPA rules are implemented for small public water systems. Substantial expenditures will be needed in coming years for repair, rehabilitation, operation, and maintenance of the water and wastewater treatment infrastructure. The Company believes that water districts using conventional sand-anthracite filters will be unable to comply with the Clean Water Act without massive installations of on-site chemical filter aids and disinfection equipment, such as ozone or ultraviolet. On a worldwide level, water supply issues are viewed by many as the next global crisis; while the quantity of available fresh water is relatively fixed, the world population and demand for clean water is increasing at a rapid pace.

The market for the treatment and purification of drinking water and the treatment, recycling and reuse of wastewater has shown significant growth as world demand for water of specified quality continues to increase and as regulations limiting waste discharges to the environment continue to mount. In addition, urbanization in the third world and the spread of agricultural activities has increased the demand for public water systems.

EXISTING PURIFICATION SYSTEMS. Until the early twentieth century, municipal water supplies consisted of flowing water directly from the source to the end user with little or no processing. In the late 19th and early 20th century, most large municipal water systems instituted a form of filtration called"slow sand filtration" to enhance the clarity and esthetics of delivered waters. These municipal water filtration systems however were extremely large plants that are typically excavated into the landscape of the facility. The surface area required for these filters could vary widely depending on the input quality of the water; generally, this involves extremely large areas or footprints. In a typical treatment facility, the first step adds to the raw incoming water a substance which causes tiny, sticky particles (called"floc") to form - these attract dirt and other particles suspended in the water. This process of coagulation results in the heavy particles of dirt and floc clumping together and falling to the bottom. These heavier particles form sediment which is siphoned off, leaving the clearer water, which passes on to filtration. The most common filtration method is known as"slow sand" or sand-anthracite, in which the water flows into large shallow beds and passes down through layers of sand, gravel and charcoal. The final process is disinfection, which is



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intended to kill bacteria or other microorganisms left in the water and leave a residual to keep the water safe through the delivery pipes to the customer. Chlorine is the most commonly employed disinfectant, although chloramine, ozone, and ultraviolet (UV) are also used.

The current trend in water filtration, due to the higher demands for water and the reduction in clean or relatively clean source waters, is to clarify and heavily filter all municipal water supplies. Smaller municipalities and water districts will also be required to meet the added water quality goals of the larger systems and will require the infrastructure to do so.

While"slow sand" filtration is by far the most common treatment method used in the United States, it has serious drawbacks. The treatment facilities themselves occupy large tracts of land. The filtration beds are large, shallow in-ground concrete structures, often hundreds of feet long to accommodate large volumes of water. The water being filtered must remain in these beds for a comparatively long-time (known as"residence time") in order for low density materials to settle out. The sand and charcoal filtering medium rapidly becomes plugged and clogged. The bed must then be taken off-line and back-flushed, which uses large volumes of water - water which becomes contaminated and is therefore wasted. Additional settling ponds are necessary to"de-water" this waste by evaporation so that the dried solids may be disposed of in an environmentally and expensive method.

The average life expectancy of a treatment plant is about 20 years, after which the plant must be extensively renovated. Population growth necessitates enlarging old facilities or building new ones, occupying still more valuable land. This process requires lengthy environmental impact studies, long design periods, and complex financing programs to fund costly construction budgets, as lead times usually stretch out for years.

Aside from cost and logistical issues, however, there are many pathogens resistant to chlorine or small enough to pass through these existing methods of filtration. Illnesses such as hepatitis, gastroenteritis, Legionnaire's Disease, as well as increasingly pervasive chemical contaminants, have become increasingly common. One of the more difficult of these problems is monitoring and providing a barrier against microscopic protozoan parasites such as cryptosporidium (3-4 microns in size) and Giardia lamblia oocysts (5-7microns). These common organisms exist naturally in the digestive systems of livestock and wild animals, and end up in lakes and streams. They have caused severe illness in millions of people in the United States. Conventional"slow sand" water filtration beds, used in most of the nation's public water districts, will not filter out these parasites - the best treatment facilities are only able to remove particles larger than 10-15 microns.

In recent years, there have been several serious public health emergencies caused by microbes breaking through the filtration barrier in treatment facilities. When ingested, they can cause diarrhea, flu-like symptoms and dehydration. In persons with immune system impairment, the illness can be life-threatening. In 1993, over 400,000 people in Milwaukee, Wisconsin became ill and about 100 people died during a failure in the drinking water filtration system.

Most surface water bodies in the United States, many of which supply drinking water, are contaminated with these organisms. They are extremely resistant to disinfection, and increasing disinfectant levels in the attempt to kill them creates a new set of problems. Disinfectants such as chlorine can react with organic matter in the water to form new chemicals known as"disinfection byproducts" . These byproducts, of which trihalomethanes (THM's) are the most common, are thought to be health-threatening and possibly cancer-causing. Recent modifications in the EPA-SDWA regulations have addressed minimum acceptable levels of THM's. Therefore, physical removal of the organisms from the water is vitally important to their control.

The challenge of removing organic matter from water has been at the crux of water treatment since antiquity. Organic matter causes water to be cloudy, or turbid. High levels of turbidity can indicate the presence of pathogens and signal that the filtration process is not working effectively. The presence of high levels of organic matter makes disinfection more difficult and clogs filter media, causing long back-flush cycles, which in turn increases the volume of back-flush waste-water. In a typical treatment plant, this back-flush water can account for up to 20 percent of the raw water volume flowing through the facility.

Other filtration methods, such as reverse osmosis and activated charcoal, may be required to remove contaminants such as organic and inorganic chemicals, salts, color, odors, and viruses. However, they too are clogged quickly by organic particles in the water. These filter media are comparatively expensive, and frequent back-flush cycles drastically shorten filter life, thereby increasing the cost of treatment.



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Products and Technology

OUR BUSINESS STRATEGY. Sionix was formed to develop advanced water treatment technology for public and private potable drinking water systems and wastewater treatment systems, as well as industrial systems, in order to address these issues. We have initially targeted (1) small to medium public and private water districts that provide communities with drinking water or sewage treatment service and (2) water reclamation systems of commercial-industrial clients that create and dispose of contaminated wastewater.

DISSOLVED AIR FLOTATION. Dissolved air flotation, or DAF, has been used in water and wastewater treatment for more than eighty years, primarily in Europe. Some of the first systems installed in the 1920's are still in operation in Scandinavia. The DAF method involves injecting microscopic bubbles of air under pressure into the water being treated. The air molecules bond with organic matter in the water, and because of their lightness, the clumps float to the surface, where they are skimmed away. Over the eight decades this technology has been utilized, various improvements have been made in the technology. Until recently, it has not been utilized widely in the United States, and is used primarily for wastewater treatment.

SIONIX "ELIXIR" WATER TREATMENT SYSTEMS. The dissolved air flotation system developed by Sionix, which employs patented technology, removes more than 99.95+ percent of the organic particles in water, and provides a barrier against microbial contaminants such as cryptosporidium and Giardia lamblia. Each Elixir Water Treatment System is a self-contained water treatment system or pre-treatment process using ordinary air, with minimal chemical flocculent aids. Our goal is to provide effective, practical and economical solutions to problems caused by pollution and toxic chemicals that seriously threaten public health and our environment. Our systems significantly reduce the risk of bacterial or parasitic contamination, particularly cryptosporidium, giardia, and e-coli, with minimal disinfecting by-products. Our systems are designed for quick installation, easy access for simple maintenance and are cost-effective for even the smallest water utilities or commercial applications. This technology is designed to support public water treatment plants, sewage treatment plants, water reclamation facilities, commercial air conditioning cooling towers, and emergency water systems for floods, earthquakes and other natural disasters. The Sionix system occupies a small footprint, is self-contained and portable.

Our Elixir system utilizes and refines this technology for a highly efficient pre-treatment process using ordinary oxygen. In addition, it helps ordinary filters meet EPA Safe Drinking Water Act regulations and eliminates potentially cancer-causing disinfection by-product precursors while reducing the risk of bacterial or parasitic contamination, particularly Trihalomethanes ("THM"), cryptosporidium and giardia. The Elixir system is designed for quick installation, is easily accessed for simple maintenance and is cost-effective enough for even the smallest water utilities or commercial applications.

By significantly reducing turbidity, the Elixir system remediates against disinfection byproducts such as THM. Used in conjunction with filtration or disinfection technology which may be required by specific raw water conditions, it reduces back-flushing cycle times, thereby lengthening the life of post-DAF equipment.

Completely modular, we plan to customize each system installation with filtration and disinfection options appropriate for the user. The entire unit is built into a standard thirty-foot or forty-foot ISO transportable container, making it easy to move by truck, train, plane, helicopter, or ship. Standard configuration includes a small control and testing laboratory located in the front of the container. The addition of a generator module makes the system self-powered. The customer can operate and control the entire system from a remote site via hardwired or wireless communications. A comprehensive service and maintenance program (which will be part of all equipment leases) includes a standard upgrade path.

A single unit should produce a minimum of 225 gallons of potable water per minute (about 325,000 gallons, or one acre-foot, per day), enough for a community of 2,400 people and its infrastructure - which is about 500-600 homes in the United States, based on U.S. Government guidelines. It is important to note that per capita usage of water in the U.S. is among the highest in the world. Two or more units can be ganged together for increased capacity.

Our systems are ideal for small to medium-sized potable water treatment utilities. They serve equally well in commercial/industrial uses where incoming process water must be treated to high levels of purity, or wastewater must be decontaminated before discharge to the environment. The products can also address water quality issues faced by commercial and industrial facilities that process water or produce toxic wastewater, such as food and beverage processing plants, dairy products facilities, and fresh water aquaculture installations, such as fish farms.



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A major problem facing the water treatment industry is the difficulty in monitoring and disposing of microscopic parasites such as Cryptosporidium (4-5 microns) and Giardia cysts (7-12 microns), common chlorine-resistant organisms that have infected millions of people in the United States. Sand-anthracite water filtration beds, in use in most of the nation's public water districts, will not filter out these parasites and experience frequent breakthroughs of Cryptosporidium sized particles.

Our system uses a more efficient method of saturating recirculated post-filter water with excess dissolved air, and injecting this excess air in the form of microscopic bubbles in a DAF particle separator. Pressurized water can hold an excess amount of dissolved air and forms microscopic bubbles when injected into water, which has a lower pressure. A booster pump recirculates a small amount (approximately 10%) of the post-filtered water through the dissolved air-saturation system. Oxygen and nitrogen molecules are transferred directly into the recirculated high-pressure water without forming air bubbles. This method of transferring air into water is 100% efficient, and reduces the amount of energy required to saturate recirculated water with excess dissolved air. The Elixir provides a denser concentration of white water bubbles. This process requires less energy than a conventional system, and uses a fraction of the floor space.

In general, water districts using sand-anthracite filters cannot meet the EPA Surface Water Treatment rules without a massive increase in on-site chemical filter-aids, additional filtering and the installation of ozone or other disinfection equipment. Plant operators must continually test raw influent water to adjust chemical filter aid dosage properly. Chemical and metal (alum) filter-aids increase sludge volume and landfill disposal problems.

Our systems include automatic computer controls to optimize ozone concentration levels and reduce monthly energy costs. Higher ozone contact concentration levels using smaller sized generators are possible if most of the algae are removed first by DAF. Extended contact time increases collision rate of ionized ozone molecules with negatively charged organic suspended particles. By utilizing the Elixir to pre-treat the feedwater, less energy is required to create the appropriate amount of ozone. By creating a turbulent flow of water and gas within the mixing chamber, we have achieved a much higher saturation with less ozone (and a minimum of excess ozone) than in other mixing methods.

The Elixir system is a sealed unit, thus preventing tampering or incursion by bio-terrorism or airborne contaminants due to the steel container in which the system is assembled. Should catastrophic damage be incurred, a replacement unit may be installed within a few days rather than many months or years with in-ground systems.

Pilot Program-Villa Park Dam

In November of 2006 we entered into an oral agreement with the Serrano Water District in Orange County, California to install an Elixir system at the Villa Park Dam (near Anaheim, California) for testing of the system by processing flood water residue behind the dam. Under our arrangement, scientists and engineers from California State University at Fullerton are coordinating with the Serrano Water District to trace and record the cleaning efficiency for the various contaminants in the water (thought to be iron, manganese and algae) against the flow rate capacity of the Elixir system. The system placed at the dam site was designed by Sionix for research purposes and contains a variety of sampling sites within the system to extract and test water outside the system, as well as a suite of internal water quality measurement instruments to monitor the cleaning process.

Villa Park Dam is operated by Orange County Flood Control and is designed to check the flow of flood waters from several small watersheds in the northern Santa Ana Mountains. The dam is capable of impounding up to 15,000 acre-feet of water (4.9 billion gallons), although its purpose is to check and safely release the waters during periods of heavy rainfall into Santiago Creek, where it is diverted to groundwater recharge ponds or allowed to discharge to the ocean. Serrano Water District has rights to 3,000 acre-feet of water from the impoundment pool. Until now, impounded waters have been released to flow downstream during storms. However, under the project, rain and other water will flow down creeks and collect to form a useable pool of water behind the dam. This water slowly degrades during the summer and has been shown to be very septic and has exceptionally high values of iron and manganese. This water has been prohibitively expensive to treat for drinking water.

In May of 2007 we placed an Elixir system at the dam and began processing runoff water. We began a thorough evaluation of every component in the system during this testing period. Data are being used to evaluate the baseline water quality to be treated, as part of an ongoing water collection and analysis study of the Elixir water treatment system. Several testing and research programs to evaluate the treatment system have been implemented and will continue throughout the remainder of 2008.



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During the next twenty-four months we plan to continue our testing program and demonstrate the ELIXIR water treatment system to potential clients at the Villa Park Dam under our arrangement with the Serrano Water District. We believe that this operation will position us to aggressively market the ELIXIR product. We plan to use these demonstrations as a model for operation and installation. Once we have sufficient financing, we plan to engage in promotional activities in connection with the operation of the unit, including media exposure and access to other public agencies and potential private customers. With the successful operation of the ELIXIR, we believe we will begin to receive orders for units. We have demonstrated this unit to over fifty prospective clients.

Marketing and Customers

THE MARKET. The potable water market includes residential, commercial, and food service customers. Demand is driven both by consumers' desire to improve the taste and quality of their drinking water and by the expanded concern of regulatory agencies. Water safety concerns have driven the growth of the consumer bottled water market to over $2 billion in the United States, as well as the growth in the water filtration market.

According to industry data, it is estimated that one billion people in the world do not have safe drinking water. Demand is driven both by consumers' desire to improve the taste and quality of their drinking water and by the expanded concern of regulatory agencies. There is significant market potential in Asian, Pacific and Latin American countries, where the quality of drinking water has been found to be severely deficient in several regions.

In the United States, the Company plans to initially target the established base of small to medium water providers, as well as industrial users (such as the dairy industry, meat and poultry producers, cruise ship operators, food and beverage processors, pharmaceuticals, cooling tower manufacturers and oil and gas producers) and disaster relief agencies with a need for a clean and consistent water supply. Outside the United States, the Company plans to market principally to local water systems and international relief organizations.

The Company's marketing efforts emphasize that its products are easily expandable and upgradable; for example, adding ozone and microfiltration equipment to a DAF unit is similar to adding a new hard drive to a personal computer. Each piece of equipment comes with state-of-the-art telemetry and wet-chemistry monitoring that expands as the system does. The Company plans to provide lease financing for all of its products, not only making it easy for a customer to acquire the equipment, but also guaranteeing that the customer will always have access to any refinements and improvements made to the Company's products.

Pilot study requirements and potential adverse environmental effects can generally be more easily addressed with Sionix' prepackaged plant approach. The company's initial approach to the market place is to supply the best of practice process for the largest number of water types encountered. The following is a brief description of the types of customers to be targeted:

DOMESTIC WATER UTILITIES. There are approximately 197,060 public rural water districts in the United States. The great majority of these are considered small to medium-sized public water systems, which support populations of fewer than 10,000 people. We believe that the Elixir system can provide a comprehensive solution for these utilities. It avoids most of the above problems, occupies a small footprint, and is self-contained and portable. Equally important, in most cases, it does not require costly and time consuming environmental studies.

INDUSTRIAL WASTEWATER PURIFICATION. Many industries use water in their manufacturing process which results in contamination. This wastewater must be treated and purified before it can be reused or released into the ocean or streams. Principal markets are: pharmaceutical manufacturers, producers of paper products, the dairy industry, and silicon chip manufacturers. The small footprint, low cost, and predictably efficient output of the Elixir system make it an excellent choice for customers in these markets.

FOOD AND BEVERAGE INDUSTRY. The production of beer and wine, soft drinks, and food products require water of a specific purity that must be controlled and monitored as part of the production process. The food service industry has an increasing need for consistent global product quality. Food service includes water used for fountain beverages, steam ovens, coffee and tea.

HEALTHCARE INDUSTRY. Hospitals require clean, uncontaminated water for their normal day-to-day operations. They also produce contaminated water that may require treatment before being reused or released. The Sionix Elixir system will process waste-water to a specific and controlled purity. The systems can be used to filter water going into or coming out of use. In such exacting situations, the customer may be able to reuse contaminated water or ensure decontamination before discharge.



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WASTEWATER UTILITIES (SEWAGE TREATMENT). The Elixir system can treat any degree of contamination. Sewage overflows are a major problem in many communities. The unit can function as a cost-effective emergency alternative to mitigate the problem of overflows.

THIRD-WORLD MARKETS. In addition to the domestic market, fast spreading urbanization in third-world countries has created a growing demand for public water systems. Most of the fatal waterborne illnesses occur in these countries. Industrial and agricultural contamination of water supplies is epidemic because environmental controls are neither adequate nor well enforced.

EMERGENCIES AND NATURAL DISASTERS. During natural disasters such as earthquakes, floods, hurricanes, and tornadoes, it is the role of the National Guard and the Federal Emergency Management Agency (FEMA) to assist local authorities with emergency services. Damage to local utilities can disrupt the drinking water supply and cause the failure of wastewater (sewage) treatment plants. The Elixir system can help address both of these problems. The system is completely self-contained, can be easily transported from place to place, is highly efficient, and can be equipped with its own power package.

DESALINIZATION. Reverse osmosis (RO) is among the most efficient desalinization processes available today. An RO desalinization system requires prefiltration to reduce clogging of the filter membrane by organic matter. Placed in front of an RO filter unit in a desalinization system, the Elixir unit will greatly lengthen the time between costly back-flushes and prolong the life of the RO filters.

MARKETING METHODS. We plan to market our products through participation in industry groups, selected advertising in specialized publications, trade shows, and direct mail. Sionix initially will utilize in-house marketing in conjunction with outsourced marketing consultants and national and international distributorships.

Patents

We hold eight U.S. patents on technology incorporated into the Elixir system and related components, with an additional two patents pending. Our patents cover process, system and waste handling, an automatic backflushing system using air pressure to activate the valves, the ozone mixing system, and the inline wet-chemistry water quality monitoring system. The extent to which patents provide a commercial advantage, or inhibit the development of competing products, varies. We plan to be aggressive in securing additional patents to further protect and position Sionix for the future. We also rely on common law concepts of confidentiality and trade secrets, as well as economic barriers created by the required investments in tooling and technical personnel and the development of customer relationships, to protect our proprietary products.

Competition

Our products will compete with other producers of water filtration and purification equipment, such as USFilter and Cuno, Inc., many of which are more established and have significantly greater resources. We will also compete with large architectural/engineering firms that design and build water treatment plants and wastewater facilities. In addition to conventional methods such as chlorination and ozonation, our products may also compete with other new technologies for water filtration. Competitive factors include system effectiveness, operational cost and practicality of application, pilot study requirements and potential adverse environmental effects. In competing in this marketplace, we have to address the conservative nature of public water agencies and fiscal constraints on the installation of new systems and technologies.

Regulatory Matters

Process water treatment plants and wastewater plants must comply with clean water standards set by the Environmental Protection Agency under the authority of the Clean Water Act and standards set by states and local communities. In many jurisdictions, including the United States, because process water treatment facilities and wastewater treatment systems require permits from environmental regulatory agencies, delays in permitting could cause delays in construction or usage of the systems by prospective customers.

In 1974, the Safe Drinking Water Act (SDWA) was passed. It empowered the EPA to set maximum levels of contamination allowable for health-threatening microbes, chemicals, and other substances which could find their way into drinking water systems, and gave the agency the power to delegate enforcement.

By 1986, Congress was dissatisfied with the speed with which the EPA was regulating and enforcing contaminant



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limits. The SDWA revision that year set rigid timetables for establishing new standards and ordered water systems to monitor their supplies for many substances not yet regulated by EPA standards.

Additionally, it limited polluting activities near public groundwater wells used as drinking water sources - an acknowledgment of the growing threat to underground water supplies. It named 83 contaminants and set out a program for adding 25 more every three years, as well as specifying the"best available technology" for treating each contaminant.

The timetable for imposing these regulations was rigid and tended to treat all contaminants as equally dangerous, regardless of relative risk. The cost to water districts for monitoring compliance became a significant burden, especially to small or medium-sized districts. The 1986 law authorized the EPA to cover 75 percent of state administrative costs, but in actuality, only about 35 percent was funded.

Congress updated the SDWA again in 1996, improving on the existing regulations in two significant ways. First, they changed the focus of contaminant regulations to reflect the risk of adverse health effects, the rate of occurrence of the contaminant in public water systems, and the estimated reduction in health risk resulting from regulation. Along with this, a thorough cost-benefit analysis must be performed by the EPA, with public health protection the primary basis for determining the level at which drinking water standards are set. Second, states were given greater flexibility to implement the standards while arriving at the same level of public health protection. In addition, a revolving loan fund was established to help districts build necessary improvements to their systems.

Research and Development

Research and development expenses for the year ended September 30, 2007 were $526,466. Research and development consists of fine-tuning the Elixir system for customer requirements, and making adjustments based on testing results. Our policy is to capitalize only the direct costs associated with tooling for new products. All other costs, including salaries and wages of employees included in research and development, are expensed as incurred.

Manufacturing and Raw Materials

We have established our initial manufacturing and research and development facility in Anaheim, California to commence production of the ELIXIR water treatment systems. For those parts to be supplied by outside sources, we plan to specify parts from multiple sources for independence from manufacturers and distributors.  Raw materials to be used will include bronze, brass, cast iron, steel, PVC and plastic, and are available from multiple sources.

Employees

We have six full-time employees, none of whom are covered by any collective bargaining agreement. The Company considers its relationship with its employees to be good.

CAUTIONARY FACTORS THAT MAY AFFECT FUTURE RESULTS

The disclosure and analysis in this report and in our other reports, press releases and public statements of our officers contain some forward-looking statements. Forward-looking statements give our current expectations or forecasts of future events, and may be identified by the fact that they do not relate strictly to historical or current facts. In particular, forward-looking statements include statements relating to future actions, prospective products or new product acceptance in the marketplace, future performance or results of current and anticipated products, sales efforts, expenses, and the outcome of contingencies and financial results. Many factors discussed in Part I of this report will be important in determining future results. We will have little or no control over many of these factors and any of these factors could cause our operating results and gross margins, and consequently the price of our common stock, to fluctuate significantly.

Any or all forward-looking statements in this report, or any other report, and in any other public statements may turn out to be wrong. They can be affected by inaccurate assumptions or by known or unknown uncertainties. No forward-looking statement can be guaranteed, and actual results may differ materially. We undertake no obligation to publicly update forward-looking statements, except as required by law. Shareholders are advised to consult further disclosures on related subjects on our other reports filed with the Securities and Exchange Commission. The following cautionary discussion of risks, uncertainties and possible inaccurate assumptions are factors that our management believes could cause actual results to differ materially from expected and historical results. Factors other than those included below could also adversely affect our business results. The following discussion is



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provided pursuant to the Private Securities Litigation Reform Act of 1995.

Prospective investors should carefully consider the following risk factors in evaluating our business. The factors listed below represent certain important factors that we believe could cause our business results to differ. These factors are not intended to represent a complete list of the general or specific risks that may affect us. It should be recognized that other risks may be significant, presently or in the future, and the risks set forth below may affect us to a greater extent than indicated.

Risks Related To Our Company

We have never generated any revenues.

Although we have been in business for more than ten years, we have never generated any revenues from operations. We have been in a development stage since inception, and have yet to manufacture products for sale to customers. All of our working capital has been generated by sales of securities and loans.

We have a history of operating losses, which may continue.

We have a history of losses and may continue to incur operating and net losses for the foreseeable future. We incurred a net loss of $33,612,516for the year ended September 30, 2007 and a net loss of $1,049,319 for the year ended September 30, 2006. As of September 30, 2007 our accumulated deficit was $49,465,126. We have not achieved profitability on a quarterly or on an annual basis. We may not be able to generate revenues or reach a level of revenue to achieve profitability.

Our future financial results, including our expected revenues, are unpredictable and difficult to forecast.

If we begin to generate revenues, it is likely that our revenues, expenses and operating results will fluctuate from quarter to quarter, which could increase the volatility of the price of our common stock. We expect that our operating results will continue to fluctuate in the future due to a number of factors, some of which are beyond our control. These factors include:

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Our ability, thus far unproven, to sell our products.

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If we receive orders for products, our ability to complete those orders in a timely fashion.

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The costs we will incur in manufacturing products.

·

The costs of marketing our products, including customer relations and warranty repairs.

Due to all of these factors, our operating results may fall below the expectations of investors, which could cause a decline in the price of our common stock.

We will need to raise additional capital to meet our business requirements in the future and such capital raising may be costly or difficult to obtain and could dilute current stockholders ownership interests.

We will need to raise additional capital in the future, which may not be available on reasonable terms or at all. The raising of additional capital may dilute our current stockholders ownership interests. Our income from operations will not be sufficient to achieve our business plan. We will need to raise additional funds through public or private debt or equity financings to meet various objectives including, but not limited to:

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pursuing growth opportunities, including more rapid expansion;

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acquiring complementary businesses;

·

making capital improvements to improve our infrastructure;

·

hiring qualified management and key employees;

·

developing new products, accessories and services;

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responding to competitive pressures; and

·

complying with regulatory requirements.



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Furthermore, any additional debt or equity financing that we may need may not be available on terms favorable to us, or at all. Registration rights agreements we have entered into in connection with private placements of our securities provide that we will not, without the prior written consent of the majority of registered holders of such securities, file or request the acceleration of any other registration statement filed with the SEC, subject to certain exceptions, until the SEC has declared the registration statement contemplated by those registration rights agreements effective. In addition, negative covenants in the purchase agreements limit our ability to raise additional capital, including through the incurrence of debt or liens on our properties or the issuance of equity securities that include registration rights. These negative covenants may impair our ability to raise additional capital. If we are unable to obtain required additional capital, we may have to curtail our growth plans or cut back on existing business and, further, we may not be able to continue operating if we do not generate sufficient revenues from operations needed to stay in business.

We may incur substantial costs in pursuing future capital financing, including investment banking fees, legal fees, accounting fees, securities law compliance fees, printing and distribution expenses and other costs. We may also be required to recognize non-cash expenses in connection with certain securities we issue, such as convertible notes and warrants, which may adversely impact our financial condition.

We may be required to pay liquidated damages to certain of our investors under certain circumstances.

We entered into registration rights agreements in connection with private placements of our securities. These registration rights agreements require us to pay partial liquidated damages under certain circumstances if we do not satisfy our obligations under such registration rights agreements, including our obligations to file or obtain or maintain the effectiveness of registration statements as required under these registration rights agreements. If we are unable to satisfy our obligations under these registration rights agreements and we are obligated to pay partial liquidated damages, it may adversely impact our financial condition.

Our auditors have indicated that our inability to generate sufficient revenue raises substantial doubt as to our ability to continue as a going concern.

Our audited financial statements for the period ended September 30, 2007 were prepared on a going concern basis in accordance with United States generally accounting principles. The going concern basis of presentation assumes that we will continue in operation for the foreseeable future and will be able to realize our assets and discharge our liabilities and commitments in the normal course of business. However, our auditors have indicated that our inability to generate revenue raises substantial doubt as to our ability to continue as a going concern. In the absence of revenues, we are seeking to raise additional funds to meet our working capital needs principally through the additional sales of our securities or debt financings. However, we cannot guarantee that will be able to obtain sufficient additional funds when needed or that such funds, if available, will be obtainable on terms satisfactory to us. In the event that these plans cannot be effectively realized, there can be no assurance that we will be able to continue as a going concern.

Failure to maintain effective internal control over financial reporting in accordance with Section 404 of the Sarbanes-Oxley Act of 2002 may result in actions filed against us by regulatory agencies or in a reduction in the price of our common stock.

We are required to maintain effective internal control over financial reporting under the Sarbanes-Oxley Act of 2002 and related regulations. Any material weakness in our internal control over financial reporting that needs to be addressed, or disclosure of a material weakness in managements assessment of internal control over financial reporting, may reduce the price of our common shares because investors may lose confidence in our financial reporting. Our failure to maintain effective internal control over financial reporting could also lead to actions being filed against us by regulatory agencies.

In connection with the restatement of our consolidated financial statements for the year ended September 30, 2007, we identified weaknesses in internal control over financial reporting that were material weaknesses as defined by standards established by the Public Company Accounting Oversight Board. The deficiencies related to our lack of a sufficient number of internal personnel possessing the appropriate knowledge, experience and training in applying US GAAP and in reporting financial information in accordance with the requirements of the SEC and our lack of an audit committee to oversee our accounting and financial reporting processes, as well as other matters. (See the discussion of our Controls and Procedures at Item 8A of this Amendment No. 3.) We cannot assure you that our remediation of our internal control over financial reporting relating to the identified material weaknesses will



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establish the effectiveness of our internal control over financial reporting or that we will not be subject to material weaknesses in the future.

The restatement of our financial statements may result in litigation or government enforcement actions. Any such action would likely harm our business, financial condition and results of operations.

We have restated our financial statements and other financial information for the year ended September 30, 2007. The restatement of our financial statements may expose us to risks associated with litigation, regulatory proceedings and government enforcement actions. In addition, securities class action litigation has often been brought against companies who have been unable to provide current public information or who have restated previously filed financial statements.

Any of these actions could result in substantial costs, divert managements attention and resources, and harm our business, financial condition and results of operations.

We intend to expand our operations and increase our expenditures in an effort to grow our business. If we are unable to achieve or manage significant growth and expansion, or if our business does not grow as we expect, our operating results may suffer.

Our business plan anticipates continued additional expenditure on development, manufacturing and other growth initiatives. We may not achieve significant growth. If achieved, significant growth would place increased demands on our management, accounting systems, network infrastructure and systems of financial and internal controls. We may be unable to expand associated resources and refine associated systems fast enough to keep pace with expansion, especially to the extent we expand into multiple facilities at distant locations. If we fail to ensure that our management, control and other systems keep pace with growth, we may experience a decline in the effectiveness and focus of our management team, problems with timely or accurate reporting, issues with costs and quality controls and other problems associated with a failure to manage rapid growth, all of which would harm our results of operations.

Our ability to effectively recruit and retain qualified officers and directors could also be adversely affected if we experience difficulty in obtaining adequate directors and officers liability insurance.

We may be unable to maintain sufficient insurance as a public company to cover liability claims made against our officers and directors. If we are unable to adequately insure our officers and directors, we may not be able to retain or recruit qualified officers and directors to manage us.

Losing key personnel or failing to attract and retain other highly skilled personnel could affect our ability to successfully grow our business.

Our future performance depends substantially on the continued service of our senior management and other key personnel. We do not currently maintain key person life insurance. If our senior management were to resign or no longer be able to serve as our employees, it could impair our revenue growth, business and future prospects.

To meet our expected growth, we believe that our future success will depend upon our ability to hire, train and retain other highly skilled personnel. We cannot be sure that we will be successful in hiring, assimilating or retaining the necessary personnel, and our failure to do so could cause our operating results to fall below our growth and profit targets.

Rules issued under the Sarbanes-Oxley Act of 2002 may make it difficult for us to retain or attract qualified officers and directors, which could adversely affect the management of our business and our ability to obtain or retain listing of our Common Stock.

We may be unable to attract and retain those qualified officers, directors and members of board committees required to provide for our effective management because of rules and regulations that govern publicly held companies, including, but not limited to, certifications by principal executive officers. The enactment of the Sarbanes-Oxley Act has resulted in the issuance of rules and regulations and the strengthening of existing rules and regulations by the SEC, as well as the adoption of new and more stringent rules by the stock exchanges and NASDAQ. The perceived increased personal risk associated with these recent changes may deter qualified individuals from accepting roles as directors and executive officers.



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Further, some of these recent changes heighten the requirements for board or committee membership, particularly with respect to an individuals independence from the corporation and level of experience in finance and accounting matters. We may have difficulty attracting and retaining directors with the requisite qualifications. If we are unable to attract and retain qualified officers and directors, the management of our business and our ability to obtain or retain listing of our shares of common stock on any stock exchange or NASDAQ (assuming we elect to seek and are successful in obtaining such listing) could be adversely affected.

RISKS RELATED TO OUR BUSINESS

We Expect Intense Competition In Our Industry

Many of our competitors are large, diversified manufacturing companies with significant expertise in the water quality business and contacts with water utilities and industrial water consumers. These competitors have significantly greater name recognition and financial and other resources. We cannot assure you that we will succeed in the face of strong competition from other water treatment companies.

Certain Aspects of Our Industry Are Subject To Government Regulation

Treatment of domestic drinking water and wastewater is regulated by a number of federal state and local agencies, including the U.S. Environmental Protection Agency. The changing regulatory environment, including changes in water quality standards, could adversely affect our business or make our products obsolete.

The Operation of Our Products Could Result In Product Liability Claims

We, like any other manufacturer of products that are designed to treat food or water that will be ingested, face an inherent risk of exposure to product liability claims in the event that the use of our products results in injury. Such claims may include, among others, that our products fail to remove harmful contaminants or bacteria, or that our products introduce other contaminants into the water. While we intend to obtain product liability insurance, there can be no assurance that such insurance will continue to be available at a reasonable cost, or, if available, will be adequate to cover liabilities. We do not anticipate obtaining contractual indemnification from parties acquiring or using our products. In any event, any such indemnification if obtained will be limited by our terms and, as a practical matter, to the creditworthiness of the indemnifying party. In the event that we do not have adequate insurance or contractual indemnification, product liabilities relating to defective products could have a material adverse effect on our operations and financial conditions.

Our water treatment system and the related technology are unproven and may not achieve widespread market acceptance among our prospective customers.

Although we have installed a water treatment system on a pilot basis, our products have not been proven in a commercial context over any significant period of time. We have developed our proprietary technology and processes for water treatment based on dissolved air flotation technology, which competes with other forms of water treatment technologies that currently are in operation throughout the United States. Our water treatment system and the technology on which it is based may not achieve widespread market acceptance. Our success will depend on our ability to market our system and services to businesses and water providers on terms and conditions acceptable to us and to establish and maintain successful relationships with various water providers and state regulatory agencies.

We believe that market acceptance of our system and technology and our related success will depend on many factors including:

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the perceived advantages of our system over competing water treatment solutions;

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the actual and perceived safety and efficacy of our system;

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the availability and success of alternative water treatment solutions;

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the pricing and cost effectiveness of our system;

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our ability to access businesses and water providers that may use our system;

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the effectiveness of our sales and marketing efforts;

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publicity concerning our system and technology or competitive solutions;



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·

timeliness in assembling and installing our system on customer sites;

·

our ability to respond to changes in the regulatory standards for levels of various contaminants; and

·

our ability to provide effective service and maintenance of our systems to our customers satisfaction.

If our system or technology fails to achieve or maintain market acceptance or if new technologies are introduced by others that are more favorably received than our technology, are more cost effective or otherwise render our technology obsolete, we may experience a decline in demand for our system. If we are unable to market and sell our system and services successfully, our revenues would decline and our operating results and prospects would suffer.

We must meet evolving customer requirements for water treatment and invest in the development of our water treatment technologies.

If we are unable to develop or enhance our system and services to satisfy evolving customer demands, our business, operating results, financial condition and prospects will be harmed significantly. The market for water treatment is characterized by changing technologies, periodic new product introductions and evolving customer and industry standards. For instance, competitors in the water treatment industry are continuously searching for methods of water treatment that are more cost-effective and more efficient. Our current and prospective customers may choose water treatment systems that are offered at a lower price than our system. To achieve market acceptance for our system, we must effectively and timely anticipate and adapt to customer requirements and offer products and services that meet customer demands. This may cause us to pursue other technologies or capabilities through acquisitions or strategic alliances. Our customers may require us to provide water treatment systems for many different contaminants or higher volumes of water or to decrease the presence of contaminants. We also may experience design, engineering and other difficulties that could delay or prevent the development, introduction or marketing of any modifications to our system or our new services. Our failure to develop successfully and offer a system or services that satisfy customer requirements would significantly weaken demand for our system or services, which would likely cause a decrease in our revenues and harm our operating results. In addition, if our competitors introduce solutions and/or services based on new or alternative water treatment technologies, our existing and future system and/or services could become obsolete, which would also weaken demand for our system, thereby decreasing our revenues and harming our operating results.

Failure to protect our intellectual property rights could impair our competitive position.

Our water treatment systems utilize a variety of proprietary rights that are important to our competitive position and success. Because the intellectual property associated with our technology is evolving and rapidly changing, our current intellectual property rights may not protect us adequately. We rely on a combination of patents, trademarks, trade secrets and contractual restrictions to protect the intellectual property we use in our business. In addition, we generally enter into confidentiality or license agreements, or have confidentiality provisions in agreements, with our employees, consultants, strategic partners and customers and control access to, and distribution of, our technology, documentation and other proprietary information.

Because legal standards relating to the validity, enforceability and scope of protection of patent and intellectual property rights in new technologies are uncertain and still evolving, the future viability or value of our intellectual property rights is uncertain. Furthermore, our competitors independently may develop similar technologies that limit the value of our intellectual property or design around patents issued to us. If competitors or third parties are able to use our intellectual property or are able to successfully challenge, circumvent, invalidate or render unenforceable our intellectual property, we likely would lose any competitive advantage we might develop. We may not be successful in securing or maintaining proprietary or patent protection for the technology used in our system or services, and protection that is secured may be challenged and possibly lost.

Risks Related to Our Industry

Changes in governmental regulation and other legal uncertainties could adversely affect our customers or decrease demand for our systems, and thus harm our business, operating results and prospects.

In the United States, many different federal, state and local laws and regulations govern the treatment and distribution of water, as well as and disposal of attendant wastes. The increased interest in the treatment of contaminated water due to increased media attention on the adverse health effects from contaminated drinking water may result in intervention by the EPA or state regulatory agencies under existing or newly enacted legislation and in the imposition of restrictions, fees or charges on users and providers of products and services in this area. These



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restrictions, fees or charges could adversely affect our potential customers, which could negatively affect our revenues. Conversely, the failure of the EPA or state regulatory agencies to act on a timely basis to set interim or permanent standards for pollutants, or to delay effective dates for standards for pollutants, grant waivers of compliance with such standards or take other discretionary actions not to enforce these standards, may decrease demand for our system if water utilities and agencies are not required to bring their water into compliance with such regulatory standards. While we are not aware of any currently proposed federal regulation directly affecting our business, we cannot predict whether there will be future legislation regarding the treatment and distribution of water and the disposal of attendant wastes.

Water treatment systems in the United States must generally be permitted by a regulatory agency prior to its use by our customers, and changing drinking water standards and other factors could affect the approval process with respect to our systems by such regulatory agencies.

In general, water treatment systems must be permitted by applicable state or local regulatory agencies prior to commencement of operations. We cannot assure you when or whether the various regulatory agencies will approve our system for use by our customers. The application process can be time consuming and often involves several information requests by the regulatory agencies with respect to the system. Any long waiting periods or difficulties faced by our customers in the application process could cause some of our customers to use competing technologies, products, services or sources of drinking water, rather than use our technology.

Demand for our products could be adversely affected by a downturn in government spending related to water treatment, or in the cyclical residential or non-residential building markets.

Our business will be dependent upon spending on water treatment systems by utilities, municipalities and other organizations that supply water, which in turn is often dependent upon residential construction, population growth, continued contamination of water sources and regulatory responses to this contamination. As a result, demand for our water treatment systems could be impacted adversely by general budgetary constraints on governmental or regulated customers, including government spending cuts, the inability of government entities to issue debt to finance any necessary water treatment projects, difficulty of customers in obtaining necessary permits or changes in regulatory limits associated with the contaminants we seek to address with our water treatment system. A slowdown of growth in residential and non-residential building would reduce demand for drinking water and for water treatment systems. The residential and non-residential building markets are generally cyclical, and, historically, down cycles have typically lasted a number of years. Any significant decline in the governmental spending on water treatment systems or residential or non-residential building markets could weaken demand for our systems.

We operate in a competitive market, and if we are unable to compete effectively, our business, operating results and prospects could suffer.

The market environment in which we operate is very dynamic and is characterized by evolving standards, the development of new technology, regulations which continually reduce the acceptable levels for contaminants and affect the means, methods and costs of disposing of wastes derived from water treatment.

We will compete with large water treatment companies, such as USFilter Corporation, a subsidiary of Siemens AG. Our competition may vary according to the contaminant being removed. Many of our current and potential competitors have technical and financial resources, marketing and service organizations, and market expertise significantly greater than ours. Many of our competitors also have longer operating histories, greater name recognition and large customer bases. Moreover, our competitors may forecast the course of market developments more accurately and could in the future develop new technologies that compete with our system and/or services or even render our system and/or services obsolete. Due to the evolving markets in which we compete, additional competitors with significant market presence and financial resources may enter those markets, thereby further increasing competition. These competitors may be able to reduce our market share by adopting more aggressive pricing policies than we can or by developing technology and services that gain wider market acceptance than our system and/or services. Existing and potential competitors also may develop relationships with distributors of our system and services or third parties with whom we have strategic relationships in a manner that could harm our ability to sell, market and develop our system and services significantly. If we do not compete successfully we may never achieve significant market penetration and we may be unable to maintain or increase our business or revenues, causing our operating results and prospects to suffer.



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RISKS RELATED TO OUR COMMON STOCK

You may have difficulty trading our Common Stock as there is a limited public market for shares of our common stock.

Our Common Stock is currently quoted on the NASDs OTC Bulletin Board under the symbolSINX.OB. Our Common Stock is not actively traded and there is a limited public market for our Common Stock. As a result, a stockholder may find it difficult to dispose of, or to obtain accurate quotations of the price of, our Common Stock. This severely limits the liquidity of our Common Stock, and would likely have a material adverse effect on the market price for our Common Stock and on our ability to raise additional capital. An active public market for

Applicable SEC rules governing the trading of penny stocks may limit the trading and liquidity of our common stock which may affect the trading price of our common stock.

Our common stock is currently quoted on the NASDs OTC Bulletin Board. Stocks such as ours which trade below $5.00 per share are consideredpenny stocks and subject to SEC rules and regulations which impose limitations upon the manner in which such shares may be publicly traded. These regulations require the delivery, prior to any transaction involving a penny stock, of a disclosure schedule explaining the penny stock market and the associated risks. Under these regulations, certain brokers who recommend such securities to persons other than established customers or certain accredited investors must make a special written suitability determination regarding such a purchaser and receive such purchasers written agreement to a transaction prior to sale. These regulations have the effect of limiting the trading activity of our common stock and reducing the liquidity of an investment in our common stock.

We do not anticipate dividends to be paid on our common stock, and stockholders may lose the entire amount of their investment.

A dividend has never been declared or paid in cash on our common stock, and we do not anticipate such a declaration or payment for the foreseeable future. We expect to use future earnings, if any, to fund business growth. Therefore, stockholders will not receive any funds absent a sale of their shares. We cannot assure stockholders of a positive return on their investment when they sell their shares, nor can we assure that stockholders will not lose the entire amount of their investment.

You may experience dilution of your ownership interests because of the future issuance of additional shares of our common stock.

In the future, we may issue our authorized but previously unissued equity securities, resulting in the dilution of the ownership interests of our present stockholders. We are currently authorized to issue an aggregate of 150,000,000 shares of common stock. As of September 30, 2007, there were 106,635,201 shares of common stock outstanding. We may also issue additional shares of our common stock or other securities that are convertible into or exercisable for common stock in connection with hiring or retaining employees, future acquisitions, future sales of our securities for capital raising purposes, or for other business purposes. The future issuance of any such additional shares of our common stock or other securities may create downward pressure on the trading price of our common stock. There can be no assurance that we will not be required to issue additional shares, warrants or other convertible securities in the future in conjunction with any capital raising efforts, including at a price (or exercise prices) below the price at which shares of our common stock are currently quoted on the OTC Bulletin Board.

Even though we are not a California corporation, our common stock could still be subject to a number of key provisions of the California General Corporation Law.

Under Section 2115 of the California General Corporation Law (theCGCL), corporations not organized under California law may still be subject to a number of key provisions of the CGCL. This determination is based on whether the corporation has significant business contacts with California and if more than 50% of its voting securities are held of record by persons having addresses in California. In the immediate future, we will continue the business and operations of Sionix in California, and a majority of our business operations, revenue and payroll will be conducted in, derived from, and paid to residents of California. Therefore, depending on our ownership, we could be subject to certain provisions of the CGCL. Among the more important provisions are those relating to the election and removal of directors, cumulative voting, standards of liability and indemnification of directors, distributions, dividends and repurchases of shares, shareholder meetings, approval of certain corporate transactions, dissenters' and appraisal rights, and inspection of corporate records.



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ITEM 2

DESCRIPTION OF PROPERTY.

Our corporate headquarters consists of approximately 1,994 square feet of office space in Irvine, California. The lease covering this space expires in February 2009. Our management believes the facilities will provide adequate space for our office, product assembly and warehouse activities, and that suitable additional space will be available to accommodate planned expansion.

ITEM 3

LEGAL PROCEEDINGS.

From time to time we are involved in routine legal proceedings, none of which is material to our financial condition.

ITEM 4

SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.

No matters were submitted to a vote of shareholders of the Company during the fourth quarter of the fiscal year ended September 30, 2007.





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PART II

ITEM 5

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

Market Prices

Our common stock is quoted on the OTC Bulletin Board under the symbolSINX. The high and low closing prices of the Companys common stock were as follows for the periods below. The quotations below reflect inter-dealer bid prices without retail markup, markdown, or commission and may not represent actual transactions.

|                                      |  |      |       |  |     |   |       | 
|------------------------------------- |  | ---- | ----- |  | --- | - | ----- | 
|                                      |  | High |       |  | Low |  
|Fiscal Year Ended September 30, 2007: |  |      |       |  |     |  
|First Quarter                         |  | $    | 0.145 |  |     | $ | 0.035 | 
|Second Quarter                        |  |      | 0.480 |  |     |   | 0.095 | 
|Third Quarter                         |  |      | 0.400 |  |     |   | 0.200 | 
|Fourth Quarter                        |  |      | 0.380 |  |     |   | 0.260 | 
|Fiscal Year Ended September 30, 2006: |  |      |       |  |     |   |       | 
|First Quarter                         |  |      | 0.035 |  |     |   | 0.012 | 
|Second Quarter                        |  |      | 0.025 |  |     |   | 0.008 | 
|Third Quarter                         |  |      | 0.013 |  |     |   | 0.003 | 
|Fourth Quarter                        |  |      | 0.060 |  |     |   | 0.005 | 



Dividends

We have not paid any cash dividends on our common stock since our inception and do not anticipate paying any cash dividends in the foreseeable future. We plan to retain our earnings, if any, to provide funds for the expansion of our business. Our Board of Directors will determine future dividend policy based upon conditions at that time, including our earnings and financial condition, capital requirements and other relevant factors.

Securities Authorized for Issuance Under Equity Compensation Plans

The following table sets forth certain information regarding the Companys equity compensation plans as of September 30, 2007.

|                                                       |  |                                                                                          |           |  |                                                                             |  |                                                                                           |  |  |         | 
|------------------------------------------------------ |  | ---------------------------------------------------------------------------------------- | --------- |  | --------------------------------------------------------------------------- |  | ----------------------------------------------------------------------------------------- |  |  | ------- | 
|Plan category                                          |  | No. of
securities
to be issued
upon
exercise of
outstanding
options,
warrants
and rights |           |  | Weighted
average
exercise price
of outstanding
options,
warrants and
rights |  | No. of
securities
remaining
available for
future
issuance
under equity
compensation
plans | 
|Equity compensation plans approved by stockholders     |  |                                                                                          | -0-       |  |                                                                             |  |                                                                                         |  |  | -0-     | 
|Equity compensation plans not approved by stockholders |  |                                                                                          | 7,034,140 |  |                                                                             |  | .15                                                                                       |  |  | 542,540 | 
|Total                                                  |  |                                                                                          | 7,034,140 |  |                                                                             |  | .15                                                                                       |  |  | 542,540 | 



Recent Issuances of Unregistered Securities

In July 2007, we completed a private offering, principally to private investment funds, in the amount of $1,025,000. The investors received Subordinated Convertible Debentures that bear interest at 8% per annum, mature twelve months after issuance, and are convertible into our common stock at a conversion price of $ .22 per share.

We believe the sale of securities described above was exempt from the registration provisions of the Securities Act of 1933 by reason of Section 4(2) thereof and Regulation D thereunder.





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ITEM 6

MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND PLAN OF OPERATION

General.

The following discussion and analysis should be read in conjunction with our Financial Statements and Notes thereto, included elsewhere in this report. Except for the historical information contained in this report, the following discussion contains certain forward-looking statements that involve risks and uncertainties, such as statements of our plans, objectives, expectations and intentions. Our actual results may differ materially from the results discussed in the forward-looking statements, as a result of certain factors including, but not limited to, those discussed in the section of this report titled Cautionary Factors That May Affect Future Results, as well as other factors, some of which will be outside of our control. You are cautioned not to place undue reliance on these forward-looking statements, which relate only to events as of the date on which the statements are made. We undertake no obligation to publicly revise these forward-looking statements to reflect events or circumstances that arise after the date hereof. You should refer to and carefully review the information in future documents we file with the Securities and Exchange Commission.

Restatement of Prior Period

On December 11, 2007 the Company received a comment letter from the Securities and Exchange Commission. In responding to the comment letter, the Company recalculated the number of shares of common stock available for issuance and determined that as of September 30, 2007, the number of shares of common stock that would be required to be issued if all of the Companys convertible securities, including debt securities, options and warrants, were converted or exercised would exceed the number of shares of authorized common stock. The difference between the original calculation and the recalculation is illustrated below.

|                                                                      |  |            |              |   |              |  |              |  
|--------------------------------------------------------------------- |  | ---------- | ------------ | - | ------------ |  | ------------ | -
|                                                                      |  | As         |              |   |              | 
|                                                                      |  | Originally |              |   | As           | 
|                                                                      |  | Calculated |              |   | Recalculated | 
|Authorized shares per Articles of Incorporation                       |  |            | 150,000,000  |   |              |  | 150,000,000  |  
|Outstanding shares                                                    |  |            | (106,635,201 | ) |              |  | (106,635,201 | )
|Available shares                                                      |  |            | 43,364,799   |   |              |  | 43,364,799   |  
|                                                                      |  |            |              |   |              |  |              |  
|Securities convertible or exercisable into common stock shares:       |  |            |              |   |              |  |              |  
|2001 Executive Officers Stock Option Plan                             |  |            | 7,343,032    |   |              |  | 7,034,140    |  
|Advisory Board Compensation                                           |  |            |              |   |              |  | 11,520,000   |  
|2004 Stock Purchase Agreement                                         |  |            |              |   |              |  | 1,463,336    |  
|Warrants Related to 2004 Stock Purchase Agreement                     |  |            |              |   |              |  | 1,463,336    |  
|Beneficial Conversion Features                                        |  |            | 32,009,087   |   |              |  | 36,606,318   |  
|Warrants Related to $1,025,000 of Subordinated Convertible Debentures |  |            | 2,159,088    |   |              |  | 2,795,454    |  
|                                                                      |  |            | 41,511,207   |   |              |  | 60,882,584   |  

Adjustments to the original calculation included the following:

1.

In 2001, the Company adopted the 2001 Executive Officers Stock Option Plan. The plan has issued options to purchase 7,034,140 shares of common stock. The original calculation included options to purchase 7,343,032 shares of common stock, an overstatement of 308,892 shares of common stock.

2.

On October 1, 2004, the Company formed an advisory board consisting of four members. In exchange for his services, each member was to receive $5,000 monthly from October 1, 2004 to February 22, 2007 (for a total of $576,000 to be paid to all members). Each member, in his sole discretion, was entitled to convert some or all of the cash amount owed to him into shares of common stock at the rate of $0.05 per share. If all of the members of the advisory board converted the total amount of cash compensation due to them into shares of common stock, the Company would be required to issue 11,520,000 shares. The accrued expense convertible into shares of common stock was not included in the original calculation.

3.

Under the terms of a 2004 Stock Purchase Agreement, the Company was to issue 1,463,336 shares of



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common stock to certain investors that had previously remitted funds to the Company from February 9, 2004 to August 25, 2004. The shares were not included in the original calculation.

4.

Under the terms of the 2004 Stock Purchase Agreement, the Company issued warrants to purchase 1,463,336 shares of common stock to these investors at an exercise price of $0.03 per share. The warrants were not included in the original calculation.

5.

As of September 30, 2007, the Company had Convertible Notes outstanding totaling $1,861,000 that included embedded beneficial conversion features that allowed for the conversion of the notes into shares of common stock at rates between $0.01 and $0.22, and matured between June 2008 and December 2008. The Convertible Notes accrue interest at rates between 8% and 10%, and any accrued but unpaid interest is also convertible into shares of common stock. The original calculation of the beneficial conversion feature did not include accrued interest of $209,843 that could be converted into 4,597,231 shares of common stock at maturity.

6.

On July 18, 2007 the Company completed an offering of $1,025,000 in principal amount of Subordinated Convertible Debentures (the Convertible Debentures) to a group of institutional and accredited investors. As part of this offering the Company issued warrants to purchase 2,795,454 shares of common stock at a price of $0.50 per share. The number of warrant shares in the original calculation was 2,159,088.

The Company analyzed the effect of the recalculation on the balance sheet and the statements of operations and cash flows as of common stock as of September 30, 2007. The analysis and results were as follows:

2001 Executive Officers Stock Option Plan

In October 2000, the Company amended its employment agreements with its executive officers. In conjunction with the amendments the Company adopted the 2001 Executive Officers Stock Option Plan. The plan has reserved 7,576,680 shares of Common Stock and has issued options for the purchase of 7,034,140 shares of Common Stock. The options expire 5 years from the date of issuance.

Balance Sheet

On the grant date, the Company applied Financial Accounting Standard Board (SFAS) Statement No. 133, Accounting for Derivative Instruments and Hedging Activities, paragraph 6 to determine if the options were within the scope and definition of a derivative. The options: had one or more underlings and one or more notional amounts, required no initial investment, and required or permitted net settlement. Therefore, the options were determined to be derivatives. In order to determine how to classify the options, the Company followed the guidance of paragraphs 7 and 8 of Emerging Issues Task Force (EITF) 00-19, Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Companys Own Stock, which states that contractsthat require settlement in shares are equity instruments. In order to determine the value of the options, the Company applied EITF 00-19, paragraph 9, which states that contracts that require the company to deliver shares as part of a physical settlement or net-share settlement should be initially measured at fair value. In accordance with EITF 00-19, the options were recorded in additional paid-in capital at fair value on the date of issuance.

The Company began the analysis for the restatement by following the guidance of SFAS 133, paragraph 6 to ascertain if the options issued remained derivatives as of September 30, 2007. All of the criteria in the original analysis were met, and the options issued were determined to be within the scope and definition of a derivative. The Company next followed the guidance of EITF 00-19, paragraph 19, which states that if a company is required to obtain shareholder approval to increase the companys authorized shares in order to net-share or physically settle a contract, share settlement is not controlled by the company, and the contract is required to be classified as a liability. The Company next applied EITF 00-19, paragraph 10, which states that if classification changes as the result of an event, the contract should be reclassified as of the date of the event at fair value. The event responsible for the change in classification was the issuance of the Convertible Debentures on July 17, 2007.

In accordance with EITF 00-19, the options were reclassified as of July 17, 2007 from additional paid-in capital to warrant liabilities on the balance sheet, at the fair value of $2,271,879 using the Black Sholes model with the following assumptions: risk free rate of return of 5.02%; volatility of 219.89%; dividend yield of 0%; and an expected term of 3.67 years.



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The Company followed the guidance of EITF 00-19, paragraph 9, which states that all contracts classified as liabilities should be measured at fair value at each balance sheet date, with changes in fair value reported in earnings and disclosed in the financial statements as long as the contracts remain classified as liabilities.

The fair value of the options was $1,926,914 as of September 30, 2007, calculated using the Black Sholes model with the following assumptions: risk free rate of return of 4.05%; volatility of 126.94%; dividend yield of 0%; and an expected term of 3.5 years.

The decrease in the fair value of the options was recorded by decreasing warrant liability on the balance sheet by $344,965.

Statement of Operations

Prior to the reclassification, the Company applied EITF 00-19, paragraph 9, which states that subsequent changes in fair value of contracts should not be recognized as long as the contracts continue to be classified as equity. Therefore, changes in the fair value of the options prior to the reclassification were not recorded. Subsequent to reclassifying the contracts as liabilities, the Company again followed the guidance of EITF 00-19, paragraph 9, which requires all contracts classified as liabilities to be measured at fair value, with changes in fair value reported in earnings as long as the contracts remain classified as liabilities.

From July 17 to September 30, 2007, the fair value of the options decreased by $344,965. This amount is included in decrease in warrant liability in the other income (expense) section of the statement of operations.

Statement of Cash Flows

The change in the statement of cash flows was the result of the decrease of $344,965 in the fair value of the options.

The reclassification of the options from additional paid-in capital to warrant liabilities was a non-cash transaction.

Advisory Board Compensation

On October 1, 2004, the Company formed an advisory board consisting of four members. In exchange for his services, each member was to receive $5,000 monthly from October 1, 2004 to February 22, 2007, for a total of $576,000 to be paid to all members. Each member, in his sole discretion, was entitled to convert some or all of the cash amount owed to him into shares of Common Stock at a rate of $0.05 per share. If all of the members of the advisory board converted the total amount of cash compensation due to them into shares of Common Stock, the Company would be required to issue 11,520,000 shares. The Company determined that: the accrued expense, embedded beneficial conversion features, embedded beneficial conversion feature discount, and related amortization expense were not recorded at the date of issuance or prior to the restatement. No payments have been made to any advisory board members and there has been no conversion by any advisory board members of the accrued liability into shares of Common Stock.

Balance Sheet

The Company began the analysis for the restatement by applying paragraph 6 of Financial Accounting Standard (SFAS) Statement No. 133, Accounting for Derivative Instruments and Hedging Activities, to ascertain if the embedded beneficial conversion features were derivatives at the date of issuance. The embedded beneficial conversion features had one or more underlings and one or more notional amounts, required no initial investment, and required or permitted net settlement. Therefore, the embedded beneficial conversion features were determined to be within the scope and definition of a derivative at the date of issuance. Next, the Company followed the guidance of SFAS 133, paragraph 12, to determine if the embedded beneficial conversion features should be bifurcated from the accrued expense. The Company determined that: the economic characteristics of the embedded beneficial conversion features are not clearly and closely related to the accrued expense, the embedded beneficial conversion feature and accrued expense are not remeasured at fair value at each balance sheet date and a separate contract with the same terms would be a derivative pursuant to SFAS 133, paragraphs 6-11. Therefore, the embedded beneficial conversion features were bifurcated from the accrued expense to determine the classification and valuation. To determine the classification, the Company followed the guidance of EITF 00-19, paragraphs 7 and 8 which states that contractsthat require settlement in shares are equity instruments. To determine the value, the Company followed the guidance of EITF 00-19, paragraph 9, which states that contracts that require the company to deliver shares as part of a physical settlement or net-share settlement should be initially measured at fair value. The



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Company next followed the guidance of EITF 00-19, paragraph 19, which states that if a company is required to obtain shareholder approval to increase the companys authorized shares in order to net-share or physically settle a contract, share settlement is not controlled by the company, and the contract is required to be classified as a liability. The Company next applied EITF 00-19, paragraph 10, which states that if classification changes as the result of an event, the contract should be reclassified as of the date of the event at fair value. The event responsible for the change in classification was the issuance of the Convertible Debentures on July 17, 2007.

The fair value of the monthly embedded beneficial conversion features was calculated using the Black Sholes model with the following assumptions: risk free rate of return of 2.28% to 5.21%; volatility of 144.19% to 270.5%; dividend yield of 0% and an expected term of 5 years. The sum of the monthly accrued expenses and embedded beneficial conversion features from October 1, 2004 to September 30, 2006, was $480,000 and $210,149, respectively, and considered earned prior to October 1, 2006. Therefore, as of September 30, 2006, $480,000 was recorded to accrued expenses and deficit accumulated during development stage, $210,149 was recorded to beneficial conversion features liability and netted against accrued expenses as a discount, and $49,192 was recorded to accrued expenses and deficit accumulated during development stage for the amortization of the beneficial conversion features discount.

The fair value of the monthly embedded beneficial conversion features was $480,000 as of September 30, 2006, which the Company calculated using the Black Sholes model with the following assumptions: risk free rate of return of 4.91%; volatility of 270.5%; dividend yield of 0%; and an expected term of 3.08 to 5 years.

During the year ended September 30, 2007, the Company incurred and recorded to accrued expenses $96,000 for advisory board compensation until February 22, 2007, the date the Companys Board of Directors terminated the compensation. The fair value of the monthly embedded beneficial conversion features was calculated using the Black Sholes model with the following assumptions: risk free rate of return of 4.94% to 5.09%; volatility of 268.59% to 277.2%; dividend yield of 0% and an expected term of 5 years. The sum of the embedded beneficial conversion features from October 1, 2006 to February 22, 2007 was $91,956 and was recorded to beneficial conversion features liability and netted against accrued expenses. As of September 30, 2007, total amortization for the beneficial conversion features discount was $106,546 ($49,192 from October 1, 2004 to September 30, 2006, and $57,354 for the year ended September 30, 2007), and was recorded to accrued expenses.

The fair value of the monthly embedded beneficial conversion features was $576,000 as of September 30, 2007, which the Company calculated using the Black Sholes model with the following assumptions: risk free rate of return of 4.05%; volatility of 126.94%; dividend yield of 0%; and an expected term of 2.08 to 4.42 years.

The increase in the fair value of the embedded beneficial conversion feature was recorded by increasing beneficial conversion features liability on the balance sheet by $4,044.

Statement of Operations

The Company followed the guidance of EITF 00-19, paragraph 9, which requires all contracts classified as liabilities to be measured at fair value, with changes in fair value reported in earnings as long as the contracts remain classified as liabilities.

The increase in the fair value of the beneficial conversion features was $4,044 and included in increase in beneficial conversion feature in the other income (expense) section of the statement of operations.

The amortization expense for the beneficial conversion feature discount was $57,354 and included in general and administrative expenses in the operating expenses section of the statement of operations for the year ended September 30, 2007.

Statement of Cash Flows

Changes in the statement of cash flows were the result of the advisory board compensation accrued expense of $480,000 and $96,000, beneficial conversion features liability of $576,000 and unamortized beneficial conversion features discount of $380,441 on the balance sheet, and change in fair value of the liability of $4,044 and amortization of the beneficial conversion features discount of $49,193 on the statement of operations.



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Warrants Related to 2004 Stock Purchase Agreement

Under the terms of a 2004 Stock Purchase Agreement, the Company issued warrants to purchase 1,463,336 shares of Common Stock at an exercise price of $0.03 which expired between February 9, 2007 and August 25, 2007. The Company determined that the warrants and related expense were not recorded at the date of issuance or prior to the restatement and there has been no exercise of the warrants into shares of Common Stock.

Balance Sheet

The Company followed the guidance of SFAS 133, paragraph 6, to determine if the warrants were within the scope and definition of a derivative at the date of issuance. The warrants had one or more underlings and one or more notional amounts, required no initial investment and required or permitted net settlement. Therefore, the warrants were determined to be derivatives at the date of issuance. In order to determine how to classify the warrants, the Company followed the guidance of EITF 00-19, paragraphs 7 and 8, which state that contractswhich require settlement in shares are equity instruments. In order to determine the value of the options, the Company followed the guidance of EITF 00-19, paragraph 9, which states that contracts which require the company to deliver shares as part of a physical settlement or net-share settlement should be initially measured at fair value.

The fair value of the warrants was $24,367 at the date of issuance, which the Company calculated using the Black Sholes model with the following assumptions: risk free rate of return of 1.21% to 2.14%; volatility of 141.91% to 170.27%; dividend yield of 0% and an expected term of 3 years. The warrants were considered an expense prior to October 1, 2006, therefore, $24,367 was recorded to additional paid-in capital and deficit accumulated during development stage.

The Company then applied EITF 00-19, paragraph 19, which states that if a company is required to obtain shareholder approval to increase the companys authorized shares in order to net-share or physically settle a contract, share settlement is not controlled by the company and the contract is required to be classified as a liability. The Company applied EITF 00-19, paragraph 10, which states that if a classification changes as the result of an event, the contract should be reclassified as of the date of the event at fair value. The event responsible for the change in classification was the issuance of the Convertible Debentures on July 17, 2007.

In accordance with EITF 00-19, the warrants were reclassified as of July 17, 2007 from additional paid-in capital to warrant liabilities on the balance sheet at the fair value of $70,029, which the Company calculated using the Black Sholes model with the following assumptions: risk free rate of return of 5.02%; volatility of 219.89%; dividend yield of 0%; and an expected term of .08 years.

The Company then applied EITF 00-19, paragraph 9, which states that all contracts classified as liabilities are to be measured at fair value at each balance sheet date, with changes in fair value reported in earnings and disclosed in the financial statements as long as the contracts remain classified as liabilities.

The Company determined that the fair value of the warrants was $0 as of September 30, 2007, due to their expiration.

The $70,029 decrease in the fair value of the warrants was recorded to warrant liability.

Statement of Operations

Prior to the reclassification, the Company followed EITF 00-19, paragraph 9, which states that subsequent changes in the fair value of contracts should not be recognized as long as the contracts continue to be classified as equity. Therefore, changes in the fair value of the warrants prior to the reclassification were not recorded. Subsequent to reclassifying the warrants as liabilities, the Company again followed EITF 00-19, paragraph 9, which requires all contracts classified as liabilities to be measured at fair value, with changes in fair value reported in earnings as long as the contracts remain classified as liabilities.

The change in the fair value of the warrants from July 17, 2007 to September 30, 2007 was $70,029 and is included in decrease in warrant liability in the other income (expense) section of the statement of operations.

Statement of Cash Flows

Changes in the statement of cash flows were the result of the change in fair value of the warrants of $70,029 on the statement of operations.



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The reclassification of the warrants from additional paid-in capital to warrant liability was a non-cash transaction.

Beneficial Conversion Features

As of September 30, 2007, the Company had Convertible Notes outstanding totaling $1,861,000 that were issued between October 17, 2006 and July 17, 2007. The convertible notes included an embedded beneficial conversion feature that allowed the holders of the convertible notes to convert their notes into Common Stock shares at rates between $0.01 and $0.22. The convertible notes mature between June 17, 2008 and December 31, 2008. The convertible notes accrue interest at rates between 8% and 10%, and any accrued but unpaid interest is also convertible by the holder of the convertible notes into shares of Common Stock at the same rate.

Balance Sheet

On the date of issuance, the Company applied SFAS 133, paragraph 6 to determine if the embedded beneficial conversion features were within the scope and definition of a derivative. The embedded beneficial conversion features: had one or more underlings and one or more notional amounts, required no initial investment and required or permitted net settlement. Therefore, the embedded beneficial conversion features were determined to be derivatives. Next, the Company followed the guidance of SFAS 133, paragraph 12 to determine if the embedded beneficial conversion features should be separated from the convertible notes. The Company determined that: the economic characteristics of the embedded beneficial conversion features are not clearly and closely related to the convertible notes; the embedded beneficial conversion feature and convertible notes are not remeasured at fair value at each balance sheet date; and a separate contract with the same terms would be a derivative pursuant to SFAS 133, paragraphs 6-11. Therefore, the embedded beneficial conversion features were separated from the convertible notes to determine the classification and valuation. The Company followed the guidance of paragraphs 7 and 8 of EITF 00-19, which state that contractsthat require settlement in shares are to be classified as equity instruments. The Company then applied paragraph 9 of EITF 00-19 to determine the value of the embedded beneficial conversion features. Paragraph 9 of EITF 00-19 states that contracts which require the company to deliver shares as part of a physical settlement or net-share settlement should be initially measured at fair value. Based on the analysis at the date of issuance, the embedded beneficial conversion features were recorded in additional paid-in capital at fair value on the date of issuance.

The fair value of the embedded beneficial conversion features was $1,021,569 computed using the Black Sholes model with the following assumptions: risk free rate of return of 6%; volatility of 122.67% to 195.97%; dividend yield of 0% and an expected term of 1 to 1.5 years. The embedded beneficial conversion features discount was $706,186 as of September 30, 2007, net of amortization of $315,383, prior to the restatement.

The Company began the analysis for the restatement by applying SFAS 133, paragraph 6, to ascertain if the embedded beneficial conversion features remained derivatives as of September 30, 2007. All of the criteria in the original analysis were met, and the embedded beneficial conversion features issued were determined to be within the scope and definition of a derivative. The Company followed the guidance of SFAS 133, paragraph 12, to determine if the embedded beneficial conversion features should be separated from the convertible notes. All of the criteria in the original analysis were met, and the embedded beneficial conversion features were separated from the convertible notes. In order to determine the classification of the embedded conversion features, the Company applied paragraphs 7 and 8 of EITF 00-19. Paragraph 7 states that contracts which require net-cash settlement are liabilities, and paragraph 8 states that contracts which give the counterparty (holders of the convertible notes) a choice of net-cash settlement or settlement in shares are liabilities. Therefore the embedded conversion features were determined to be liabilities. The change in the determination of the classification from equity to a liability was based on the contractual right granted to the holders of the convertible notes to convert the notes to shares of Common Stock. Therefore, share settlement is not controlled by the Company. In order to determine the value of the embedded conversion features, the Company followed the guidance of EITF 00-19, paragraph 9, which states that all contracts classified as liabilities are to be measured at fair value at each balance sheet date, with changes in fair value reported in earnings and disclosed in the financial statements as long as the contracts remain classified as liabilities.

The fair value of the embedded beneficial conversion features was recalculated and determined to be $1,430,812 at the date of issuance using the Black Sholes model with the following assumptions: risk free rate of return of 2.02% to 5.09%; volatility of 108.5% to 274.86%; dividend yield of 0% and an expected term of 1 to 1.5 years. Based on the recalculation, the embedded beneficial conversion features discount was $779,300 at September 30, 2007, net of amortization of $651,511, subsequent to the restatement.



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The increase in the fair value of $409,242 ($1,430,811-$1,021,569) of the embedded beneficial conversion features was recorded to the beneficial conversion features and netted against convertible notes on the balance sheet. The increase in the amortization of the beneficial conversion features discount of $336,129 ($651,511-$315,382) was recorded to convertible notes.

The fair value of the embedded beneficial conversion features was $1,430,812 as of September 30, 2007, which was calculated using the Black Sholes model with the following assumptions: risk free rate of return of 4.05%; volatility of 126.94%; dividend yield of 0% and an expected term of .58 to 1.25 years.

Statement of Operations

Prior to the reclassification, the Company applied EITF 00-19, paragraph 9 which states that subsequent changes in fair value of contracts are not to be recognized as long as the contracts continue to be classified as equity. Therefore, the Company did not record changes in the fair value of the beneficial conversion features. Subsequent to reclassifying the beneficial conversion features, the Company again followed the guidance of paragraph 9 of EITF 00-19, which requires all contracts classified as liabilities to be measured at fair value, with changes in fair value reported in earnings as long as the contracts remain classified as liabilities. There was no change in the fair value of the beneficial conversion features from the date of issuance and September 30, 2007.

The increase in the amortization of the beneficial conversion features discount of $336,129 was included in interest expense in the other income (expense) section of the statement of operations.

Statement of Cash Flows

Changes in the statement of cash flows were the result of the change in the amortization of the beneficial conversion features discounts of $336,129 on the statement of operations.

Warrants related to Convertible Debentures

On July 17, 2007 the Company completed an offering of $1,025,000 of Convertible Debentures to a group of institutional and accredited investors which included warrants to purchase 2,795,454 shares of Common Stock (2,329,546 shares of Common Stock to holders of the Convertible Debentures and 465,908 shares of Common Stock as a placement fee) at an exercise price of $0.50 per share.

Balance Sheet

On the grant date, the Company applied SFAS 133, paragraph 6 to determine if the warrants were within the scope and definition of a derivative. The warrants: had one or more underlings and one or more notional amounts, required no initial investment and required or permitted net settlement. Therefore, the warrants were determined to be derivatives. In order to determine the classification of the warrants, the Company followed the guidance of paragraphs 7 and 8 of EITF 00-19, which state that contractswhich require settlement in shares are equity instruments. In order to determine the value of the warrants, the Company followed the guidance of paragraph 9 of EITF 00-19, which states that contracts which require the company to deliver shares as part of a physical settlement or net-share settlement are to be initially measured at fair value. In accordance with EITF 00-19, the warrants were recorded in additional paid-in capital at fair value on the date of issuance.

The fair value of the warrants was calculated as $340,583 ($304,259 attributable to the holders of the Convertible Debentures and $36,324 attributable to the placement fee) at the date of issuance prior to the restatement using the Black Sholes model with the following assumptions: risk free rate of return of 6%; volatility of 122.67% to 195.97%; dividend yield of 0% and an expected term of 5 years.

The Company began the analysis for the restatement by applying SFAS 133, paragraph 6 to ascertain if the warrants issued remained derivatives as of September 30, 2007. All of the criteria in the original analysis were met, and the warrants issued were determined to be within the scope and definition of a derivative. In order to determine the classification of the warrants, the Company followed the guidance of paragraph 19 of EITF 00-19, which states that if a company is required to obtain shareholder approval to increase the companys authorized shares in order to net-share or physically settle a contract, share settlement is not controlled by the company and the contract is required to be classified as a liability. In order to determine the value of the warrants, the Company followed the guidance of paragraph 9 of EITF 00-19, which states that all contracts classified as liabilities are to be measured at fair value at each balance sheet date, with changes in fair value reported in earnings and disclosed in the financial statements as



26



---





long as the contracts remain classified as liabilities.

Based on the change in the determination of the classification of the warrants, $340,583 was reclassified from additional paid-in capital to warrant liabilities.

The fair value of the warrants was recalculated and was determined to be $554,249 ($430,189 attributable to the holders of the Convertible Debentures and $124,060 attributable to the placement fee) at the date of issuance calculated using the Black Sholes model with the following assumptions: risk free rate of return of 4.96% to 5.02%; volatility of 219.89% to 226.04%; dividend yield of 0% and an expected term of 5 years.

The increase in the fair value of the warrants attributable to the holders of the Convertible Debentures was $125,930 ($430,189-$304,259) and was recorded to warrant liabilities and netted against convertible notes. The increase in the fair value of the warrants attributable to the placement fee was $87,736 ($124,060-$36,324) and was recorded in warrant liability and general and administrative expenses.

Based on the increase in the warrant discount, the amortization of warrant discount increased by $55,179, and was recorded to convertible notes.

The fair value of the warrants was determined to be $499,932 ($379,672 attributable to the holders of the Convertible Debentures and $120,260 attributable to the placement fee) as of September 30, 2007, which was calculated using the Black Sholes model with the following assumptions: risk free rate of return of 4.05%; volatility of 126.94%; dividend yield of 0%; and an expected term of 4.67 to 4.75 years.

The decrease in the fair value of the warrants was recorded by decreasing warrant liabilities on the balance sheet by $54,317 ($50,518 attributable to the holders of the Convertible Debentures and $3,799 attributable to the placement fee).

Statement of Operations

The Company followed the guidance of EITF 00-19, paragraph 9, which requires all contracts classified as liabilities to be measured at fair value, with changes in fair value reported in earnings as long as the contracts remain classified as liabilities. The change in the fair value of the warrants was $54,317 for the year ended September 30, 2007, and recorded in decrease in warrants in the other income (expense) section of the statement of operations.

The increase in the amortization of the warrant discount of $124,961 is included in interest expense in the other income (expense) section of the statement of operations.

Statement of Cash Flows

Changes in the statement of cash flows were the result of the decrease in the fair value of the warrant liability of $54,317, increase in the amortization of the warrant discount of $55,179 on the balance sheet, and the change in fair value of the warrants at the date of issuance of $87,736 on the statement of operations.

In addition to the analysis of the securities exercisable or convertible into Common Stock, the Company analyzed the classification of general and administrative expenses for the year ended September 30, 2007, and determined that research and development costs of $526,466, a legal settlement of $89,654 and income tax expense of $2,592 were incorrectly classified as general and administrative expenses.  See below for the specific line items affected in the statement of operations by the reclassification.



27



---





Table 1 shows the effect of each of the changes discussed above on the Companys balance sheet, statement of operation, statement of equity, and statement of cash flows for the year ended September 30, 2007.

Table 1



|                                                                |  |                      |             |                                     |  |            |                             |   |         |                                                   |   |  |                                                                            |         |   |                                                                                 |           |            |                     |         |         |             |   |   |           |          |         |           |             |            |  
|--------------------------------------------------------------- |  | -------------------- | ----------- | ----------------------------------- |  | ---------- | --------------------------- | - | ------- | ------------------------------------------------- | - |  | -------------------------------------------------------------------------- | ------- | - | ------------------------------------------------------------------------------- | --------- | ---------- | ------------------- | ------- | ------- | ----------- | - | - | --------- | -------- | ------- | --------- | ----------- | ---------- | -
|                                                                |  | As
Previously
Stated |             | 2001
Executive
Officers
Option
Plan |  |            | Advisory
Board
Compensation |   |         | Warrants
Related to
2004 Stock
Purchase
Agreement |   |  | Beneficial
Conversion
Features
and
Beneficial
Conversion
Features
Discount |         |   | Warrants
Related to
$1,025,000
of Convertible
Bridge Notes
and
Warrant
Discount |           |            | Reclassifi-
cations |         |         | As
Restated |  
|Balance Sheet                                                   |  |                      |             |                                     |  |            |                             |   |         |                                                   |   |  |                                                                            |         |   |                                                                                 |           |            |                     |         |         |             |  
|Accrued expenses                                                |  | $                    | 1,687,673   |                                     |  |            |                             | $ | 380,441 |                                                   |   |  |                                                                            |         |   |                                                                                 |           |            |                     |         |         |             |   | $ | 2,068,114 |         
|Convertible Notes, net                                          |  |                      | 920,337     |                                     |  |            |                             |   |         |                                                   |   |  |                                                                            |         |   | (73,114                                                                         | )         |            |                     | (70,751 | )       |             |   |   |           |          | 776,472 |          
|Warrant liability                                               |  |                      |           |                                     |  | 1,926,914  |                             |   |         |                                                   |   |  |                                                                            |         |   |                                                                                 |           |            |                     |         | 499,932 |             |   |   |           |          |         | 2,426,846 |            
|Beneficial conversion feature liability                         |  |                      |             |                                     |  |            |                             |   |         | 576,000                                           |   |  |                                                                            |         |   |                                                                                 | 1,430,812 |            |                     |         |         |             |   |   |           |          |         | 2,006,812 |            
|Additional paid-in capital                                      |  |                      | 14,712,527  |                                     |  | (2,271,879 | )                           |   |         | (269,851                                          | ) |  |                                                                            | (45,663 | ) |                                                                                 |           | (1,021,569 | )                   |         |         | (340,583    | ) |   |           |          |         |           | 10,762,982  |           
|Deficit accumulated during development stage                    |  |                      | (17,300,147 | )                                   |  | 344,965    |                             |   |         | (686,590                                          | ) |  |                                                                            | 45,663  |   |                                                                                 |           | (336,129   | )                   |         |         | (88,598     | ) |   |           |          |         |           | (18,020,836 | )         
|                                                                |  |                      |             |                                     |  |            |                             |   |         |                                                   |   |  |                                                                            |         |   |                                                                                 |           |            |                     |         |         |             |   |   |           |          |         |           |             |           
|Statement of Operations (for the year ended September 30, 2007) |  |                      |             |                                     |  |            |                             |   |         |                                                   |   |  |                                                                            |         |   |                                                                                 |           |            |                     |         |         |             |   |   |           |          |         |           |             |           
|General and administrative                                      |  | $                    | 1,423,347   |                                     |  |            |                             |   | $       | 153,354                                           |   |  |                                                                            |         |   |                                                                                 |           |            |                     |         | $       | 87,736      |   |   | $         | (618,712 | )       |           | $           | 1,045,725  |  
|Research and development                                        |  |                      |           |                                     |  |            |                             |   |         |                                                   |   |  |                                                                            |         |   |                                                                                 |           |            |                     |         |         |             |   |   |           | 526,466  |         |           |             | 526,466    |  
|Interest expense                                                |  |                      | (550,935    | )                                   |  |            |                             |   |         |                                                   |   |  |                                                                            |         |   |                                                                                 |           | (336,129   | )                   |         |         | (55,179     | ) |   |           |          |         |           |             | (942,243   | )
|Decrease in warrant liability                                   |  |                      |           |                                     |  | 344,965    |                             |   |         |                                                   |   |  |                                                                            | 70,029  |   |                                                                                 |           |            |                     |         |         | 54,317      |   |   |           |          |         |           |             | 469,311    |  
|Increase in beneficial conversion feature                       |  |                      |             |                                     |  |            |                             |   |         | (4,044                                            | ) |  |                                                                            |         |   |                                                                                 |           |            |                     |         |         |             |   |   |           |          |         |           |             | (4,044     | )
|Legal settlement                                                |  |                      |           |                                     |  |            |                             |   |         |                                                   |   |  |                                                                            |         |   |                                                                                 |           |            |                     |         |         |             |   |   |           | (89,654  | )       |           |             | (89,654    | )
|Income tax expense                                              |  |                      |             |                                     |  |            |                             |   |         |                                                   |   |  |                                                                            |         |   |                                                                                 |           |            |                     |         |         |             |   |   |           | 2,592    |         |           |             | 2,592      |  
|Basic and dilutive loss per share                               |  |                      | 0.02        |                                     |  |            |                             |   |         |                                                   |   |  |                                                                            |         |   |                                                                                 |           |            |                     |         |         |             |   |   |           |          |         |           |             | 0.02       |  
|                                                                |  |                      |             |                                     |  |            |                             |   |         |                                                   |   |  |                                                                            |         |   |                                                                                 |           |            |                     |         |         |             |   |   |           |          |         |           |             |            |  
|Statement of Operations (since inception)                       |  |                      |             |                                     |  |            |                             |   |         |                                                   |   |  |                                                                            |         |   |                                                                                 |           |            |                     |         |         |             |   |   |           |          |         |           |             |            |  
|General and administrative                                      |  | $                    | 13,585,568  |                                     |  |            |                             |   | $       | 250,546                                           |   |  | $                                                                          | 24,367  |   |                                                                                 |           |            |                     |         | $       | 87,736      |   |   | $         | (618,712 | )       |           | $           | 13,329,505 |  
|Research and development                                        |  |                      | 1,449,474   |                                     |  |            |                             |   |         |                                                   |   |  |                                                                            |         |   |                                                                                 |           |            |                     |         |         |             |   |   |           | 526,466  |         |           |             | 1,975,940  |  
|Interest expense                                                |  |                      | (785,621    | )                                   |  |            |                             |   |         |                                                   |   |  |                                                                            |         |   |                                                                                 |           | (336,129   | )                   |         |         | (55,179     | ) |   |           |          |         |           |             | (1,176,929 | )
|Decrease in warrant liability                                   |  |                      |           |                                     |  | 344,965    |                             |   |         |                                                   |   |  |                                                                            | 70,029  |   |                                                                                 |           |            |                     |         |         | 54,317      |   |   |           |          |         |           |             | 469,311    |  
|Increase in beneficial conversion feature                       |  |                      |             |                                     |  |            |                             |   |         | (4,044                                            | ) |  |                                                                            |         |   |                                                                                 |           |            |                     |         |         |             |   |   |           |          |         |           |             | (4,044     | )
|Legal settlement                                                |  |                      | 434,603     |                                     |  |            |                             |   |         |                                                   |   |  |                                                                            |         |   |                                                                                 |           |            |                     |         |         |             |   |   |           | (89,654  | )       |           |             | 344,949    |  
|Income tax expense                                              |  |                      | 9,900       |                                     |  |            |                             |   |         |                                                   |   |  |                                                                            |         |   |                                                                                 |           |            |                     |         |         |             |   |   |           | 2,592    |         |           |             | 12,492     |  





28



---





Table 1 (continued)



|                                                                                      |  |                      |             |                                     |   |          |                             |  |   |                                                   |   |  |                                                                            |         |   |                                                                                 |   |          |                     |  |   |             |   |  |  |          |   |  |   |             |  
|------------------------------------------------------------------------------------- |  | -------------------- | ----------- | ----------------------------------- | - | -------- | --------------------------- |  | - | ------------------------------------------------- | - |  | -------------------------------------------------------------------------- | ------- | - | ------------------------------------------------------------------------------- | - | -------- | ------------------- |  | - | ----------- | - |  |  | -------- | - |  | - | ----------- | -
|                                                                                      |  | As
Previously
Stated |             | 2001
Executive
Officers
Option
Plan |   |          | Advisory
Board
Compensation |  |   | Warrants
Related to
2004 Stock
Purchase
Agreement |   |  | Beneficial
Conversion
Features
and
Beneficial
Conversion
Features
Discount |         |   | Warrants
Related to
$1,025,000
of Convertible
Bridge Notes
and
Warrant
Discount |   |          | Reclassifi-
cations |  |   | As
Restated |  
|Statement of Cash Flows (for the year ended September 30, 2007)                       |  |                      |             |                                     |   |          |                             |  |   |                                                   |   |  |                                                                            |         |   |                                                                                 |   |          |                     |  |   |             |   |  |  |          |   |  |   |             |  
|Net loss                                                                              |  | $                    | (2,001,095  | )                                   | $ | 344,965  |                             |  | $ | (157,398                                          | ) |  | $                                                                          | 70,029  |   |                                                                                 | $ | (336,129 | )                   |  | $ | (88,598     | ) |  |  |          |   |  | $ | (2,168,226  | )
|Other                                                                                 |  |                      |             |                                     |   |          |                             |  |   | (799,044                                          | ) |  |                                                                            |         |   |                                                                                 |   |          |                     |  |   |             |   |  |  |          |   |  |   | (799,044    | )
|Stock based compensation expense- consultant                                          |  |                      | 84,292      |                                     |   |          |                             |  |   |                                                   |   |  |                                                                            |         |   |                                                                                 |   |          |                     |  |   | 124,697     |   |  |  |          |   |  |   | 208,989     |  
|Decrease in warrant liability                                                         |  |                      |           |                                     |   | (344,965 | )                           |  |   |                                                   |   |  |                                                                            | (70,029 | ) |                                                                                 |   |          |                     |  |   | (54,317     | ) |  |  |          |   |  |   | (469,311    | )
|Increase in beneficial conversion feature liaiblity                                   |  |                      |             |                                     |   |          |                             |  |   | 4,044                                             |   |  |                                                                            |         |   |                                                                                 |   |          |                     |  |   |             |   |  |  |          |   |  |   | 4,044       |  
|Accrued expenses                                                                      |  |                      | 566,278     |                                     |   |          |                             |  |   | 895,044                                           |   |  |                                                                            |         |   |                                                                                 |   |          |                     |  |   |             |   |  |  | (15,376  | ) |  |   | 1,445,946   |  
|Accrual of liquidating damages                                                        |  |                      |           |                                     |   |          |                             |  |   |                                                   |   |  |                                                                            |         |   |                                                                                 |   |          |                     |  |   |             |   |  |  | 15,375   |   |  |   | 15,375      |  
|                                                                                      |  |                      |             |                                     |   |          |                             |  |   |                                                   |   |  |                                                                            |         |   |                                                                                 |   |          |                     |  |   |             |   |  |  |          |   |  |   |             |  
|Statement of Cash Flows (since inception)                                             |  |                      |             |                                     |   |          |                             |  |   |                                                   |   |  |                                                                            |         |   |                                                                                 |   |          |                     |  |   |             |   |  |  |          |   |  |   |             |  
|Net loss                                                                              |  | $                    | (17,030,296 | )                                   | $ | 344,965  |                             |  |   | (956,441                                          |   |  |                                                                            | 45,663  |   |                                                                                 |   | (336,129 | )                   |  |   | (88,598     | ) |  |  |          |   |  |   | (18,020,836 | )
|Other                                                                                 |  |                      |             |                                     |   |          |                             |  |   | (799,044                                          | ) |  |                                                                            |         |   |                                                                                 |   |          |                     |  |   |             |   |  |  |          |   |  |   | (799,044    | )
|Stock based compensation expense-consultant                                           |  |                      | 2,840,172   |                                     |   |          |                             |  |   |                                                   |   |  |                                                                            |         |   |                                                                                 |   |          |                     |  |   | 124,697     |   |  |  |          |   |  |   | 2,964,869   |  
|Decrease in warrant liability                                                         |  |                      |           |                                     |   |        |                             |  |   |                                                   |   |  |                                                                            |       |   |                                                                                 |   |          |                     |  |   |           |   |  |  |          |   |  |   |           |  
|Increase in beneficial conversion feature liaiblity                                   |  |                      |             |                                     |   |          |                             |  |   |                                                 |   |  |                                                                            |         |   |                                                                                 |   |          |                     |  |   |             |   |  |  |          |   |  |   |           |  
|Amoritzation of consulting fees                                                       |  |                      | 13,075      |                                     |   |          |                             |  |   |                                                   |   |  |                                                                            |         |   |                                                                                 |   |          |                     |  |   |             |   |  |  | (13,075  | ) |  |   |           |  
|Increase in warranty liability                                                        |  |                      |           |                                     |   | (344,965 | )                           |  |   |                                                 |   |  |                                                                            | (70,029 | ) |                                                                                 |   |          |                     |  |   | (54,317     | ) |  |  |          |   |  |   | (469,311    | )
|Decrease in other assets                                                              |  |                      | 40,370      |                                     |   |          |                             |  |   |                                                   |   |  |                                                                            |         |   |                                                                                 |   |          |                     |  |   |             |   |  |  | (40,370  | ) |  |   |           |  
|Increase in advances to employees                                                     |  |                      | (512,077    | )                                   |   |          |                             |  |   |                                                   |   |  |                                                                            |         |   |                                                                                 |   |          |                     |  |   |             |   |  |  | 512,077  |   |  |   |           |  
|Decrease in other receivables                                                         |  |                      | 3,000       |                                     |   |          |                             |  |   |                                                   |   |  |                                                                            |         |   |                                                                                 |   |          |                     |  |   |             |   |  |  | (3,000   | ) |  |   |           |  
|Increase in deposits                                                                  |  |                      | (104,600    | )                                   |   |          |                             |  |   |                                                   |   |  |                                                                            |         |   |                                                                                 |   |          |                     |  |   |             |   |  |  | 104,600  |   |  |   |           |  
|Other current assets                                                                  |  |                      |           |                                     |   |          |                             |  |   |                                                   |   |  |                                                                            |         |   |                                                                                 |   |          |                     |  |   |             |   |  |  | (1,350   |   |  |   | (1,350      | )
|Other assets                                                                          |  |                      |           |                                     |   |          |                             |  |   |                                                   |   |  |                                                                            |         |   |                                                                                 |   |          |                     |  |   |             |   |  |  | (104,600 |   |  |   | (104,600    | )
|Accrued expenses                                                                      |  |                      | 2,021,239   |                                     |   |          |                             |  |   |                                                   |   |  |                                                                            |         |   |                                                                                 |   |          |                     |  |   |             |   |  |  | (14,427  |   |  |   | 2,006,812   |  
|Accrual of liquidating damages                                                        |  |                      |             |                                     |   |          |                             |  |   |                                                   |   |  |                                                                            |         |   |                                                                                 |   |          |                     |  |   |             |   |  |  | 15,375   |   |  |   | 15,375      |  
|Proceeds from issuance of notes                                                       |  |                      | 2,318,433   |                                     |   |          |                             |  |   |                                                   |   |  |                                                                            |         |   |                                                                                 |   |          |                     |  |   |             |   |  |  | (457,433 |   |  |   | 1,861,000   |  
|Proceeds from notes payable, related                                                  |  |                      |           |                                     |   |          |                             |  |   |                                                   |   |  |                                                                            |         |   |                                                                                 |   |          |                     |  |   |             |   |  |  | 457,433  |   |  |   | 457,433     |  
|Increase in fair value of beneficial conversion features discount at date of issuance |  |                      |             |                                     |   |          |                             |  |   |                                                   |   |  |                                                                            |         |   |                                                                                 |   | 4,044    |                     |  |   |             |   |  |  |          |   |  |   | 4,044       |  
|Issuance of common stock for cash                                                     |  |                      | 7,376,094   |                                     |   |          |                             |  |   |                                                   |   |  |                                                                            |         |   |                                                                                 |   |          |                     |  |   |             |   |  |  | 10,000   |   |  |   | 7,386,094   |  
|Receipt of cash for stock to be issued                                                |  |                      | 53,900      |                                     |   |          |                             |  |   |                                                   |   |  |                                                                            |         |   |                                                                                 |   |          |                     |  |   |             |   |  |  | (10,000  |   |  |   | 43,900      |  









29



---





Subsequent Restatement to Previous Restatement

As discussed above, the Company restated its September 30, 2007 financial statements due to a comment letter received from the Securities and Exchange Commission. However, the restatement did not properly account for certain derivative transactions as discussed below.

The Company issued approximately 25 secured convertible promissory notes between October 17, 2006 and February 27, 2007 for total proceeds to the Company of $750,000 (Convertible Notes 1). Convertible Notes 1 could be converted into shares of the Companys common stock at a conversion price of $0.05 per share. Convertible Notes 1 contained a provision that would automatically adjust the conversion price if equity securities or instruments convertible into equity securities were issued at a conversion price of less than $0.05.

On June 6, 2007, the Company issued 5 convertible promissory notes for a total of $86,000 (Convertible Notes 2). No warrants were issued in connection with Convertible Notes 2. Convertible Notes 2 matures on or about December 31, 2008, and is convertible into common stock at $0.01 per share.

As a result of the issuance of Convertible Notes 2, the conversion price for Convertible Notes 1 was adjusted down from $0.05 to $0.01. The decrease in the conversion price increased the potential dilutive shares from 15,000,000 to 75,000,000, and this subsequently increased the total outstanding and potential dilutive shares over the authorized common share limit of 150,000,000. Because there were insufficient authorized shares to fulfill all potential conversions, the Company should have classified all potentially dilutive securities as derivative liabilities as of June 6, 2007. The Company researched its debt and equity instruments and determined that the potentially dilutive securities are as follows:

·

2001 Executive Officers Stock Option Plan

·

Advisory Board Compensation

·

Warrants Related to 2004 Stock Purchase Agreement

·

Convertible Notes 1

·

Convertible Notes 2

·

Subordinated Convertible Notes 3

·

Warrants related to Subordinated Convertible Notes 3

The Company analyzed the effect of the recalculation on the balance sheet and the statements of operations and cash flows as of June 30, 2007. The analysis and results were as follows:

2001 Executive Officers Stock Option Plan

In October 2000, the Company amended the employment agreements with its executive officers. In conjunction with the amendments, the Company adopted the 2001 Executive Officers Stock Option Plan (Plan). The Plan has reserved 7,576,680 shares of common stock and has issued options for the purchase of 7,034,140 shares of common stock. The options vest over 5 years and expire 10 years from the date of issuance.

Balance Sheet

The Company determined that because there were not sufficient authorized shares available, the embedded conversion feature met the definition of a derivative based on Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities, (SFAS 133) as of June 6, 2007.

The Company determined the fair value of the stock options to be $2,454,597 using the Black Sholes model with the following assumptions:

·

risk free rate of return of 5.03%;

·

volatility of 285%;

·

dividend yield of 0%; and

·

expected term of 3.87 years.



30



---





Therefore, at June 6, 2007 the Company recorded on the accompanying balance sheet an accrued liability of $2,454,597 for the fair value of the options and a reduction to additional paid in capital (APIC) of $2,454,597.

The Company followed the guidance of SFAS 133, which requires all contracts classified as liabilities to be measured at fair value with changes in fair value reported in earnings as long as the contracts remain classified as liabilities.

At September 30, 2007, the Company determined the fair value of the options to be $2,240,124 using the Black Sholes model with the following assumptions:

·

risk free rate of return of 4.03%;

·

volatility of 283%;

·

dividend yield of 0%; and

·

expected term of 3.56 years.

In order to adjust the liability to the proper balance, the Company recorded an increase in the liability of $130,491 that was recorded as a change in accrued derivative liability in the accompanying statement of operations.

Statement of Operations

At September 30, 2007, the Company recorded $130,491 as a change in accrued derivative liability in the accompanying statement of operations.

Statement of Cash Flows

Changes in the statement of cash flows were the result of the change in fair value of the liability of $130,491.

Advisory Board Compensation

On October 1, 2004, the Company formed an advisory board consisting of four members. In exchange for their services, each member was to receive $5,000 monthly from October 1, 2004 to February 22, 2007, for a total of $576,000 to be paid to all members. Each member, in his sole discretion, was entitled to convert some or all of the cash amount owed to him into shares of common stock at a rate of $0.05 per share. If all of the members of the advisory board converted the total amount of cash compensation due to them into shares of common stock, the Company would be required to issue 11,520,000 shares. The Company determined that the accrued expense, embedded beneficial conversion features, embedded beneficial conversion feature discount, and related amortization expense were not recorded at the date of issuance or prior to the restatement. No payments have been made to any advisory board members and there has been no conversion by any advisory board members of the accrued liability into shares of common stock.

Balance Sheet

The Company determined that because there were not sufficient authorized shares available that the embedded conversion feature met the definition of a derivative based on SFAS 133 as of June 6, 2007.

The Company determined the fair value of the embedded conversion feature to be $3,614,932 using the Black Sholes model with the following assumptions:

·

risk free rate of return of 4.99%;

·

volatility between 186% and 277%;

·

dividend yield of 0%; and

·

an expected term of 0.52 years to 1.30 years.

Therefore, at June 6, 2007, the Company recorded on the accompanying balance sheet an accrued liability of $576,000 for the accrued compensation and an embedded conversion derivative liability of $3,614,932.

The Company followed the guidance of SFAS 133, which requires all contracts classified as liabilities to be measured at fair value, with changes in fair value reported in earnings as long as the contracts remain classified as liabilities.



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At September 30, 2007, the Company determined the fair value of the embedded conversion feature to be $3,128,617 using the Black Sholes model with the following assumptions:

·

risk free rate of return of 4.09%;

·

volatility of 121%;

·

dividend yield of 0%; and

·

expected term of 0.20 years to 0.98 years.

Statement of Operations

The Company recorded an adjustment of $4,037,578 to compensation expense, which is the accrued advisory board compensation related to the fiscal year ended September 30, 2007 plus the fair value of the embedded derivative.

At September 30, 2007, the Company recorded $1,289,402 as a gain on change in fair value of the beneficial conversion option in the accompanying statement of operations.

Statement of Cash Flows

Changes in the statement of cash flows were the result of the advisory board compensation accrued expense of $576,000, additional compensation expense for beneficial conversion features liability of $3,461,578 (total compensation expense of $4,037,578 less $576,000 that is shown as a change in accrued expenses), and a decrease in fair value of beneficial conversion liability of $1,289,402.

Warrants Related to 2004 Stock Purchase Agreement

Under the terms of a 2004 Stock Purchase Agreement, the Company issued warrants to purchase 1,463,336 shares of common stock at an exercise price of $0.03, which expired between February 9, 2007 and August 25, 2007. The Company determined that the warrants and related expense were not recorded at the date of issuance or prior to the restatement and there has been no exercise of the warrants into shares of common stock. As of September 30, 2007, all of the warrants had expired.

Convertible Notes 1

As of June 6, 2007, the Company had Convertible Notes 1 outstanding totaling $750,000 that were issued between October 17, 2006 and February 27, 2007. Convertible Notes 1 included an embedded beneficial conversion feature that allowed the holders to convert the Convertible Notes 1 into common stock at an initial rate of $0.05. Convertible Notes 1 mature between April 2008 and December 2008, accrue interest at 10%, and any accrued but unpaid interest is also convertible into common stock at $0.05. Because of the price protection offered holders of Convertible Notes 1 and the subsequent issuance of Convertible Notes 2, the conversion price was decreased from $0.05 to $0.01.

Balance Sheet

The Company determined that because there were not sufficient authorized shares available that the embedded conversion feature met the definition of a derivative based on SFAS 133 as of June 6, 2007.

The Company determined the fair value of the embedded conversion feature to be $27,057,645 using the Black Sholes model with the following assumptions:

·

risk free rate of return of 4.99%;

·

volatility between 186% and 277%;

·

dividend yield of 0%; and

·

expected term of 0.87 years to 1.23 years.

Therefore, at June 6, 2007, the Company recorded on the accompanying balance sheet an accrued embedded conversion derivative liability of $27,057,645, a reduction to additional paid in capital of $619,513 (the amount that had been previously recorded to APIC) and financing costs of $26,438,132.



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At September 30, 2007, the Company determined the fair value of the embedded conversion feature to be $25,292,237 using the Black Sholes model with the following assumptions:

·

risk free rate of return of 4.09%;

·

volatility of189%;

·

dividend yield of 0%; and

·

expected term of 0.55 years to 0.91 years.

Statement of Operations

The Company recorded the $26,438,132 as interest and financing costs and recorded the decrease of $2,576,707 as a gain on change in fair value of beneficial conversion liability in the accompanying statement of operations.

Statement of Cash Flows

Changes in the statement of cash flows were the result of the non-cash financing charge of $26,438,132 and the $2,576,707 decrease in fair value of beneficial conversion option.

Convertible Notes 2

On June 6, 2007, the Company issued 5 convertible promissory notes for a total of $86,000. No warrants were issued in connection with Convertible Notes 2. The Convertible Notes 2 mature on or about December 31, 2008, accrue interest at 10% and are convertible at $0.01.

Balance Sheet

The Company determined that because there were not sufficient authorized shares available that the embedded conversion feature met the definition of a derivative based on SFAS 133as of June 6, 2007.

The Company determined the fair value of the embedded conversion feature to be $2,982,540 using the Black Sholes model with the following assumptions:

·

risk free rate of return of 4.99%;

·

volatility of 277%;

·

dividend yield of 0%; and

·

expected term of 1.57 years.

Therefore, at June 6, 2007, the Company recorded on the accompanying balance sheet an accrued embedded conversion derivative liability of $2,982,540 and financing costs of $2,982,540.

At September 30, 2007, the Company determined the fair value of the embedded conversion feature to be $2,787,690 using the Black Sholes model with the following assumptions:

·

risk free rate of return of 4.05%;

·

volatility of 241%;

·

dividend yield of 0%; and

·

expected term of 1.25 years.

Statement of Operations

The Company recorded the $2,982,540 as interest and financing costs and the decrease of $194,850 as a gain on change in fair value of beneficial conversion liability in the accompanying statement of operations.

Statement of Cash Flows

Changes in the statement of cash flows were the result of the non-cash financing charge of $2,982,540 and the $194,850 decrease in fair value of beneficial conversion option.



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Subordinated Convertible Notes 3

From June 21, 2007 through July 17, 2007, the Company issued 11 subordinated convertible promissory notes (Subordinated Convertible Notes 3) for a total of $1,025,000. The Company issued to the investors 2,329,546 five year warrants with an exercise price of $0.50. In addition, the Company issued 465,908 warrants as a placement fee, which have the same terms as the warrants issued to the investors. The Subordinated Convertible Notes 3 mature one year from date of issuance, accrue interest at 8% and are convertible at $0.22.

Balance Sheet

The Company determined that because there were not sufficient authorized shares available that the embedded conversion feature met the definition of a derivative based on SFAS 133as of June 6, 2007.

The Company determined the fair value of the embedded conversion feature to be $1,116,030 using the Black Sholes model with the following assumptions:

·

risk free rate of return between 4.96% and 5%;

·

volatility between 196% and 198%;

·

dividend yield of 0%; and

·

expected term of 1 year.

Therefore, the Company recorded on the accompanying balance sheet an accrued embedded conversion derivative liability of $1,116,030 and financing costs of $1,116,030.

At September 30, 2007, the Company determined the fair value of the embedded conversion features to be $1,008,368 using the Black Sholes model with the following assumptions:

·

risk free rate of return of 4.09%;

·

volatility of 189%;

·

dividend yield of 0%; and

·

expected term between 0.72 years and 0.80 years.

Statement of Operations

The Company recorded the $1,116,030 as financing costs and recorded the decrease of $107,662 as a gain on change in fair value of beneficial conversion liability in the accompanying statement of operations.

Statement of Cash Flows

Changes in the statement of cash flows were the result of the non-cash financing charge of $1,116,030 and the decrease in fair value of beneficial conversion option of $107,662.

Warrants related to Subordinated Convertible Notes 3

Pursuant to the Subordinated Convertible Notes 3 issued during June and July 2007, the Company issued to the investors 2,329,546 five year warrants with an exercise price of $0.50. In addition, the Company issued 465,908 warrants as a placement fee, which have the same terms as the warrants issued to the investors.

Balance Sheet

The Company determined that because there were not sufficient authorized shares available that the warrants met the definition of a derivative based on SFAS 133 as of June 6, 2007.



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The Company calculated the fair value of the 2,795,454 warrants to be $897,793 using the Black Sholes model with the following assumptions:

·

risk free rate of return between 5.00% and 5.06%;

·

volatility between 265% and 266%;

·

dividend yield of 0%; and

·

expected term of 5 years.

The Company recorded an accrued warrant derivative liability of $897,793 and interest and financing costs of $897,793.

The Company followed the guidance of SFAS 133, which requires all contracts classified as liabilities to be measured at fair value, with changes in fair value reported in earnings as long as the contracts remain classified as liabilities.

At September 30, 2007, the Company determined the fair value of the warrant liability to be $890,607 using the Black Sholes model with the following assumptions:

·

risk free rate of return of 4.23%;

·

volatility of 265%;

·

dividend yield of 0% and

·

expected term between 4.73 and 4.80 years.

Statement of Operations

The Company recorded as financing costs the $897,793 and recorded the increase of $10,347 as a loss on change in fair value of beneficial conversion liability in the accompanying statement of operations.

Statement of Cash Flows

Changes in the statement of cash flows were the result of the non-cash financing charge of $897,793 and a change in the warrant and option liability of $10,347.



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The following table shows the effect of each of the changes discussed above on the Companys balance sheet, statement of operation, and statement of cash flows for the year ended September 30, 2007.

|                                                                       |  |   |                      |   |   |                                |   |   |                       |   |   |                            |  
|---------------------------------------------------------------------- |  | - | -------------------- | - | - | ------------------------------ | - | - | --------------------- | - | - | -------------------------- | -
|                                                                       |  |   | As
Previously
Stated |   |   | Benficial
Conversion 
Features |   |   | Warrants
and
 Options |   |   | As Restated
June 30,
 2007 |  
|Balance Sheet                                                          |  |   |                      |   |   |                                |   |   |                       |   |   |                            |  
|Accrued expenses                                                       |  | $ | 2,068,114            |   | $ | 195,559                        |   | $ |                     |   | $ | 2,263,673                  |  
|Warrant and option liability                                           |  |   | 2,426,846            |   |   |                              |   |   | 703,885               |   |   | 3,130,731                  |  
|Beneficial conversion liability                                        |  |   | 2,006,812            |   |   | 30,210,100                     |   |   |                     |   |   | 32,216,912                 |  
|Additional paid-in capital                                             |  |   | 10,762,982           |   |   |                              |   |   | 334,746               |   |   | 11,097,728                 |  
|Deficit accumulated during developmental stage                         |  |   | (18,020,836          | ) |   | (30,405,659                    | ) |   | (1,038,631            | ) |   | (49,465,126                | )
|                                                                       |  |   |                      |   |   |                                |   |   |                       |   |   |                            |  
|Statement of Operations (for the year ended September 30, 2007)        |  |   |                      |   |   |                                |   |   |                       |   |   |                            |  
|Gain (loss) on change in fair value of warrant and option liability    |  | $ | 469,311              |   | $ |                              |   | $ | (140,838              | ) | $ | 328,473                    |  
|Gain (loss) on change in fair value of beneficial conversion liability |  |   | (4,044               | ) |   | 4,168,621                      |   |   |                     |   |   | 4,164,577                  |  
|General and administrative                                             |  |   | 1,045,725            |   |   | 4,037,578                      |   |   |                     |   |   | 5,083,303                  |  
|Interest and financing costs                                           |  |   | (942,243             | ) |   | (30,536,702                    | ) |   | (897,793              | ) |   | (32,376,738                | )
|                                                                       |  |   |                      |   |   |                                |   |   |                       |   |   |                            |  
|Statement of Operations (since inception)                              |  |   |                      |   |   |                                |   |   |                       |   |   |                            |  
|Gain (loss) on change in fair value of warrant and option liability    |  | $ | 469,311              |   | $ |                              |   | $ | (140,838              | ) | $ | 328,473                    |  
|Gain (loss) on change in fair value of beneficial conversion liability |  |   | (4,044               | ) |   | 3,918,075                      |   |   |                     |   |   | 3,914,031                  |  
|General and administrative                                             |  |   | 13,329,505           |   |   | 3,787,032                      |   |   |                     |   |   | 17,116,537                 |  
|Interest and financing costs                                           |  |   | (1,176,929           | ) |   | (30,536,702                    | ) |   | (897,793              | ) |   | (32,611,424                | )
|                                                                       |  |   |                      |   |   |                                |   |   |                       |   |   |                            |  
|Statement of Cash Flows (for the year ended September 30, 2007)        |  |   |                      |   |   |                                |   |   |                       |   |   |                            |  
|Net loss                                                               |  | $ | (2,168,226           | ) | $ | (30,405,659                    | ) | $ | (1,038,631            | ) | $ | (33,612,516                | )
|(Gain) loss on change in fair value of warrant and option liability    |  |   | (469,311             | ) |   |                              |   |   | 140,838               |   |   | (328,473                   | )
|(Gain) loss on change in fair value of beneficial conversion liability |  |   | 4,044                |   |   | (4,168,621                     | ) |   |                     |   |   | (4,164,577                 | )
|Change in accrued expenses                                             |  |   | 1,445,946            |   |   | 576,000                        |   |   |                     |   |   | 2,021,946                  |  
|Non-cash compensation expense                                          |  |   |                    |   |   | 3,461,578                      |   |   |                     |   |   | 3,461,578                  |  
|Non-cash financing costs                                               |  |   |                    |   |   | 30,536,702                     |   |   | 897,793               |   |   | 31,434,495                 |  
|                                                                       |  |   |                      |   |   |                                |   |   |                       |   |   |                            |  
|Statement of Cash Flows (since inception)                              |  |   |                      |   |   |                                |   |   |                       |   |   |                            |  
|Net loss                                                               |  | $ | (18,020,836          | ) | $ | (30,405,659                    | ) | $ | (1,038,631            | ) | $ | (49,465,126                | )
|(Gain) loss on change in fair value of warrant and option liability    |  |   | (469,311             | ) |   |                              |   |   | 140,838               |   |   | (328,473                   | )
|(Gain) loss on change in fair value of beneficial conversion liability |  |   | 4,044                |   |   | (4,168,621                     | ) |   |                     |   |   | (4,164,577                 | )
|Change in accrued expenses                                             |  |   | 2,006,812            |   |   | 576,000                        |   |   |                     |   |   | 2,582,812                  |  
|Non-cash compensation expense                                          |  |   |                    |   |   | 3,461,578                      |   |   |                     |   |   | 3,461,578                  |  
|Non-cash financing costs                                               |  |   |                    |   |   | 30,536,702                     |   |   | 897,793               |   |   | 31,434,495                 |  











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Application of Critical Accounting Policies and Estimates

The preparation of our consolidated financial statements in accordance with U.S. GAAP requires management to make judgments, assumptions and estimates that affect the amounts reported. A critical accounting estimate is an assumption about highly uncertain matters and could have a material effect on the consolidated financial statements if another, also reasonable, amount were used, or, a change in the estimate is reasonably likely from period to period. We base our assumptions on historical experience and on other estimates that we believe are reasonable under the circumstances. Actual results could differ significantly from these estimates. There were no changes in accounting policies or significant changes in accounting estimates during fiscal 2007. Management believes the following critical accounting policies reflect its more significant estimates and assumptions.

Revenue Recognition. Although the Company has yet to generate sales, it plans to follow the guidance provided by SAB 104 for recognition of revenues. The Company does not plan to recognize revenue unless there is persuasive evidence of an arrangement, title and risk of loss has passed to the customer, delivery has occurred or the services have been rendered, the sales price is fixed or determinable and collection of the related receivable is reasonably assured. In general, the Company plans to require a deposit from a customer before a unit is fabricated and shipped. It is the Company's policy to require an arrangement with its customers, either in the form of a written contract or purchase order containing all of the terms and conditions governing the arrangement, prior to the recognition of revenue. Title and risk of loss will generally pass to the customer at the time of delivery of the product to a common carrier. At the time of the transaction, the Company will assess whether the sale price is fixed or determinable and whether or not collection is reasonably assured. If the sales price is not deemed to be fixed or determinable, revenue will be recognized as the amounts become due from the customer. The Company does not plan to offer a right of return on its products and the products will generally not be subject to customer acceptance rights. The Company plans to assess collectability based on a number of factors, including past transaction and collection history with a customer and the creditworthiness of the customer. The Company plans to perform ongoing credit evaluations of its customers' financial condition. If the Company determines that collectability of the sales price is not reasonably assured, revenue recognition will be deferred until such time as collection becomes reasonably assured, which is generally upon receipt of payment from the customer. The Company plan to include shipping and handling costs in revenue and cost of sales.

Support Services. The Company plans to provide support services to customers primarily through service contracts, and it will recognize support service revenue ratably over the term of the service contract or as services are rendered.

Warranties. The Company's products are generally subject to warranty, and related costs will be provided for in cost of sales when revenue is recognized. Once the Company has a history of sales, the Company's warranty obligation will be based upon historical product failure rates and costs incurred in correcting a product failure. If actual product failure rates or the costs associated with fixing failures differ from historical rates, adjustments to the warranty liability may be required in the period in which determined.

Allowance for Doubtful Accounts. The Company will evaluate the adequacy of its allowance for doubtful accounts on an ongoing basis through detailed reviews of its accounts and notes receivables. Estimates will be used in determining the Company's allowance for doubtful accounts and will be based on historical collection experience, trends including prevailing economic conditions and adverse events that may affect a customer's ability to repay, aging of accounts and notes receivable by category, and other factors such as the financial condition of customers. This evaluation is inherently subjective because estimates may be revised in the future as more information becomes available about outstanding accounts.

Inventory Valuation. Inventories will be stated at the lower of cost or market, with costs generally determined on a first-in first-out basis. We plan to utilize both specific product identification and historical product demand as the basis for determining excess or obsolete inventory reserve. Changes in market conditions lower than expected customer demand or changes in technology or features could result in additional obsolete inventory that is not saleable and could require additional inventory reserve provisions.

Goodwill and other Intangibles. Goodwill and intangible assets with indefinite lives will be tested annually for impairment in accordance with the provisions of Financial Accounting Standards Board Statement No. 142 Goodwill and Other Intangible Assets (FAS 142). We will use our judgment in assessing whether assets may have become impaired between annual impairment tests. We perform our annual test for indicators of goodwill and non-amortizable intangible assets impairment in the fourth quarter of our fiscal year or sooner if indicators of impairment exist.



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Accrued Derivative Liabilities. The Company applies a two-step model to determine whether a financial instrument or an embedded feature is indexed to an issuers own stock and thus able to qualify for equity treatment.  The Company further evaluates and determines which instruments or embedded features require liability accounting and records it at its fair value as an accrued derivative liability. The changes in the values of the accrued derivative liabilities are shown in the accompanying statements of operations.

Legal Contingencies. From time to time we are a defendant in litigation. As required by Financial Accounting Standards Board Statement No. 5Accounting for Contingencies (FAS 5), we determine whether an estimated loss from a loss contingency should be accrued by assessing whether a loss is deemed probable and the loss amount can be reasonably estimated, net of any applicable insurance proceeds. Estimates of potential outcomes of these contingencies are developed in consultation with outside counsel. While this assessment is based upon all available information, litigation is inherently uncertain and the actual liability to fully resolve this litigation cannot be predicted with any assurance of accuracy. Final settlement of these matters could possibly result in significant effects on our results of operations, cash flows and financial position.

Plan of Operation.

During the next twenty-four months we plan to test and continue demonstrating the ELIXIR water treatment system to potential clients at the Villa Park Dam under our arrangement with the Serrano Water District. We believe that the operation of the unit at this facility will position us to aggressively market the ELIXIR to public water utilities, private companies and other potential customers. These demonstrations will serve as a sales tool and a model for possible applications and installations. Once we obtain sufficient financing, we plan to engage in substantial promotional activities in connection with the operation of the unit, including media exposure and access to other public agencies and potential private customers. If the unit continues to operate successfully, we believe we can receive orders for operating units. We have demonstrated the unit at the Villa Park Dam to over fifty prospective clients.

We have established our manufacturing facility in Anaheim, California to begin production of the units, and we have installed the machinery and tooling in the building. Once we have obtained financing we will begin to recruit and hire employees to serve at the facility. We anticipate that most of our capital needs will need to be funded by equity financing until such time that we have received orders for, and deposits with respect to, our products.

Once we receive orders, we intend to manufacture Elixir systems at our facility to fulfill the orders and ship them to customers.

Results of Operations (Year Ended September 30, 2007 Compared To Year Ended September 30, 2006, As Restated).

The Company was relatively inactive during most of the 2006 fiscal year due to lack of resources, although it reactivated operations in the last quarter. Revenues for both the 2006 and 2007 fiscal years were zero, as the Company had not yet commenced the sale of products. The Company incurred operating expenses of $5,641,468 during the fiscal year ended September 30, 2007 representing an increase of $4,696,451 as compared to operating expenses of $945,017 for the fiscal year ended September 30, 2006. The significant increase in operating expenses was partially the result of an increase of $526,466 in research and development expenses for the fiscal year ended September 30, 2007, as compared to no research and development expenses incurred during the fiscal year ended September 30, 2006. The increase in research and development expenses resulted from the completion of the design and the refinement of the ELIXIR water treatment system and costs associated with the establishment of the pilot project at the Villa Park Dam. During the fiscal year ended September 30, 2006, the Company did not have the capital necessary to invest in research and development activities. General and administrative expenses for the 2007 fiscal year increased significantly. General and administrative expenses totaled $5,083,,303 representing an increase of $4,169,612 over general and administrative expenses of $913,691 incurred during the 2006 fiscal year. The significant increase in general and administrative expenses is attributed to the recording of the advisory board compensation of $4,037,578 that includes accrued board compensation and the accounting of the embedded derivative relating to the boards ability to convert compensation due to the board to common shares. The remaining increase in general and administrative expenses incurred during the fiscal year ended September 30, 2007 relates to the Companys corporate office and engaging in financing activities.

Other income (expense) totaled $(27,968,456) during the fiscal year ended September 30, 2007 representing an increase of $27,864,154 as compared to $(104,302) for the fiscal year ended September 30, 2006. The Company



38



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earned interest income of $4,886 during the fiscal year ended September 30, 2007, as compared to no interest income during the fiscal year ended September 30, 2006. The Company also recorded a gain of $4,493,050 on the change in fair value of its warrant and option liability and beneficial conversion liability during the year ended September 30, 2007, as compared to no gain during the fiscal year ended September 30, 2006. These items were offset by interest expense and financing costs of $32,376,738 incurred during the fiscal year ended September 30, 2007, as compared to interest expense and financing costs of $10,080 incurred during the fiscal year ended September 30, 2006, an increase of $32,366,658. The majority of the increase relates to financing costs of $31,434,495. The financing costs are directly attributed the Companys issuance of convertible notes and specifically to the recording of beneficial conversion feature and warrants attached to the notes as financing costs. The remaining increase represents interest expense on the convertible notes and the amortization of the debt discount of the convertible notes during the fiscal year ended September 30, 2007. During the fiscal year ended September 30, 2007, the Company recorded an expense in the amount of $89,654 related to the settlement of a legal action. No comparable expenses were incurred during the fiscal year ended September 30, 2006. However, during the fiscal year ended September 30, 2006, the Company incurred an extraordinary loss on settlement of debts in the amount of $94,222, with no corresponding loss during the fiscal year ended September 30, 2007. As a result of these items, the loss before income taxes for the fiscal year ended September 30, 2007 was $33,609,924, an increase of $32,560,605 over the loss before income taxes of $1,049,319 incurred for the fiscal year ended September 30, 2006.

Liquidity and Capital Resources, As Restated.

On September 30, 2007, the Company had cash and cash equivalents of $372,511. The Companys sole source of liquidity has been the sale of its securities. Additional capital will be required to finance the Company's operations. The Company believes that anticipated proceeds from sales of securities and other financing activities, plus possible cash flow from operations during the 2008 fiscal year, will be sufficient to finance the Company's operations. However, the Company has no commitments for financing, and there can be no assurance that such financing will be available or that the Company will not encounter unforeseen difficulties that may deplete its capital resources more rapidly than anticipated. Also, the Company may not be able to generate revenues from operations during the fiscal year.

During the fiscal year ended September 30, 2007, the Company used $1,117,861 of cash in operating activities, as compared to $44,290 of cash used in operating activities during the fiscal year ended September 30, 2006. During the fiscal year ended September 30, 2007, non-cash adjustments included $31,434,495 for financing costs and $3,461,578 for advisory board compensation. The Company also recorded an increase of $1,350 in current assets, an increase of $104,600 in deposits, a decrease of $115,209 in accounts payable and an increase of $2,021,946 in accrued expenses. Cash provided by operating activities included $31,699 in depreciation, $833,826 in amortization of beneficial conversion features discount and warrant, and $208,989 in stock based compensation paid to a consultant. The Company also accrued liquidated damages of $15,375 during the fiscal year ended September 30, 2007.

During the fiscal year ended September 30, 2007, the Company acquired property and equipment totaling $27,772, as compared to property acquisitions of $950 during the fiscal year ended September 30, 2006.

Financing activities provided $1,513,600 to the Company during the fiscal year ended September 30, 2007, as compared to $49,440 during the fiscal year ended September 30, 2006. Financing activities for the fiscal year ended September 30, 2007 provided $1,861,000 in proceeds from the placement of convertible notes.  The Company made payments of $47,400 to an officer for a loan and $300,000 toward an equity line of credit during the fiscal year ended September 30, 2007. During the fiscal year ended September 30, 2006, the Company borrowed $49,440 from a related party.

At September 30, 2007, the Company had cash of $372,511, as compared to cash of $4,544 at September 30, 2006.

As of September 30, 2007, the Company had an accumulated deficit of $49,465,126. Management anticipates that future operating results will continue to be subject to many of the problems, expenses, delays and risks inherent in the establishment of a developmental business enterprise, many of which the Company cannot control.

Recent Private Placements

In a private offering that commenced in October of 2006 and concluded in early 2007, we issued convertible notes in the amount of $750,000 to a group of private investors. The notes bear interest at 10% per annum, are due



39



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eighteen months after issuance, and are convertible into our Common Stock at a conversion price of $0.04 per share. The holders have the option to convert accrued interest on these notes into Common Stock at the same conversion rate.

In June 2007 we completed a private offering of 10% Convertible Promissory Notes totaling $86,000 to five private investors. The notes are convertible into Common Stock at a conversion price of $0.01 per share. The rights of the holders of these notes to convert is subject to the completion of certain financing milestones.

In July 2007 we completed a private offering, principally to private investment funds, in the amount of $1,025,000. The investors received Subordinated Convertible Debentures that bear interest at 8% per annum, are due twelve months after issuance, and are convertible into share of our Common Stock at a conversion price of $0.22 per share. The investors also received warrants to purchase 2,329,546 shares of Common Stock at a cost of $0.50 per share. In addition, we issued a warrant to purchase 465,908 shares of our Common Stock at $0.50 per share as a fee for assisting us with the transaction.

Going Concern Opinion, As Restated.

The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. This basis of accounting contemplates the recovery of the Companys assets and the satisfaction of its liabilities in the normal course of business. Through September 30, 2007, the Company has incurred cumulative losses of $49,465,126, including a loss for the year ended September 30, 2007 of $33,612,516. As the Company has no cash flow from operations, its ability to transition from a development stage company to an operating company is entirely dependent upon obtaining adequate financing to pay for its overhead, research and development activities, and acquisition of production equipment. It is unknown when, if ever, the Company will achieve a level of revenues adequate to support its costs and expenses. In order for the Company to meet its basic financial obligations, including rent, salaries, debt service and operations, it plans to undertake additional equity or debt financing. Because of the Companys history and current debt levels, there is considerable doubt that the Company will be able to obtain financing. The Companys ability to meet its cash requirements for the next twelve months depends on its ability to obtain such financing. Even if financing is obtained, any such financing will likely involve additional fees and debt service requirements, which may significantly reduce the amount of cash we will have for our operations. Accordingly, there is no assurance that the Company will be able to implement its plans.

The Company expects to continue to incur substantial operating losses for the foreseeable future, and it cannot predict the extent of the future losses or when it may become profitable, if ever. It expects to incur increasing sales and marketing, research and development and general and administrative expenses. Also, the Company has a substantial amount of short-term debt, which will need to be repaid or refinanced, unless it is converted into equity. As a result, if it begins to generate revenues from operations, those revenues will need to be significant in order to cover current and anticipated expenses. These factors raise substantial doubt about the Company's ability to continue as a going concern unless it is able to obtain substantial additional financing in the short term and generate revenues over the long term. If the Company is unable to obtain financing, it would likely discontinue operations.





40



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ITEM 7

FINANCIAL STATEMENTS



SIONIX CORPORATION

INDEX TO FINANCIAL STATEMENTS





|                                                                                                                                                                       |  |  |      | 
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  |  | ---- | 
|Report of Independent Registered Public Accounting Firm                                                                                                                |  |  | F-2  | 
|                                                                                                                                                                       |  |  |      | 
|Balance Sheet as of September 30, 2007 (Restated)                                                                                                                      |  |  | F-3  | 
|                                                                                                                                                                       |  |  |      | 
|Statement of Operations for the years ended September 30, 2007 and September 30, 2006 and Cumulative from Inception (October 3, 1994) to September 30, 2007 (Restated) |  |  | F-4  | 
|                                                                                                                                                                       |  |  |      | 
|Statement of Stockholders Equity (Deficit) from Inception (October 3, 1994) to September 30, 2007 (Restated)                                                          |  |  | F-5  | 
|                                                                                                                                                                       |  |  |      | 
|Statement of Cash Flows for the years ended September 30, 2007 and September 30, 2006 and Cumulative From Inception (October 3, 1994) to September 30, 2007 (Restated) |  |  | F-9  | 
|                                                                                                                                                                       |  |  |      | 
|Notes to Financial Statements                                                                                                                                          |  |  | F-10 | 





41



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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders

Sionix Corporation

We have audited the accompanying balance sheet of Sionix Corporation (a development stage entity) (a Nevada corporation) as of September 30, 2007 and the related statements of operations, stockholders' equity (deficit), and cash flows for the years ended September 30, 2007 and 2006 and for the period from October 3, 1994 (inception) to September 30, 2007. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Sionix Corporation as of September 30, 2007 and the results of its operations and its cash flows for the years ended September 30, 2007 and 2006 and for the period from October 3, 1994 (inception) to September 30, 2007, in conformity with accounting principles generally accepted in the United States of America.

The Company's financial statements are prepared using the generally accepted accounting principles applicable to a going concern, which contemplates the realization of assets and liquidation of liabilities in the normal course of business. The Company has deficit accumulated from inception amounting $49,465,126 at September 30, 2007 including a net loss of $33,612,516incurred in the year ended September 30, 2007. These factors as discussed in Note 13 to the financial statements, raises substantial doubt about the Company's ability to continue as a going concern. Management's plans in regard to these matters are also described in note 13. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.

As discussed in note 16, the financial statements for the years ended September 30, 2007 and 2006 have been restated.

Kabani & Company, Inc.

Certified Public Accountants

Los Angeles, California.

December 7, 2007 except for notes 8, 9, 10, 11, 12, & 15, which are as of October 9, 2008 and notes 2, 4, 13, & 16, which are as of December 31, 2009.



42



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SIONIX CORPORATION

(A DEVELOPMENT STAGE COMPANY)

BALANCE SHEET

AS OF SEPTEMBER 30, 2007



|                                                                                                                                |  |   |             |  
|------------------------------------------------------------------------------------------------------------------------------- |  | - | ----------- | -
|                                                                                                                                |  |   | As
Restated |  
|ASSETS                                                                                                                          |  |   |             |  
|CURRENT ASSETS                                                                                                                  |  |   |             |  
|Cash and cash equivalents                                                                                                       |  | $ | 372,511     |  
|Other current assets                                                                                                            |  |   | 1,350       |  
|TOTAL CURRENT ASSETS                                                                                                            |  |   | 373,861     |  
|                                                                                                                                |  |   |             |  
|PROPERTY AND EQUIPMENT, net                                                                                                     |  |   | 40,834      |  
|DEPOSITS                                                                                                                        |  |   | 104,600     |  
|TOTAL ASSETS                                                                                                                    |  | $ | 519,294     |  
|                                                                                                                                |  |   |             |  
|LIABILITIES AND STOCKHOLDERS' DEFICIT                                                                                           |  |   |             |  
|CURRENT LIABILITIES                                                                                                             |  |   |             |  
|Accounts payable                                                                                                                |  | $ | 157,399     |  
|Accrued expenses                                                                                                                |  |   | 2,263,673   |  
|Liquidated damages liability                                                                                                    |  |   | 15,375      |  
|Notes payable to related parties                                                                                                |  |   | 129,000     |  
|Notes payable - Officers                                                                                                        |  |   | 19,260      |  
|Convertible notes, net of debt discounts of 543,686                                                                             |  |   | 776,472     |  
|Equity line of credit                                                                                                           |  |   | 27,336      |  
|Warrant and option liability                                                                                                    |  |   | 3,130,731   |  
|Beneficial conversion feature liability                                                                                         |  |   | 32,216,912  |  
|TOTAL CURRENT LIABILITIES                                                                                                       |  |   | 38,736,158  |  
|                                                                                                                                |  |   |             |  
|STOCKHOLDERS' DEFICIT                                                                                                           |  |   |             |  
|Common Stock (150,000,000 shares authorized; 107,117,101 shares issued and 106,635,201 shares outstanding at September 30, 2007 |  |   | 106,635     |  
|Shares to be issued                                                                                                             |  |   | 43,900      |  
|Additional paid-in capital                                                                                                      |  |   | 11,097,729  |  
|Deficit accumulated during development stage                                                                                    |  |   | (49,465,126 | )
|TOTAL STOCKHOLDERS' DEFICIT                                                                                                     |  |   | 38,216,860  |  
|TOTAL LIABILITIES AND STOCKHOLDERS' DEFICIT                                                                                     |  | $ | 519,295     |  

The accompanying notes form an integral part of these financial statements.



43



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SIONIX CORPORATION

(A DEVELOPMENT STAGE COMPANY)

STATEMENT OF OPERATIONS

|                                                                |  |   |                     |   |   |                          |   |   |               |  
|--------------------------------------------------------------- |  | - | ------------------- | - | - | ------------------------ | - | - | ------------- | -
|                                                                |  |   |                     |   |   |                          |   |   | Cummulative   |  
|                                                                |  |   | For the Years       |   |   | from
October 3, 1994) to |  
|                                                                |  |   | Ended September 30, |   |   | September 30,            |  
|                                                                |  |   | 2007                |   |   | 2006                     |   |   | 2007          |  
|                                                                |  |   | (As Restated)       |   |   | (As Restated)            |   |   | (As Restated) |  
|Revenues                                                        |  | $ |                   |   | $ |                        |   | $ |             |  
|                                                                |  |   |                     |   |   |                          |   |   |               |  
|Operating expenses                                              |  |   |                     |   |   |                          |   |   |               |  
|General and administrative                                      |  |   | 5,083,303           |   |   | 913,691                  |   |   | 17,116,537    |  
|Research and development                                        |  |   | 526,466             |   |   |                        |   |   | 1,975,940     |  
|Depreciation and amortization                                   |  |   | 31,699              |   |   | 31,326                   |   |   | 532,105       |  
|Total operating expenses                                        |  |   | 5,641,468           |   |   | 945,017                  |   |   | 19,624,582    |  
|Loss from operations                                            |  |   | (5,641,468          | ) |   | (945,017                 | ) |   | (19,624,582   | )
|                                                                |  |   |                     |   |   |                          |   |   |               |  
|Other income (expense)                                          |  |   |                     |   |   |                          |   |   |               |  
|Interest income                                                 |  |   | 4,886               |   |   |                        |   |   | 58,543        |  
|Interest expense and financing costs                            |  |   | (32,376,738         | ) |   | (10,080                  | ) |   | (32,611,424   | )
|Gain on change in fair value of warrant and option liability    |  |   | 328,473             |   |   |                        |   |   | 328,473       |  
|Gain on change in fair value of beneficial conversion liability |  |   | 4,164,577           |   |   |                        |   |   | 3,914,031     |  
|Impairment of intangibles                                       |  |   |                   |   |   |                        |   |   | (1,267,278    | )
|Inventory obsolesence                                           |  |   |                   |   |   |                        |   |   | (365,078      | )
|Legal settlement                                                |  |   | (89,654             | ) |   |                        |   |   | 344,949       |  
|Loss on settlement of debt                                      |  |   |                   |   |   | (94,222                  | ) |   | (230,268      | )
|Total other expense                                             |  |   | (27,968,456         | ) |   | (104,302                 | ) |   | (29,828,052   | )
|Loss before income taxes                                        |  |   | (33,609,924         | ) |   | (1,049,319               | ) |   | (49,452,634   | )
|Income taxes                                                    |  |   | 2,592               |   |   |                          |   |   | 12,492        |  
|Net loss                                                        |  | $ | (33,612,516         | ) | $ | (1,049,319               | ) | $ | (49,465,126   | )
|                                                                |  |   |                     |   |   |                          |   |   |               |  
|Basic loss per share                                            |  | $ | (0.32               | ) | $ | (0.01                    | ) |   |               |  
|Dilutive loss per share                                         |  | $ | (0.32               | ) | $ | (0.01                    | ) |   |               |  
|                                                                |  |   |                     |   |   |                          |   |   |               |  
|Basic weighted average number of                                |  |   |                     |   |   |                          |   |   |               |  
|shares of common stock outstanding                              |  |   | 106,207,706         |   |   | 102,524,186              |   |   |               |  
|Dilutive weighted average number of                             |  |   |                     |   |   |                          |   |   |               |  
|shares of common stock outstanding                              |  |   | 106,207,706         |   |   | 102,524,186              |   |   |               |  
|                                                                |  |   |                     |   |   |                          |   |   |               |  



The accompanying notes form an integral part of these financial statements.





44



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SIONIX CORPORATION

A DEVELOPMENT STAGE COMPANY

STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)

FOR THE PERIOD FROM OCTOBER 3, 1994 (INCEPTION) TO SEPTEMBER 30, 2007



|                                              |  |                   |   |            |        |                 |   |              |   |                         |         |                 |   |                 |   |                |         |                |       |          |   |   |            |   |   |            |  
|--------------------------------------------- |  | ----------------- | - | ---------- | ------ | --------------- | - | ------------ | - | ----------------------- | ------- | --------------- | - | --------------- | - | -------------- | ------- | -------------- | ----- | -------- | - | - | ---------- | - | - | ---------- | -
|                                              |  |                   |   |            |        |                 |   |              |   |                         |         |                 |   |                 |   |                | Deficit |                | Total |         
|                                              |  | Common Stock      |   | Additional |        | Shares          |   | Stock        |   | Shares                  |         | Unamortized     |   | Accumulated     |   | Stockholders  |        
|                                              |  | Number 
of Shares |   | Amount     |        | Paid-in
Capital |   | To be
Issued |   | Subscription
Receivable |         | To be
Cancelled |   | Consulting
Fees |   | From
Inception |         | Equity
Deficit |      
|Stock issued for cash, October 3, 1994        |  | 10,000.00         |   | $          | 10     |                 | $ | 90           |   | $                       |       |                 | $ |               |   | $              |       |                | $     |        |   | $ |          |   | $ | 100        |  
|Net loss                                      |  |                 |   |            |      |                 |   |            |   |                         |       |                 |   |               |   |                |       |                |       |        |   |   | (1,521     | ) |   | (1,521     | )
|Balance at December 31, 1994                  |  | 10,000            |   |            | 10     |                 |   | 90           |   |                         |       |                 |   |               |   |                |       |                |       |        |   |   | (1,521     | ) |   | (1,421     | )
|Shares issued for assignment rights           |  | 1,990,000         |   |            | 1,990  |                 |   | (1,990       | ) |                         |       |                 |   |               |   |                |       |                |       |        |   |   |          |   |   |          |  
|Shares issued for services                    |  | 572,473           |   |            | 572    |                 |   | 135,046      |   |                         |       |                 |   |               |   |                |       |                |       |        |   |   |          |   |   | 135,618    |  
|Shares issued for debt                        |  | 1,038,640         |   |            | 1,038  |                 |   | 1,164,915    |   |                         |       |                 |   |               |   |                |       |                |       |        |   |   |          |   |   | 1,165,953  |  
|Shares issued for cash                        |  | 232,557           |   |            | 233    |                 |   | 1,119,027    |   |                         |       |                 |   |               |   |                |       |                |       |        |   |   |          |   |   | 1,119,260  |  
|Shares issued for subscription receivable     |  | 414,200           |   |            | 414    |                 |   | 1,652,658    |   |                         |       |                 |   | (1,656,800      | ) |                |       |                |       |        |   |   |          |   |   | (3,728     | )
|Shares issued for productions costs           |  | 112,500           |   |            | 113    |                 |   | 674,887      |   |                         |       |                 |   | (675,000        | ) |                |       |                |       |        |   |   |          |   |   |          |  
|Net loss                                      |  |                 |   |            |      |                 |   |            |   |                         |       |                 |   |               |   |                |       |                |       |        |   |   | (914,279   | ) |   | (914,279   | )
|Balance at December 31, 1995                  |  | 4,370,370         |   |            | 4,370  |                 |   | 4,744,633    |   |                         |       |                 |   | (2,331,800      | ) |                |       |                |       |        |   |   | (915,800   | ) |   | 1,501,403  |  
|Shares issued for reorganization              |  | 18,632,612        |   |            | 18,633 |                 |   | (58,033      | ) |                         |       |                 |   |               |   |                |       |                |       |        |   |   |          |   |   | (39,400    | )
|Shares issued for cash                        |  | 572,407           |   |            | 573    |                 |   | 571,834      |   |                         |       |                 |   |               |   |                |       |                |       |        |   |   |          |   |   | 572,407    |  
|Shares issued for services                    |  | 24,307            |   |            | 24     |                 |   | 24,283       |   |                         |       |                 |   |               |   |                |       |                |       |        |   |   |          |   |   | 24,307     |  
|Net loss                                      |  |                 |   |            |      |                 |   |            |   |                         |       |                 |   |               |   |                |       |                |       |        |   |   | (922,717   | ) |   | (922,717   | )
|Balance at September 30,1996                  |  | 23,599,696        |   |            | 23,600 |                 |   | 5,282,717    |   |                         |       |                 |   | (2,331,800      | ) |                |       |                |       |        |   |   | (1,838,517 | ) |   | 1,136,000  |  
|Shares issued for cash                        |  | 722,733           |   |            | 723    |                 |   | 365,857      |   |                         |       |                 |   |               |   |                |       |                |       |        |   |   |          |   |   | 366,580    |  
|Shares issued for services                    |  | 274,299           |   |            | 274    |                 |   | 54,586       |   |                         |       |                 |   |               |   |                |       |                |       |        |   |   |          |   |   | 54,860     |  
|Cancellation of shares                        |  | (542,138          | ) |            | (542   | )               |   | (674,458     | ) |                         |       |                 |   | 675,000         |   |                |       |                |       |        |   |   |          |   |   |          |  
|Net loss                                      |  |                 |   |            |      |                 |   |            |   |                         |       |                 |   |               |   |                |       |                |       |        |   |   | (858,915   | ) |   | (858,915   | )
|Balance at September 30,1997                  |  | 24,054,590        |   |            | 24,055 |                 |   | 5,028,702    |   |                         |       |                 |   | (1,656,800      | ) |                |       |                |       |        |   |   | (2,697,432 | ) |   | 698,525    |  
|Shares issued for cash                        |  | 2,810,000         |   |            | 2,810  |                 |   | 278,190      |   |                         |       |                 |   |               |   |                |       |                |       |        |   |   |          |   |   | 281,000    |  
|Shares issued for services                    |  | 895,455           |   |            | 895    |                 |   | 88,651       |   |                         |       |                 |   |               |   |                |       |                |       |        |   |   |          |   |   | 89,546     |  
|Shares issued for compensation                |  | 2,200,000         |   |            | 2,200  |                 |   | 217,800      |   |                         |       |                 |   |               |   |                |       |                |       |        |   |   |          |   |   | 220,000    |  
|Cancellation of shares                        |  | (2,538,170        | ) |            | (2,538 | )               |   | (1,534,262   | ) |                         |       |                 |   | 1,656,800       |   |                |       |                |       |        |   |   |          |   |   | 120,000    |  
|Net loss                                      |  |                 |   |            |      |                 |   |            |   |                         |       |                 |   |               |   |                |       |                |       |        |   |   | (1,898,376 | ) |   | (1,898,376 | )
|Balance at September 30,1998                  |  | 27,421,875        |   |            | 27,422 |                 |   | 4,079,081    |   |                         |       |                 |   |               |   |                |       |                |       |        |   |   | (4,595,808 | ) |   | (489,305   | )
|Shares issued for compensation                |  | 3,847,742         |   |            | 3,847  |                 |   | 389,078      |   |                         |       |                 |   |               |   |                |       |                |       |        |   |   |          |   |   | 392,925    |  
|Shares issued for services                    |  | 705,746           |   |            | 706    |                 |   | 215,329      |   |                         |       |                 |   |               |   |                |       |                |       |        |   |   |          |   |   | 216,035    |  
|Shares issued for cash                        |  | 9,383,000         |   |            | 9,383  |                 |   | 928,917      |   |                         |       |                 |   |               |   |                |       |                |       |        |   |   |          |   |   | 938,300    |  
|Net loss                                      |  |                 |   |            |      |                 |   |            |   |                         |       |                 |   |               |   |                |       |                |       |        |   |   | (1,158,755 | ) |   | (1,158,755 | )
|Balance at September 30,1999                  |  | 41,358,363        |   |            | 41,358 |                 |   | 5,612,405    |   |                         |       |                 |   |               |   |                |       |                |       |        |   |   | (5,754,563 | ) |   | (100,800   | )
|Shares issued for cash                        |  | 10,303,500        |   |            | 10,304 |                 |   | 1,020,046    |   |                         |       |                 |   |               |   |                |       |                |       |        |   |   |          |   |   | 1,030,350  |  
|Shares issued for compensation                |  | 1,517,615         |   |            | 1,518  |                 |   | 1,218,598    |   |                         |       |                 |   |               |   |                |       |                |       |        |   |   |          |   |   | 1,220,116  |  
|Shares issued for services                    |  | 986,844           |   |            | 986    |                 |   | 253,301      |   |                         |       |                 |   |               |   |                |       |                |       |        |   |   |          |   |   | 254,287    |  
|Net loss                                      |  |                 |   |            |      |                 |   |            |   |                         |       |                 |   |               |   |                |       |                |       |        |   |   | (2,414,188 | ) |   | (2,414,188 | )
|Balance at September 30,2000                  |  | 54,166,322        |   |            | 54,166 |                 |   | 8,104,350    |   |                         |       |                 |   |               |   |                |       |                |       |        |   |   | (8,168,751 | ) |   | (10,235    | )
|Shares issued for services                    |  | 2,517,376         |   |            | 2,517  |                 |   | 530,368      |   |                         |       |                 |   |               |   |                |       |                |       | (141,318 | ) |   |          |   |   | 391,567    |  
|Shares issued for cash                        |  | 6,005,000         |   |            | 6,005  |                 |   | 594,495      |   |                         |       |                 |   |               |   |                |       |                |       |        |   |   |          |   |   | 600,500    |  
|Shares to be issued for cash (100,000 shares) |  |                 |   |            |      |                 |   |            |   |                         | 10,000  |                 |   |               |   |                |       |                |       |        |   |   |          |   |   | 10,000     |  
|Shares to be issued for debt (639,509 shares) |  |                 |   |            |      |                 |   |            |   |                         | 103,295 |                 |   |               |   |                |       |                |       |        |   |   |          |   |   | 103,295    |  
|Net loss                                      |  |                 |   |            |      |                 |   |            |   |                         |       |                 |   |               |   |                |       |                |       |        |   |   | (1,353,429 | ) |   | (1,353,429 | )



45



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SIONIX CORPORATION

A DEVELOPMENT STAGE COMPANY

STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)

FOR THE PERIOD FROM OCTOBER 3, 1994 (INCEPTION) TO SEPTEMBER 30, 2007(Continued)

|                                                                 |  |                   |   |            |         |                 |   |              |   |                         |          |                 |   |                 |  |                |         |                |       |          |   |   |             |   |   |             |  
|---------------------------------------------------------------- |  | ----------------- | - | ---------- | ------- | --------------- | - | ------------ | - | ----------------------- | -------- | --------------- | - | --------------- |  | -------------- | ------- | -------------- | ----- | -------- | - | - | ----------- | - | - | ----------- | -
|                                                                 |  |                   |   |            |         |                 |   |              |   |                         |          |                 |   |                 |  |                | Deficit |                | Total |         
|                                                                 |  | Common Stock      |   | Additional |         | Shares          |   | Stock        |   | Shares                  |          | Unamortized     |   | Accumulated     |  | Stockholders  |        
|                                                                 |  | Number 
of Shares |   | Amount     |         | Paid-in
Capital |   | To be
Issued |   | Subscription
Receivable |          | To be
Cancelled |   | Consulting
Fees |  | From
Inception |         | Equity
Deficit |      
|Balance at September 30,2001                                     |  | 62,688,698        |   | $          | 62,688  |                 | $ | 9,229,213    |   | $                       | 113,295  |                 | $ |               |  | $              |       |                | $     | (141,318 | ) | $ | (9,522,180  | ) | $ | (258,302    | )
|Shares issued for services                                       |  | 1,111,710         |   |            | 1,112   |                 |   | 361,603      |   |                         |        |                 |   |               |  |                |       |                |       | 54,400   |   |   |           |   |   | 417,115     |  
|Shares issued as a contribution                                  |  | 100,000           |   |            | 100     |                 |   | 11,200       |   |                         |        |                 |   |               |  |                |       |                |       |        |   |   |           |   |   | 11,300      |  
|Shares issued for compensation                                   |  | 18,838            |   |            | 19      |                 |   | 2,897        |   |                         |        |                 |   |               |  |                |       |                |       |        |   |   |           |   |   | 2,916       |  
|Shares issued for cash                                           |  | 16,815,357        |   |            | 16,815  |                 |   | 1,560,782    |   |                         | (10,000  | )               |   |               |  |                |       |                |       |        |   |   |           |   |   | 1,567,597   |  
|Shares issued for debt                                           |  | 1,339,509         |   |            | 1,340   |                 |   | 208,639      |   |                         | (103,295 | )               |   |               |  |                |       |                |       |        |   |   |           |   |   | 106,684     |  
|Shares to be issued related to equity financing (967,742 shares) |  |                 |   |            |       |                 |   | (300,000     | ) |                         | 300,000  |                 |   |               |  |                |       |                |       |        |   |   |           |   |   |           |  
|Cancellation ofshares                                            |  | (7,533,701        | ) |            | (7,534  | )               |   |            |   |                         |        |                 |   |               |  |                |       |                |       |        |   |   |           |   |   | (7,534      | )
|Net loss                                                         |  |                 |   |            |       |                 |   |            |   |                         |        |                 |   |               |  |                |       |                |       |        |   |   | (1,243,309  | ) |   | (1,243,309  | )
|Balance at September 30,2002                                     |  | 74,540,411        |   |            | 74,540  |                 |   | 11,074,334   |   |                         | 300,000  |                 |   |               |  |                |       |                |       | (86,918  | ) |   | (10,765,489 | ) |   | 596,467     |  
|Shares issued for services                                       |  | 2,467,742         |   |            | 2,468   |                 |   | 651,757      |   |                         | (300,000 | )               |   |               |  |                |       |                |       |        |   |   |           |   |   | 354,225     |  
|Shares issued for capital equity line                            |  | 8,154,317         |   |            | 8,154   |                 |   | 891,846      |   |                         |        |                 |   |               |  |                |       |                |       |        |   |   |           |   |   | 900,000     |  
|Amortization of consulting fees                                  |  |                 |   |            |       |                 |   |            |   |                         |        |                 |   |               |  |                |       |                |       | 86,918   |   |   |           |   |   | 86,918      |  
|Cancellation of shares                                           |  | (50,000           | ) |            | (50     | )               |   | 50           |   |                         |        |                 |   |               |  |                |       |                |       |        |   |   |           |   |   |           |  
|Shares to becancelled (7,349,204 shares)                         |  |                 |   |            |       |                 |   | 7,349        |   |                         |        |                 |   |               |  |                | (7,349  | )              |       |        |   |   |           |   |   |           |  
|Net loss                                                         |  |                 |   |            |       |                 |   |            |   |                         |        |                 |   |               |  |                |       |                |       |        |   |   | (1,721,991  | ) |   | (1,721,991  | )
|Balance at September 30,2003                                     |  | 85,112,470        |   |            | 85,112  |                 |   | 12,625,336   |   |                         |        |                 |   |               |  |                | (7,349  | )              |       |        |   |   | (12,487,480 | ) |   | 215,619     |  
|Shares issued for capital equity line                            |  | 19,179,016        |   |            | 19,179  |                 |   | 447,706      |   |                         |        |                 |   |               |  |                |       |                |       |        |   |   |           |   |   | 466,885     |  
|Shares issued for services                                       |  | 5,100,004         |   |            | 5,100   |                 |   | 196,997      |   |                         |        |                 |   |               |  |                |       |                |       | (13,075  | ) |   |           |   |   | 189,022     |  
|Share to be issued for cash (963,336 shares)                     |  |                 |   |            |       |                 |   |            |   |                         | 28,900   |                 |   |               |  |                |       |                |       |        |   |   |           |   |   | 28,900      |  
|Shares to be issued for debt (500,000 shares)                    |  |                 |   |            |       |                 |   |            |   |                         | 15,000   |                 |   |               |  |                |       |                |       |        |   |   |           |   |   | 15,000      |  
|Cancellation ofshares                                            |  | (7,349,204        | ) |            | (7,349  | )               |   |            |   |                         |        |                 |   |               |  |                | 7,349   |                |       |        |   |   |           |   |   |           |  
|Issuance of warrants related to 2004 stock purchase              |  |                 |   |            |       |                 |   | 24,366       |   |                         |        |                 |   |               |  |                |       |                |       |        |   |   |           |   |   | 24,366      |  
|Net loss                                                         |  |                 |   |            |       |                 |   |            |   |                         |        |                 |   |               |  |                |       |                |       |        |   |   | (1,593,135  |   |   | (1,593,135  |  
|Balance at September 30, 2004, restated                          |  | 102,042,286       |   |            | 102,042 |                 |   | 13,294,405   |   |                         | 43,900   |                 |   |               |  |                |       |                |       | (13,075  |   |   | (14,080,615 |   |   | (653,343    |  
|Amortization of consulting fees                                  |  |                 |   |            |       |                 |   |            |   |                         |        |                 |   |               |  |                |       |                |       | 13,075   |   |   |           |   |   | 13,075      |  
|Net loss                                                         |  |                 |   |            |       |                 |   |            |   |                         |        |                 |   |               |  |                |       |                |       |        |   |   | (722,676    |   |   | (722,676    |  
|Balance at September 30, 2005, restated                          |  | 102,042,286       |   |            | 102,042 |                 |   | 13,294,405   |   |                         | 43,900   |                 |   |               |  |                |       |                |       |        |   |   | (14,803,291 |   |   | (1,362,944  |  
|Net loss                                                         |  |                 |   |            |       |                 |   |            |   |                         |        |                 |   |               |  |                |       |                |       |        |   |   | (1,049,319  |   |   | (1,049,319  |  
|Balance at September 30, 2006, restated                          |  | 102,042,286       |   |            | 102,042 |                 |   | 13,294,405   |   |                         | 43,900   |                 |   |               |  |                |       |                |       |        |   |   | (15,852,610 |   |   | (2,412,263  |  
|Stock issued for consulting                                      |  | 4,592,915         |   |            | 4,593   |                 |   | 80,336       |   |                         |        |                 |   |               |  |                |       |                |       |        |   |   |           |   |   | 84,929      |  
|Reclassification to warrant and option liability                 |  |                 |   |            |       |                 |   | (2,277,013   |   |                         |        |                 |   |               |  |                |       |                |       |        |   |   |           |   |   | (2,277,013  |  
|Net loss                                                         |  |                 |   |            |       |                 |   |            |   |                         |        |                 |   |               |  |                |       |                |       |        |   |   | (33,612,516 |   |   | (33,612,516 |  
|Balance at September 30, 2007, restated                          |  | 106,635,201       |   |            | 106,635 |                 |   | 11,097,728   |   |                         | 43,900   |                 |   |               |  |                |       |                |       |        |   |   | (49,465,126 |   |   | (38,216,863 |  

The accompanying notes form an integral part of these financial statements.



46



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SIONIX CORPORATION

A DEVELOPMENT STAGE COMPANY

STATEMENT OF CASH FLOWS

|                                                                             |  |                                   |             |   |                                                 |   |            |                    |  |   |             |  
|---------------------------------------------------------------------------- |  | --------------------------------- | ----------- | - | ----------------------------------------------- | - | ---------- | ------------------ |  | - | ----------- | -
|                                                                             |  | For the Years
Ended September 30, |             |   | Cummulative from
Inception
(October 3, 1994) to |  
|                                                                             |  | 2007                              |             |   | 2006                                            |   |            | September 30, 2007 | 
|                                                                             |  | (As Restated)                     |             |   | (As Restated)                                   |   |            | (As Restated)      | 
|OPERATING ACTIVITIES:                                                        |  |                                   |             |   |                                                 |   |            |                    |  |   |             |  
|Net loss                                                                     |  | $                                 | (33,612,516 | ) |                                                 | $ | (1,049,319 | )                  |  | $ | (49,465,126 | )
|Adjustments to reconcile net loss to net cash used in operating activities:  |  |                                   |             |   |                                                 |   |            |                    |  |   |             |  
|Depreciation and amortization                                                |  |                                   | 31,699      |   |                                                 |   | 31,326     |                    |  |   | 619,023     |  
|Amortization of beneficial conversion features discount and warrant discount |  |                                   | 833,826     |   |                                                 |   |           |                    |  |   | 883,018     |  
|Stock based compensation expense - employee                                  |  |                                   |            |   |                                                 |   |           |                    |  |   | 1,835,957   |  
|Stock based compensation expense - consultant                                |  |                                   | 208,989     |   |                                                 |   |           |                    |  |   | 2,964,869   |  
|Gain on change in fair value of warrant and option liability                 |  |                                   | (328,473    | ) |                                                 |   |           |                    |  |   | (328,473    | )
|Gain on change in  fair value of beneficial conversion liability             |  |                                   | (4,164,577  | ) |                                                 |   |           |                    |  |   | (4,164,577  | )
|Non-cash financing costs                                                     |  |                                   | 31,434,495  |   |                                                 |   |           |                    |  |   | 31,434,495  |  
|Non-cash compensation costs                                                  |  |                                   | 3,461,578   |   |                                                 |   |           |                    |  |   | 3,461,578   |  
|Impairment of assets                                                         |  |                                   |            |   |                                                 |   |           |                    |  |   | 514,755     |  
|Write-down of obsolete assets                                                |  |                                   |            |   |                                                 |   |           |                    |  |   | 38,862      |  
|Impairment of intangible assets                                              |  |                                   |            |   |                                                 |   |           |                    |  |   | 1,117,601   |  
|Loss on settlement of debt                                                   |  |                                   |            |   |                                                 |   | 94,221     |                    |  |   | 130,268     |  
|Accrual of liquidated damages                                                |  |                                   | 15,375      |   |                                                 |   |           |                    |  |   | 15,375      |  
|Other                                                                        |  |                                   | (799,044    | ) |                                                 |   |           |                    |  |   | (799,044    | )
|Increase in assets:                                                          |  |                                   |             |   |                                                 |   |            |                    |  |   |             |  
|Other current assets                                                         |  |                                   | (1,350      | ) |                                                 |   |           |                    |  |   | (1,350      | )
|Other assets                                                                 |  |                                   | (104,600    | ) |                                                 |   |           |                    |  |   | (104,600    | )
|Increase (decrease) in liabilities:                                          |  |                                   |             |   |                                                 |   |            |                    |  |   |             |  
|Accounts payable                                                             |  |                                   | (115,209    | ) |                                                 |   | 50,147     |                    |  |   | 157,399     |  
|Accrued expenses                                                             |  |                                   | 2,021,946   |   |                                                 |   | 829,335    |                    |  |   | 2,582,812   |  
|Net cash used in operating activities                                        |  |                                   | (1,117,861  | ) |                                                 |   | (44,290    | )                  |  |   | (9,107,158  | )
|                                                                             |  |                                   |             |   |                                                 |   |            |                    |  |   |             |  
|INVESTING ACTIVITIES:                                                        |  |                                   |             |   |                                                 |   |            |                    |  |   |             |  
|Acquisition of property and equipment                                        |  |                                   | (27,772     | ) |                                                 |   | (950       | )                  |  |   | (371,455    | )
|Acquisition of patents                                                       |  |                                   |            |   |                                                 |   |           |                    |  |   | (154,061    | )
|Net cash used in investing activities                                        |  |                                   | (27,772     | ) |                                                 |   | (950       | )                  |  |   | (525,516    | )
|                                                                             |  |                                   |             |   |                                                 |   |            |                    |  |   |             |  
|FINANCING ACTIVITIES:                                                        |  |                                   |             |   |                                                 |   |            |                    |  |   |             |  
|Payment on notes payable to officer                                          |  |                                   | (47,400     | ) |                                                 |   |           |                    |  |   | (199,242    | )
|Proceeds from notes payable, related party                                   |  |                                   |            |   |                                                 |   | 49,440     |                    |  |   | 457,433     |  
|Receipt from (payments to) equity line of credit                             |  |                                   | (300,000    | ) |                                                 |   |           |                    |  |   | 456,000     |  
|Proceeds from convertible notes payable                                      |  |                                   | 1,861,000   |   |                                                 |   |           |                    |  |   | 1,861,000   |  
|Issuance of common stock                                                     |  |                                   |            |   |                                                 |   |           |                    |  |   | 7,386,094   |  
|Receipt of cash for stock to be issued                                       |  |                                   |            |   |                                                 |   |           |                    |  |   | 43,900      |  
|Net cash provided by financing activities                                    |  |                                   | 1,513,600   |   |                                                 |   | 49,440     |                    |  |   | 10,005,185  |  
|                                                                             |  |                                   |             |   |                                                 |   |            |                    |  |   |             |  
|Net increase in cash and cash equivalents                                    |  |                                   | 367,967     |   |                                                 |   | 4,200      |                    |  |   | 372,511     |  
|                                                                             |  |                                   |             |   |                                                 |   |            |                    |  |   |             |  
|CASH AND CASH EQUIVALENTS, BEGINNING                                         |  |                                   | 4,544       |   |                                                 |   | 344        |                    |  |   |            |  
|CASH AND CASH EQUIVALENTS, ENDING                                            |  | $                                 | 372,511     |   |                                                 | $ | 4,544      |                    |  | $ | 372,511     |  
|                                                                             |  |                                   |             |   |                                                 |   |            |                    |  |   |             |  
|SUPPLEMENTAL INFORMATION:                                                    |  |                                   |             |   |                                                 |   |            |                    |  |   |             |  
|Cash and cash equivalents paid for interest                                  |  | $                                 |            |   |                                                 | $ |           |                    |  | $ |            |  
|Cash and cash equivalents paid for taxes                                     |  | $                                 |            |   |                                                 | $ |           |                    |  | $ |            |  

The accompanying notes form an integral part of these financial statements.



47



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NOTE 1. ORGANIZATION AND DESCRIPTION OF BUSINESS

Sionix Corporation (the "Company") was incorporated in Utah in 1985. The Company was formed to design, develop, and market automatic water filtration system primarily for small water districts.

The Company completed its reincorporation as a Nevada Corporation, effective July 1, 2003. The reincorporation was completed pursuant to an Agreement and Plan of Merger between Sionix Corporation, a Utah corporation ("Sionix Utah") and its wholly-owned Nevada subsidiary, Sionix Corporation ("Sionix Nevada"). Under the merger agreement, Sionix Utah merged with and into Sionix Nevada, and each share of Sionix Utahs Common Stock was automatically converted into one share of Common Stock, par value $0.001 per share, of Sionix Nevada. The merger was effected by the filing of Articles of Merger, along with the Agreement and Plan of Merger, with the Secretary of State of Nevada.

The Company is a development stage company as defined in Statement of Financial Accounting Standards (SFAS) No. 7, Accounting and Reporting by Development Stage Enterprises. The Company is in the development stage and its efforts have been principally devoted to research and development, organizational activities, and raising capital. All losses accumulated since inception have been considered as part of the Companys development stage activities.

NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - RESTATED

USE OF ESTIMATES

The preparation of financial statements in conformity with generally accepted accounting principles in the United States (GAAP) requires management to make certain estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Significant estimates include collectibility of accounts receivable, accounts payable, sales returns and recoverability of long-term assets.

CASH AND CASH EQUIVALENTS

Cash and cash equivalents represent cash and short-term highly liquid investments with original maturities of three months or less.

PROPERTY AND EQUIPMENT

Property and equipment is stated at cost. The cost of additions and improvements are capitalized while maintenance and repairs are expensed as incurred. Depreciation of property and equipment is provided on a straight-line basis over the estimated five year useful lives of the assets.

PROVISION FOR INCOME TAXES

The Company utilizes SFAS No. 109, Accounting for Income Taxes, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements or tax returns. Under this method, deferred income taxes are recognized for the tax consequences in future years of differences between the tax bases of assets and liabilities and their financial reporting amounts at each period end based on enacted tax laws and statutory tax rates applicable to the periods in which the differences are expected to affect taxable income. Valuation allowances are established, when necessary, to reduce deferred tax assets to the amount expected to be realized.

ADVERTISING

The cost of advertising is expensed as incurred. Total advertising costs were $4,555 and $3,355 for the years ended September 30, 2007 and 2006, respectively.

ACCRUED DERIVATIVE LIABILITIES

The Company applies a two-step model to determine whether a financial instrument or an embedded feature is indexed to an issuers own stock and thus able to qualify for equity treatment. However, liability accounting is triggered as there were insufficient shares to fulfill all potential conversions. The Company determines which instruments or embedded features require liability accounting and records the fair values as an accrued derivative



48



---





liability. The changes in the values of the accrued derivative liabilities are shown in the accompanying statements of operations as gain on change in fair value of warrant and option liability and gain on change in fair value of beneficial conversion liability.

STOCK BASED COMPENSATION

Effective October 1, 2006, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 123-R, Share-Based Payment (SFAS 123-R), which requires the measurement and recognition of compensation expense for all share-based payment awards made to employees and directors, including stock options, to be based on their fair values. SFAS 123-R supersedes Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (APB 25), which the Company previously followed in accounting for stock-based awards. In March 2005, the SEC issued Staff Accounting Bulletin No. 107 (SAB 107) to provide guidance on SFAS 123-R. The Company has applied SAB 107 in its adoption of SFAS 123-R.

EARNINGS PER SHARE - RESTATED

Statement of Financial Accounting Standards No. 128, Earnings per share requires the presentation of basic earnings per share and diluted earnings per share. Basic and diluted earnings per share computations presented by the Company conform to the standard and are based on the weighted average number of shares of Common Stock outstanding during the year.

Basic earnings per share is computed by dividing net income or loss by the weighted average number of shares outstanding for the year. Diluted earnings per share is computed by dividing net income or loss by the total of the weighted average number of shares outstanding, and the dilutive effect of outstanding stock options (applying the treasury stock method).

The Company had 7,034,140 of granted stock options that were exercisable as of September 30, 2007.

The following is a reconciliation of the numerators and denominators of the basic and diluted earnings per share computations:

|                                          |  |          |             |   |        |  |             |            |  |   |          |   |  |        |            |   |            |  |             |  |  |   |       |  
|----------------------------------------- |  | -------- | ----------- | - | ------ |  | ----------- | ---------- |  | - | -------- | - |  | ------ | ---------- | - | ---------- |  | ----------- |  |  | - | ----- | -
|Year  ended September 30,                 |  | 2007     |             |   | 2006   | 
|Basic Earnings per Share                  |  | Net Loss |             |   | Shares |  |             | Per
 Share |  |   | Net Loss |   |  | Shares |            |   | Per 
Share | 
|Net loss available to common shareholders |  | $        | (33,612,516 | ) |        |  | 106,207,706 |            |  | $ | (0.32    | ) |  | $      | (1,049,319 | ) |            |  | 102,524,186 |  |  | $ | (0.01 | )
|                                          |  |          |             |   |        |  |             |            |  |   |          |   |  |        |            |   |            |  |             |  |  |   |       |  
|Effect of dilutive securities (none)      |  |          |           |   |        |  |           |            |  |   |        |   |  |        |          |   |            |  |           |  |  |   |     |  
|                                          |  |          |             |   |        |  |             |            |  |   |          |   |  |        |            |   |            |  |             |  |  |   |       |  
|Diluted Earnings per Share                |  | $        | (33,612,516 | ) |        |  | 106,207,706 |            |  | $ | (0.32    | ) |  | $      | (1,049,319 | ) |            |  | 102,524,186 |  |  | $ | (0.01 | )



FAIR VALUE OF FINANCIAL INSTRUMENTS

Statement of Financial Accounting Standard No. 107, Disclosures about Fair Value of Financial Instruments, requires that the Company disclose estimated fair values of financial instruments. The carrying amounts reported in the statements of financial position for assets and liabilities qualifying as financial instruments are a reasonable estimate of fair value.

RECLASSIFICATIONS

Certain items in the prior year financial statements have been reclassified to conform to the current periods presentation. These reclassifications have no effect on the previously reported net loss.

RECENT PRONOUNCEMENTS

In September 2006, SFAS issued SFAS 157, Fair Value Measurements. This Statement defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles (GAAP), and expands disclosures about fair value measurements. This Statement applies under other accounting pronouncements that require or permit fair value measurements, the Board having previously concluded in those accounting pronouncements that fair value is the relevant measurement attribute. Accordingly, this Statement does not require



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any new fair value measurements. However, for some entities, the application of this Statement will change current practice. This Statement is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. Management is currently evaluating the effect of this pronouncement on the Companys financial statements.

In September 2006, SFAS issued SFAS 158, Employers Accounting for Defined Benefit Pension and Other Postretirement Plansan amendment of SFAS Statements No. 87, 88, 106, and 132(R). This Statement improves financial reporting by requiring an employer to recognize the over funded or under funded status of a defined benefit postretirement plan (other than a multiemployer plan) as an asset or liability in its statement of financial position and to recognize changes in that funded status in the year in which the changes occur through comprehensive income of a business entity or changes in unrestricted net assets of a not-for-profit organization. This Statement also improves financial reporting by requiring an employer to measure the funded status of a plan as of the date of its year-end statement of financial position, with limited exceptions. An employer with publicly traded equity securities is required to initially recognize the funded status of a defined benefit postretirement plan and to provide the required disclosures as of the end of the fiscal year ending after December 15, 2006. An employer without publicly traded equity securities is required to recognize the funded status of a defined benefit postretirement plan and to provide the required disclosures as of the end of the fiscal year ending after June 15, 2007. However, an employer without publicly traded equity securities is required to disclose the following information in the notes to financial statements for a fiscal year ending after December 15, 2006, but before June 16, 2007, unless it has applied the recognition provisions of this Statement in preparing those financial statements:

a.

A brief description of the provisions of this Statement

b.

The date that adoption is required

c.

The date the employer plans to adopt the recognition provisions of this Statement, if earlier.

The requirement to measure plan assets and benefit obligations as of the date of the employers fiscal year-end statement of financial position is effective for fiscal years ending after December 15, 2008. Management is currently evaluating the effect of this pronouncement on the Companys financial statements.

In February 2007, SFAS issued SFAS Statement No. 159, The Fair Value Option for Financial Assets and Financial Liabilities. FAS159 is effective for fiscal years beginning after November 15, 2007. Early adoption is permitted subject to specific requirements outlined in the new Statement. Therefore, calendar-year companies may be able to adopt FAS 159 for their first quarter 2007 financial statements.

The new Statement allows entities to choose, at specified election dates, to measure eligible financial assets and liabilities at fair value that are not otherwise required to be measured at fair value. If a company elects the fair value option for an eligible item, changes in that item's fair value in subsequent reporting periods must be recognized in current earnings. FAS 159 also establishes presentation and disclosure requirements designed to draw comparison between entities that elect different measurement attributes for similar assets and liabilities. Management is currently evaluating the effect of this pronouncement on the Companys financial statements.

In December 2007, SFAS issued SFAS Statement No. 160, Noncontrolling Interests in Consolidated Financial Statementsan amendment of ARB No. 51. This Statement applies to all entities that prepare consolidated financial statements, except not-for-profit organizations, but will affect only those entities that have an outstanding non-controlling interest in one or more subsidiaries or that deconsolidate a subsidiary. Not-for-profit organizations should continue to apply the guidance in Accounting Research Bulletin No. 51, Consolidated Financial Statements, before the amendments made by this Statement, and any other applicable standards, until the Board issues interpretative guidance. This Statement is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008 (that is, January 1, 2009, for entities with calendar year-ends). Earlier adoption is prohibited. The effective date of this Statement is the same as that of the related Statement 141(R). This Statement shall be applied prospectively as of the beginning of the fiscal year in which this Statement is initially applied, except for the presentation and disclosure requirements. The presentation and disclosure requirements shall be applied retrospectively for all periods presented. This statement has no effect on the Companys financial statements as the Company does not have any outstanding non-controlling interest in one or more subsidiaries.



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NOTE 3. PROPERTY AND EQUIPMENT

Property and equipment consisted of the following at September 30, 2007:

|                                          |  |   |          |  
|----------------------------------------- |  | - | -------- | -
|Equipment and machinery                   |  | $ | 213,166  |  
|Furniture and fixtures                    |  |   | 24,594   |  
|TOTAL PROPERTY AND EQUIPMENT              |  |   | 237,760  |  
|Less accumulated depreciation (deduction) |  |   | (196,926 | )
|NET PROPERTY AND EQUIPMENT                |  | $ | 40,834   |  

Depreciation expenses for fiscal years ended September 30, 2007 and 2006 were $31,699 and $31,326, respectively.

NOTE 4. ACCRUED EXPENSES - RESTATED

Accrued expenses consisted of the following at September 30, 2007:

|                            |  |   |           | 
|--------------------------- |  | - | --------- | 
|Accrued salaries            |  | $ | 1,381,981 | 
|Advisory board compensation |  |   | 576,000   | 
|Auto allowance accruals     |  |   | 71,768    | 
|Interest payable            |  |   | 165,770   | 
|Other accruals              |  |   | 68,154    | 
|TOTAL ACCRUED EXPENSES      |  | $ | 2,263,673 | 

NOTE 5. NOTES PAYABLE  RELATED PARTIES

The Company has received advances in the form of unsecured promissory notes from stockholders in order to pay ongoing operating expenses. These notes bear interest at rates up to 13% and are due on demand. As of September 30, 2007, notes payable amounted to $129,000. Accrued interest on the notes amounted to $64,548 at September 30, 2007, and is included in accrued expenses. Interest expenses on these notes for the years ended September 30, 2007 and 2006 amounted to $12,850 and $10,080 respectively.

NOTE 6. NOTES PAYABLE  OFFICERS

Notes payables to officers are unsecured, interest free and due on demand. Proceeds from these notes payable were used to pay ongoing operating expenses. The balance at September 30, 2007 was $19,260.

NOTE 7. NOTES PAYABLE UNDER EQUITY LINE OF CREDIT

During the year ended September 30, 2003, the Company received proceeds of $1,307,500 from promissory notes issued to Cornell Capital Partners, LP, net of a 4% fee of $56,000 and $36,500 for escrow and other fees. The Company has settled $900,000 by issuing shares of Common Stock during the year ended September 30, 2003. In 2006, the Company entered into a settlement agreement with Cornell Capital Partners, LP to pay the total outstanding principal and accrued interest amount of $327,336; $50,000 was to be paid on or before November 15, 2006, $25,000 was payable per month on the 15th day of each month commencing December 15, 2006, with the balance of $27,336 due and payable on or before October 15, 2007. The Company recorded a loss on settlement of debt of $94,221 for the year ended September 30, 2006. The balance as of September 30, 2007 is $27,336, which was subsequently paid in October 2007 (See note 15).

NOTE 8. CONVERTIBLE NOTES  RESTATED

Convertible Notes 1

Between October 2006 and February 2007, the Company completed an offering of $750,000 in principal amount of convertible notes, which bear interest at 10% per annum and mature the earlier of (i) eighteen (18) months from the date of issuance (ii) an event of default or (iii) the closing of any equity related financing by the Company in which the gross proceeds are a minimum of $2,500,000. These notes are convertible into shares of the Companys Common Stock at $0.05 per share or shares of any equity security issued by the Company at a conversion price equal to the price at which such security is sold to any other party. In the event that a registration statement covering the underlying shares is not declared effective within 180 days after the closing, the conversion price shall be reduced by $0.0025 per share for each 30 day period that the effectiveness of the registration statement is delayed



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but in no case may the conversion price to be reduced below $0.04 per share. As of September 30, 2007, the conversion price was $0.04 per share.

SFAS 133, paragraph 12 was applied to determine if the embedded beneficial conversion features should be bifurcated from the convertible notes. The Company determined that the economic characteristics of the embedded beneficial conversion features are not clearly and closely related to the convertible notes, the embedded beneficial conversion feature and convertible notes are not remeasured at fair value at each balance sheet date, and a separate contract with the same terms would be a derivative pursuant to SFAS 133, paragraphs 6-11. Therefore, the embedded beneficial conversion features were bifurcated from the convertible notes. SFAS 133, paragraph 6 was applied to determine if the embedded beneficial conversion features were within the scope and definition of a derivative. The embedded beneficial conversion features had one or more underlings and one or more notional amounts, required no initial investment and required or permitted net settlement. Therefore, the embedded beneficial conversion features were determined to be derivatives. The Company applied EITF 00-19, paragraph 8 to determine the classification of the beneficial conversion feature, which states that contracts which require net-share settlement are equity. Therefore the embedded conversion features were determined to be equity instruments at the date of issuance. The Company applied EITF 00-19, paragraph 9, which states that all contracts be initially measured at fair value. The terms of the conversion feature only allow the counterparty to convert the notes into shares of common stock. Therefore, the convertible notes are not conventional convertible as defined in EITF 05-02. To determine the classification of the conversion feature, we followed the guidance of paragraphs 12-33 of EITF 00-19. The Company included SFAS 150 in the analysis of the convertible notes. SFAS 150 requires three classes of freestanding financial instruments, as defined in paragraphs 8 through 17, to be classified as liabilities. The first class, as defined in paragraph 9, is financial instruments that are mandatorily redeemable financial instruments. There are no terms or conditions that require the Company to unconditionally redeem the convertible notes by transferring assets at a specified or determinable date. The second class, as defined in paragraph 11, is financial instruments that require the repurchase of shares of Common Stock by transferring assets. There are no terms or conditions that require the Company to repurchase shares of Common Stock. The third class, as defined in paragraph 12, is financial instruments that require the issuance of a variable number of shares of Common Stock. There are no terms or conditions that require the Company to issue a variable number of shares of Common Stock. Therefore, the Company concluded that the convertible notes were not within the scope of SFAS 150.

The fair value of the embedded beneficial conversion features was $750,000 at the date of issuance using the Black Sholes model with the following assumptions: risk free rate of return of 2.02% to 5.09%; volatility of 268% to 275%; dividend yield of 0% and an expected term of 1.5 years.

Based on the calculation of the fair value of the embedded beneficial conversion feature, the Company allocated $750,000 to the beneficial conversion feature and the beneficial conversion feature discount, and none to the convertible note at the date

issuance. The embedded beneficial conversion feature discount is amortized to interest expense over the term of the note, which is $41,667 per month.

As of September 30, 2007, the outstanding principal amount of the convertible notes was $750,000 and the unamortized embedded beneficial conversion feature discount was $290,556, for a net convertible debt of $459,444.

For the year ended September 30, 2007, interest expense was $65,718, and amortization expense for the embedded beneficial conversion feature discount was $459,444, which was included in interest expense in the other income (expense) section of the statement of operations.

Calico Capital Management, LLC acted as a financial advisor for Convertible Notes 1 and 2 for the Company and received a fee of $75,000. Southridge Investment Group LLC, Ridgefield, Connecticut (Southridge) acted as an agent for the Company in arranging the transaction for Convertible Notes 1 and 2. The Company recorded these fees as an expense during the period.

Convertible Notes 2

On June 6, 2007, the Company completed an offering of $86,000 in principal amount of convertible notes, which bear interest at 10% per annum and mature on December 31, 2008.These notes are convertible into shares of the Companys Common Stock at $0.01 per share or shares of any equity security issued by the Company at a conversion price equal to the price at which such security is sold to any other party. There is no registration rights associated with these notes.



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SFAS 133, paragraph 12 was applied to determine if the embedded beneficial conversion features should be bifurcated from the convertible notes. The Company determined that the economic characteristics of the embedded beneficial conversion features are not clearly and closely related to the convertible notes, the embedded beneficial conversion feature and convertible notes are not remeasured at fair value at each balance sheet date, and a separate contract with the same terms would be a derivative pursuant to SFAS 133, paragraphs 6-11. Therefore, the embedded beneficial conversion features were bifurcated from the convertible notes. SFAS 133, paragraph 6 was applied to determine if the embedded beneficial conversion features were within the scope and definition of a derivative. The embedded beneficial conversion features had one or more underlings and one or more notional amounts, required no initial investment and required or permitted net settlement. Therefore, the embedded beneficial conversion features were determined to be derivatives. The Company applied EITF 00-19, paragraph 8 to determine the classification of the beneficial conversion feature, which states that contracts which require net-share settlement are equity. Therefore the embedded conversion features were determined to be equity instruments at the date of issuance. The Company applied EITF 00-19, paragraph 9, which states that all contracts be initially measured at fair value. The terms of the conversion feature only allow the counterparty to convert the notes into shares of common stock. Therefore, the convertible notes are not conventional convertible as defined in EITF 05-02. To determine the classification of the conversion feature, we followed the guidance of paragraphs 12-33 of EITF 00-19. The Company included SFAS 150 in the analysis of the convertible notes. SFAS 150 requires three classes of freestanding financial instruments, as defined in paragraphs 8 through 17, to be classified as liabilities. The first class, as defined in paragraph 9, is financial instruments that are mandatorily redeemable financial instruments. There are no terms or conditions that require the Company to unconditionally redeem the convertible notes by transferring assets at a specified or determinable date. The second class, as defined in paragraph 11, is financial instruments that require the repurchase of shares of Common Stock by transferring assets. There are no terms or conditions that require the Company to repurchase shares of Common Stock. The third class, as defined in paragraph 12, is financial instruments that require the issuance of a variable number of shares of Common Stock. There are no terms or conditions that require the Company to issue a variable number of shares of Common Stock. Therefore, the Company concluded that the convertible notes were not within the scope of SFAS 150.

The fair value of the embedded beneficial conversion features was $86,000 at the date of issuance using the Black Sholes model with the following assumptions: risk free rate of return of 4.96%; volatility of 259.58%; dividend yield of 0% and an expected term of 1.5 years.

Based on the calculation of the fair value of the embedded beneficial conversion feature, the Company allocated $86,000 to the beneficial conversion feature and the beneficial conversion feature discount, and none to the convertible note. The embedded beneficial conversion feature discount is amortized to interest expense over the term of the note, which is $4,778 per month.

As of September 30, 2007, the outstanding principal amount of the convertible notes was $86,000 and the unamortized embedded beneficial conversion feature discount was $66,889, for a net convertible debt of $19,111.

For the year ended September 30, 2007, interest expense was $2,795, and amortization expense for the embedded beneficial conversion feature discount was $19,111, which was included in interest expense in the other income (expense) section of the statement of operations.

Calico Capital Management, LLC acted as a financial advisor for Convertible Notes 1 and 2 for the Company and received a fee of $75,000. Southridge acted as an agent for the Company in arranging the transaction for Convertible Notes 1 and 2. The Company recorded these fees as an expense during the period.

Subordinated Convertible Notes 3

On July 18, 2007, the Company completed an offering of $1,025,000 in principal amount of Subordinated Convertible Debentures to a group of institutional and accredited investors, which bear interest at the rate of 8% per annum, and mature 12 months from the date of issuance. The Subordinated Convertible Debentures are convertible into shares of the Companys Common Stock at an initial conversion rate of $0.22 per share, subject to anti-dilution adjustments. As part of the above offering the Company issued warrants to purchase 2,329,546 shares of Common Stock at an initial exercise price of $0.50 per share. An amendment to convertible note 3 dated March 13, 2008, reduces the conversion rate of the notes to $0.15 per share, and the exercise price of the warrants to $0.30 per share.

Under the terms of a Registration Rights Agreement signed in conjunction with this offering, the Company is required to file a registration statement under the Securities Act of 1933 in order to register the resale of the shares



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of Common Stock issuable upon conversion of the Subordinated Convertible Debentures and the warrant shares (collectively, the "Registrable Securities"). If the Company does not file a registration statement with respect to the registrable securities within forty-five days following the closing of the Offering, or if the Registration Statement is not declared effective by the Securities and Exchange Commission within 90 days, then the Company must pay to each purchaser damages equal to 1.5% of the purchase price paid by the purchaser for its Subordinated Convertible Debentures, for each 30 days that transpires after these deadlines. The aggregate amount of damages payable by the Company is limited to 15% of the purchase price. The Company had until August 31, 2007 to file the registration statement. The Company recorded $15,375 as liquidated damages for a period of one month as of September 30, 2007. No derivative liability is recorded as the amount of liquidated damage is fixed with a maximum ceiling.

The Company applied APB 14, paragraph 15 to determine the allocation of the proceeds of the convertible debt, which states that proceeds from the sale of debt with stock purchase warrants should be allocated between the debt and warrants, and paragraph 16 states that the proceeds should be allocated based on the relative fair values of the two securities at the time of issuance.

The fair value of warrants was $741,371 at the date of issuance calculated using the Black Sholes model with the following assumptions: risk free rate of return of 4.96% to 5.02%; volatility of 219.89% to 226.04%; dividend yield of 0% and an expected term of 5 years. As a result, the relative fair value of the warrants was $594,811.

SFAS 133, paragraph 12 was applied to determine if the embedded beneficial conversion features should be bifurcated from the convertible notes. The Company determined that the economic characteristics of the embedded beneficial conversion features are not clearly and closely related to the convertible notes, the embedded beneficial conversion feature and convertible notes are not remeasured at fair value at each balance sheet date, and a separate contract with the same terms would be a derivative pursuant to SFAS 133, paragraphs 6-11. Therefore, the embedded beneficial conversion features were bifurcated from the convertible notes. SFAS 133, paragraph 6 was applied to determine if the embedded beneficial conversion features were within the scope and definition of a derivative. The embedded beneficial conversion features had one or more underlings and one or more notional amounts, required no initial investment and required or permitted net settlement. Therefore, the embedded beneficial conversion features were determined to be derivatives. The Company applied EITF 00-19, paragraph 8 to determine the classification of the beneficial conversion feature, which states that contracts which require net-share settlement are equity. Therefore the embedded conversion features were determined to be equity instruments at the date of issuance. The Company applied EITF 00-19, paragraph 9, which states that all contracts be initially measured at fair value. The terms of the conversion feature only allow the counterparty to convert the notes into shares of common stock. Therefore, the convertible notes are not conventional convertible as defined in EITF 05-02. To determine the classification of the conversion feature, we followed the guidance of paragraphs 12-33 of EITF 00-19. The Company included SFAS 150 in the analysis of the convertible notes. SFAS 150 requires three classes of freestanding financial instruments, as defined in paragraphs 8 through 17, to be classified as liabilities. The first class, as defined in paragraph 9, is financial instruments that are mandatorily redeemable financial instruments. There are no terms or conditions that require the Company to unconditionally redeem the convertible notes by transferring assets at a specified or determinable date. The second class, as defined in paragraph 11, is financial instruments that require the repurchase of shares of Common Stock by transferring assets. There are no terms or conditions that require the Company to repurchase shares of Common Stock. The third class, as defined in paragraph 12, is financial instruments that require the issuance of a variable number of shares of Common Stock. There are no terms or conditions that require the Company to issue a variable number of shares of Common Stock. Therefore, the Company concluded that the convertible notes were not within the scope of SFAS 150.

The fair value of the embedded beneficial conversion features was $430,189 at the date of issuance using the Black Sholes model with the following assumptions: risk free rate of return of 4.96% to 5.02%; volatility of 219.89% to 226.04%; dividend yield of 0% and an expected term of 1 year.

Southridge Investment Group LLC, Ridgefield, Connecticut (Southridge) acted as the Companys agent in arranging the transaction, and received a placement fee of $102,500. Southridge also received warrants to purchase 465,909 shares of the Companys Common Stock on the same terms and conditions as the warrants issued to the purchasers. The Company recorded the placement fees as an expense. The grant date fair value of the warrants amounted to $124,060 and was calculated using the Black-Sholes option pricing model, using the following assumptions: risk free rate of return of 5.01%, volatility of 226.04%, dividend yield of 0% and expected term of five years.



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As of September 30, 2007, the outstanding principal amount of the convertible notes were $1,025,000, the unamortized warrant discount was $305,228, the embedded beneficial conversion feature discount was $421,855, for a net convertible debt of $297,917, and the number of outstanding warrants was 2,329,546.

For the year ended September 30, 2007, interest expense was $20,559, amortization expense for the warrant discount was $124,961, which was included in interest expense in the other income (expense) section of the statement of operations, and amortization expense for the beneficial conversion feature discount was $172,955, which was also included in interest expense in the other income (expense) section of the statement of operations.

NOTE 9. WARRANT LIABILITY  RESTATED

2001 Executive Officers Stock Option Plan

In October 2000, the Company amended its employment agreements with its executive officers. In conjunction with the amendments the Company adopted the 2001 Executive Officers Stock Option Plan. The plan has reserved 7,576,680 shares of Common Stock and has issued options for the purchase of 7,034,140 shares of Common Stock. The options expire 5 years from the date of issuance.

On the grant date, the Company applied SFAS 133, paragraph 6 to determine if the options were within the scope and definition of a derivative. The options: had one or more underlings, and one or more notional amounts; required no initial investment; and required or permitted net settlement. Therefore, the options were determined to be derivatives. In order to determine how to classify the options, the Company followed the guidance of paragraphs 7 and 8 of EITF 00-19, which states that contractsthat require settlement in shares are equity instruments. In order to determine the value of the options, the Company applied EITF 00-19, paragraph 9, which states that contracts that require the company to deliver shares as part of a physical settlement or net-share settlement should be initially measured at fair value. In accordance with EITF 00-19, the options were recorded in additional paid-in capital at fair value on the date of issuance.

The Company analyzed the options as of September 30, 2007, by following the guidance of SFAS 133, paragraph 6 to ascertain if the options issued remained derivatives as of September 30, 2007. All of the criteria in the original analysis were met, and the options issued were determined to be within the scope and definition of a derivative. The Company next followed the guidance of EITF 00-19, paragraph 19, which states that if a company is required to obtain shareholder approval to increase the companys authorized shares in order to net-share or physically settle a contract, share settlement is not controlled by the company, and the contract is required to be classified as a liability. The Company next applied EITF 00-19, paragraph 10, which states that if classification changes as the result of an event, the contract should be reclassified as of the date of the event at fair value. The event responsible for the change in classification was the issuance of the Convertible Debentures on July 17, 2007.

In accordance with EITF 00-19, the options were reclassified as of July 17, 2007 from additional paid-in capital to warrant liability on the balance sheet, at the fair value of $2,271,879 using the Black Sholes model with the following assumptions: risk free rate of return of 5.02%; volatility of 219.89%; dividend yield of 0%; and an expected term of 3.67 years.

The Company followed the guidance of EITF 00-19, paragraph 9, which states that all contracts classified as liabilities should be measured at fair value at each balance sheet date, with changes in fair value reported in earnings and disclosed in the financial statements as long as the contracts remain classified as liabilities.

The fair value of the options was $1,926,914 as of September 30, 2007, calculated using the Black Sholes model with the following assumptions: risk free rate of return of 4.05%; volatility of 126.94%; dividend yield of 0%; and an expected term of 3.5 years.

The decrease in the fair value of the options was recorded by decreasing warrant liability on the balance sheet by $344,965.

Warrants Related to 2004 Stock Purchase Agreement

Under the terms of a 2004 Stock Purchase Agreement, the Company issued warrants to purchase 1,463,336 shares of Common Stock at an exercise price of $0.03 which expired between February 9, 2007 and August 25, 2007.





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The Company followed the guidance of SFAS 133, paragraph 6, to determine if the warrants were within the scope and definition of a derivative at the date of issuance. The warrants had one or more underlings and one or more notional amounts, required no initial investment and required or permitted net settlement. Therefore, the warrants were determined to be derivatives at the date of issuance. In order to determine how to classify the warrants, the Company followed the guidance of EITF 00-19, paragraphs 7 and 8, which state that contractswhich require settlement in shares are equity instruments. In order to determine the value of the warrants, the Company followed the guidance of EITF 00-19, paragraph 9, which states that contracts which require the company to deliver shares as part of a physical settlement or net-share settlement should be initially measured at fair value.

The fair value of the warrants was $24,366 at the date of issuance, which the Company calculated using the Black Sholes model with the following assumptions: risk free rate of return of 1.21% to 2.14%; volatility of 141.91% to 170.27%; dividend yield of 0% and an expected term of 5 years.

The Company then applied EITF 00-19, paragraph 19, which states that if a company is required to obtain shareholder approval to increase the companys authorized shares in order to net-share or physically settle a contract, share settlement is not controlled by the company and the contract is required to be classified as a liability. The Company applied EITF 00-19, paragraph 10, which states that if a classification changes as the result of an event, the contract should be reclassified as of the date of the event at fair value. The event responsible for the change in classification was the issuance of the Convertible Debentures on July 17, 2007.

In accordance with EITF 00-19, the warrants were reclassified as of July 17, 2007 from additional paid-in capital to warrant liability on the balance sheet at the fair value of $70,029, which the Company calculated using the Black Sholes model with the following assumptions: risk free rate of return of 5.02%; volatility of 219.89%; dividend yield of 0%; and an expected term of .08 years.

The Company then applied EITF 00-19, paragraph 9, which states that all contracts classified as liabilities are to be measured at fair value at each balance sheet date, with changes in fair value reported in earnings and disclosed in the financial statements as long as the contracts remain classified as liabilities.

The Company determined that the fair value of the warrants was $0 as of September 30, 2007, due to their expiration.

The $70,029 decrease in the fair value of the warrants was recorded to warrant liability.

Warrants related to Convertible Debentures

On July 17, 2007 the Company completed an offering of $1,025,000 of Convertible Debentures to a group of institutional and accredited investors which included warrants to purchase 2,795,454 shares of Common Stock (2,329,546 shares of Common Stock to holders of the Convertible Debentures and 465,908 shares of Common Stock as a placement fee) at an exercise price of $0.50 per share.

The Company followed the guidance of SFAS 133, paragraph 6, to determine if the warrants were within the scope and definition of a derivative at the date of issuance. The warrants had one or more underlings and one or more notional amounts, required no initial investment and required or permitted net settlement. Therefore, the warrants were determined to be derivatives at the date of issuance. In order to determine how to classify the warrants, the Company followed the guidance of EITF 00-19, paragraphs 7 and 8, which state that contracts that require net-cash settlement (including a requirement to net cash settle the contract if an event occurs and if that event is outside the control of the company) are liability instruments. In order to determine the value of the options, the Company followed the guidance of EITF 00-19, paragraph 9, which states that contracts which require the company to deliver shares as part of a physical settlement or net-share settlement should be initially measured at fair value.

The fair value of warrants was $554,249 ($430,189 attributable to the holders of the Convertible Debentures and $124,060 attributable to the placement fee) at the date of issuance calculated using the Black Sholes model with the following assumptions: risk free rate of return of 4.96% to 5.02%; volatility of 219.89% to 226.04%; dividend yield of 0% and an expected term of 5 years.

The Company then applied EITF 00-19, paragraph 9, which states that all contracts classified as liabilities are to be measured at fair value at each balance sheet date, with changes in fair value reported in earnings and disclosed in the financial statements as long as the contracts remain classified as liabilities.



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The fair value of the warrants was determined to be $499,932 ($379,672 attributable to the holders of the Convertible Debentures and $120,260 attributable to the placement fee) as of September 30, 2007, which was calculated using the Black Sholes model with the following assumptions: risk free rate of return of 4.05%; volatility of 126.94%; dividend yield of 0%; and an expected term of 4.67 to 4.75 years.

The decrease in the fair value of the warrants was recorded by decreasing warrant liabilities on the balance sheet by $54,317 ($50,518 attributable to the holders of the Convertible Debentures and $3,799 attributable to the placement fee).

NOTE 10. BENEFICIAL CONVERSION FEATURES LIABILITY - RESTATED

Advisory Board Compensation

On October 1, 2004, the Company formed an advisory board consisting of four members. Each member was to receive $5,000 monthly from October 1, 2004 to February 22, 2007, for a total of $576,000. Any portion of this amount is convertible by the advisory board members at any time into shares of Common Stock at a rate of $0.05 per share.

The Company followed the guidance of SFAS 133, paragraph 6 to ascertain if the embedded beneficial conversion features were derivatives at the date of issuance. The embedded beneficial conversion features had one or more underlings and one or more notional amounts, required no initial investment, and required or permitted net settlement. Therefore, the embedded beneficial conversion features were determined to be within the scope and definition of a derivative at the date of issuance. Next, the Company followed the guidance of SFAS 133, paragraph 12, to determine if the embedded beneficial conversion features should be separated from the accrued expense. The Company determined that: the economic characteristics of the embedded beneficial conversion features are not clearly and closely related to the accrued expense, the embedded beneficial conversion feature and accrued expense are not remeasured at fair value at each balance sheet date and a separate contract with the same terms would be a derivative pursuant to SFAS 133, paragraphs 6-11. Therefore, the embedded beneficial conversion features were separated from the accrued expense to determine the classification and valuation. The Company followed the guidance of EITF 00-19, paragraphs 7 and 8 to determine the classification which states that contractsthat require settlement in shares are equity instruments. The Company followed the guidance of EITF 00-19, paragraph 9, to determine the value which states that contracts that require the company to deliver shares as part of a physical settlement or net-share settlement should be initially measured at fair value. The Company next followed the guidance of EITF 00-19, paragraph 19, which states that if a company is required to obtain shareholder approval to increase the companys authorized shares in order to net-share or physically settle a contract, share settlement is not controlled by the company, and the contract is required to be classified as a liability. The Company next applied EITF 00-19, paragraph 10, which states that if classification changes as the result of an event, the contract should be reclassified as of the date of the event at fair value. The event responsible for the change in classification was the issuance of the Convertible Debentures on July 17, 2007.

The fair value of the embedded beneficial conversion features was calculated using the Black Sholes model with the following assumptions: risk free rate of return of 4.94% to 5.09%; volatility of 268.59% to 277.2%; dividend yield of 0% and an expected term of 5 years. The sum of the monthly embedded beneficial conversion features from October 1, 2006 to February 22, 2007, was $91,956.

The fair value of the monthly embedded beneficial conversion features was $576,000 as of September 30, 2007, which the Company calculated using the Black Sholes model with the following assumptions: risk free rate of return of 4.05%; volatility of 126.94%; dividend yield of 0%; and an expected term of 2.08 to 4.42 years.

The increase in the fair value of the embedded beneficial conversion feature was recorded by increasing beneficial conversion features liability on the balance sheet by $4,044.

Beneficial Conversion Features

As of September 30, 2007, the Company had Convertible Notes outstanding totaling $1,861,000 that were issued between October 17, 2006, and July 17, 2007. The convertible notes included an embedded beneficial conversion features that allowed the holders of the convertible notes to convert their notes into Common Stock shares at rates between $.01 and $.22. The convertible notes mature between June 17, 2008 and December 31, 2008. The convertible notes accrue interest at rates between 8% and 10%, and any accrued but unpaid interest is also convertible by the holder of the convertible notes into shares of Common Stock at the same rate.



57



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The Company followed the guidance of SFAS 133, paragraph 6, to ascertain if the embedded beneficial conversion features remained derivatives as of September 30, 2007. All of the criteria in the original analysis were met, and the embedded beneficial conversion features issued were determined to be within the scope and definition of a derivative. The Company followed the guidance of SFAS 133, paragraph 12, to determine if the embedded beneficial conversion features should be separated from the convertible notes. All of the criteria in the original analysis were met, and the embedded beneficial conversion features were separated from the convertible notes. In order to determine the classification of the embedded conversion features, the Company applied paragraph 19 of EITF 00-19, which states that if a company is required to obtain shareholder approval to increase the companys authorized shares in order to net-share or physically settle a contract, share settlement is not controlled by the company, and the contract is required to be classified as a liability. In order to determine the value of the embedded conversion features, the Company followed the guidance of EITF 00-19, paragraph 9, which states that all contracts classified as liabilities are to be measured at fair value at each balance sheet date, with changes in fair value reported in earnings and disclosed in the financial statements as long as the contracts remain classified as liabilities.

The fair value of the embedded beneficial conversion features was $1,430,811 at the date of issuance using the Black Sholes model with the following assumptions: risk free rate of return of 2.02% to 5.09%; volatility of 108.5% to 274.86%; dividend yield of 0% and an expected term of 1 to 1.5 years.

The fair value of the embedded beneficial conversion features was $1,430,811 as of September 30, 2007, which was calculated using the Black Sholes model with the following assumptions: risk free rate of return of 4.05%; volatility of 126.94%; dividend yield of 0% and an expected term of .58 to 1.25 years.

NOTE 11. INCOME TAXES - RESTATED

Through September 30, 2007, the Company incurred net operating losses for tax purposes of approximately $13,157,000. The net operating loss carry forward for federal and state purposes may be used to reduce taxable income through the year 2027. The availability of the Company's net operating loss carry forward is subject to limitation if there is a 50% or more positive change in the ownership of the Company's stock.

The gross deferred tax asset balance as of September 30, 2007 is $4,740,000. A 100% valuation allowance has been established against the deferred tax assets, as the utilization of the loss carry forward cannot reasonably be assured. Components of deferred tax asset at September 30, 2007 are as follows:

|                         |  |      |            |   |      |   |            |  
|------------------------ |  | ---- | ---------- | - | ---- | - | ---------- | -
|                         |  | 2007 |            |   | 2006 |  
|Deferred tax asset       |  | $    | 4,740,000  |   |      | $ | 3,785,000  |  
|Less valuation allowance |  |      | (4,740,000 | ) |      |   | (3,785,000 | )
|                         |  | $    |          |   |      | $ |          |  



Differences between the benefit from income taxes and income taxes at the statutory federal income tax rate for years ended September 30, 2007 and 2006 are as follows:



|                                                              |  |                    |          |   |                    |  |       |        |  |   |          |   |  |  |       |   
|------------------------------------------------------------- |  | ------------------ | -------- | - | ------------------ |  | ----- | ------ |  | - | -------- | - |  |  | ----- | --
|                                                              |  | September 30, 2007 |          |   | September 30, 2006 | 
|                                                              |  | Amount             |          |   | Percent            |  |       | Amount |  |   | Percent  |  
|Income tax expense (benefit) at statutory federal rate        |  | $                  | (819,000 | ) |                    |  | (34.0 | )%     |  | $ | (378,000 | ) |  |  | (34.0 | )%
|State income tax expense (benefit), net of federal income tax |  |                    | (136,000 | ) |                    |  | (6.0  | )%     |  |   | (63,000  | ) |  |  | (6.0  | )%
|Valuation allowance                                           |  |                    | 955,000  |   |                    |  | 40.0  | %      |  |   | 441,000  |   |  |  | 40.0  | % 
|                                                              |  |                    |        |   |                    |  | 0.0   | %      |  |   |        |   |  |  | 0.0   | % 





58



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A detail of the Companys deferred tax assets and liabilities as of September 30, 2007 follows:



|                                                               |  |   |            |  
|-------------------------------------------------------------- |  | - | ---------- | -
|Warrant amortization expense                                   |  | $ | 45,000     |  
|                                                               |  |   |            |  
|Beneficial conversion feature expense                          |  |   | 134,000    |  
|                                                               |  |   |            |  
|Increase in fair market value of warrants                      |  |   | (85,000    | )
|                                                               |  |   |            |  
|Decrease in fair market value of beneficial conversion feature |  |   | 2,000      |  
|                                                               |  |   |            |  
|Increase in fair market value of stock options                 |  |   | (138,000   | )
|                                                               |  |   |            |  
|Net operating loss carryforward                                |  |   | 4,698,000  |  
|                                                               |  |   |            |  
|Valuation allowance                                            |  |   | (4,740,000 | )
|                                                               |  |   |            |  
|                                                               |  | $ |          |  



NOTE 12. STOCKHOLDERS EQUITY  RESTATED

COMMON STOCK

The Company has 150,000,000 authorized shares, par value $0 .001 per share. As of September 30, 2007, the Company had 107,117,101 shares issued and 106,635,201 shares outstanding.

During the year ended September 30, 2007, the Company issued 3,292,915 shares, valued at $0.01 per share, and 1,300,000 shares valued at $0.04 per share for consulting services recorded at the fair market value.

The Company has not issued 1,463,336 shares of Common Stock to certain investors under the terms of a 2004 Stock Purchase Agreement. The investment was made and funds deposited into the Companys bank accounts between February 9, 2004, and August 25, 2004. The investment has been carried on the Companys balance sheet in the Stockholders Deficit section as Shares to be Issued.

STOCK OPTIONS

2001 Executive Officers Stock Option Plan

In October 2000, the Company entered into amendments to its employment agreement with each of its executive officers eliminating the provisions of stock bonuses. In lieu of the bonus provision, the Company adopted the 2001 Executive Officers Stock Option Plan. The Company reserved 7,576,680 shares for issuance under the plan.

A summary of the Companys option activity is listed below:

|                                  |  |                                 |      |  |                   |  |           |                           |  |   |           | 
|--------------------------------- |  | ------------------------------- | ---- |  | ----------------- |  | --------- | ------------------------- |  | - | --------- | 
|                                  |  | Weighted
Average
Exercise
Price |      |  | Number of
Options |  |           | Aggregate
Intrinsic
Value | 
|Outstanding at September 30, 2006 |  | $                               | 0.15 |  |                   |  | 7,034,140 |                           |  | $ |         | 
|Granted                           |  |                                 |    |  |                   |  |         |                           |  |   |         | 
|Forfeited                         |  |                                 |    |  |                   |  |         |                           |  |   |         | 
|Exercised                         |  |                                 |    |  |                   |  |         |                           |  |   |         | 
|Outstanding at September 30, 2007 |  | $                               | 0.15 |  |                   |  | 7,034,140 |                           |  | $ | 1,055,121 | 





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Options outstanding:



|               |       |  |               |  |                            |             |                                 |                  |           |             |           |  |             |       |  |  |  |       | 
|-------------- | ----- |  | ------------- |  | -------------------------- | ----------- | ------------------------------- | ---------------- | --------- | ----------- | --------- |  | ----------- | ----- |  |  |  | ----- | 
|               |       |  | Stock Options |  | Weighted Average
Remaining |             | Weighted Average Exercise Price |                 
|Exercise Price |       |  | Outstanding   |  |                            | Exercisable |                                 | Contractual Life |           | Outstanding |           |  | Exercisable |      
|               | $0.15 |  |               |  | 7,034,140                  |             |                                 |                  | 7,034,140 |             | 3.5 Years |  |             | $0.15 |  |  |  | $0.15 | 



The fair value of the options was $1,926,914 calculated using the Black Sholes option valuation model with the following assumptions for the year ended September 30, 2007: risk free interest rates of 4.05%; expected volatility of 126.94%; dividend yields of 0%; and expected term of 3.56 years.

During the year ended September 30, 2007 the Company did not issue any new options.

STOCK WARRANTS

Under the terms of the 2004 Stock Purchase Agreement, the Company was to issue 1,463,336 warrants to purchase shares of Common Stock at a price of $0.03 per share. The warrants attached to this issue of Common Stock have, by the terms of the agreement, expired as of September 30, 2007.

As part of the offering of Convertible Note 3, the Company issued warrants to purchase 2,795,454 shares of the Companys Common Stock at a price of $0.50 per share. The warrants expire five years from the date of issuance.

A summary of the Companys warrant activity is listed below:

|                                  |  |                                 |      |  |                    |  |            |                           |  |   |    | 
|--------------------------------- |  | ------------------------------- | ---- |  | ------------------ |  | ---------- | ------------------------- |  | - | -- | 
|                                  |  | Weighted
Average
Exercise
Price |      |  | Number of
Warrants |  |            | Aggregate
Intrinsic
Value | 
|Outstanding at September 30, 2006 |  | $                               | 0.03 |  |                    |  | 1,463,336  |                           |  | $ |  | 
|Granted                           |  |                                 | 0.50 |  |                    |  | 2,795,454  |                           |  |   |  | 
|Expired                           |  |                                 | 0.03 |  |                    |  | (1,463,336 | )                         |  |   |  | 
|Forfeited                         |  |                                 |    |  |                    |  |          |                           |  |   |  | 
|Exercised                         |  |                                 |    |  |                    |  |          |                           |  |   |  | 
|Outstanding at September 30, 2007 |  | $                               | 0.50 |  |                    |  | 2,795,454  |                           |  | $ |  | 



All outstanding warrants were exercisable as of September 30, 2007.

Warrants outstanding:

|               |  |  |                    |  |  |                                             |  |  |                                 | 
|-------------- |  |  | ------------------ |  |  | ------------------------------------------- |  |  | ------------------------------- | 
|Exercise
Price |  |  | Number of
Warrants |  |  | Weighted
Average
Remaining
Contractual
Life |  |  | Weighted
Average
Exercise
Price | 
|$0.50          |  |  | 2,795,454          |  |  | 4.70                                        |  |  | $0.50                           | 



NOTE 13. GOING CONCERN  RESTATED



The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. This basis of accounting contemplates the recovery of the Companys assets and the satisfaction of its liabilities in the normal course of business. Through September 30, 2007, the Company has incurred cumulative losses of $49,465,126 including a loss for the year ended September 30, 2007 of $33,612,516. As the Company has no cash flow from operations, its ability to transition from a development stage company to an operating company is entirely dependent upon obtaining adequate cash to finance its overhead, research and development activities, and acquisition of production equipment. It is unknown when, if ever, the Company will achieve a level of revenues adequate to support its cost and expenses. In order for the Company to meet its basic financial obligations, including rent, salaries, debt service and operations, it plans to seek additional equity or debt financing. Because of the Companys history and current debt levels, there is considerable doubt that the Company will be able to obtain financing. The Companys ability to meet its cash requirements for the next twelve months depends on its ability to



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obtain such financing. Even if financing is obtained, any such financing will likely involve additional fees and debt service requirements which may significantly reduce the amount of cash we will have for our operations. Accordingly, there is no assurance that the Company will be able to implement its plans.

The Company expects to continue to incur substantial operating losses for the foreseeable future, and it cannot predict the extent of the future losses or when it may become profitable, if ever. The Company expects to incur increasing sales and marketing, research and development and general and administrative expenses. Also, the Company has a substantial amount of short-term debt, which will need to be repaid or refinanced, unless it is converted into equity. As a result, if the Company begins to generate revenues from operations, those revenues will need to be significant in order to cover current and anticipated expenses. These factors raise substantial doubt about the Company's ability to continue as a going concern unless it is able to obtain substantial additional financing in the short term and generate revenues over the long term. If the Company is unable to obtain financing, it would likely discontinue its operations.

NOTE 14. COMMITMENT

On February 19, 2007 the Company entered into a two year lease agreement beginning March 1, 2007. According to the terms of the agreement, at the beginning of each lease year, the then most recently published Consumer Price Index (CPI) figure shall be determined and the monthly rental payable for the succeeding lease year will be calculated. The future aggregate minimum annual lease payments arising from these lease agreements are as follows.

During the year ended September 30,

|     |  |   |        | 
|---- |  | - | ------ | 
|2008 |  | $ | 55,200 | 
|2009 |  |   | 23,000 | 
|     |  | $ | 78,200 | 



Total rent expense under the operating lease was approximately $32,200 for the year ended September 30, 2007.

NOTE 15. SUBSEQUENT EVENTS  RESTATED

Notes Payable Under Equity Line of Credit

The Company paid $27,336 plus interest of $13,859 against a note payable under equity line of credit in October 2007 (See note 7).

Issuance of Options

On December 13, 2007, the Company issued 2,000,000 options to employees to purchase shares of Common Stock at $0.25 per share, which expire on December 12, 2012. The fair value of the options was $478,589 at the date of issuance and was calculated using the Black Sholes option valuation model with the following assumptions: risk free interest rates of 3.54%; expected volatility of 264%; dividend yields of 0%; and expected term of 5 years.

Agreements with Richard Papalian

On December 19, 2007, the Company entered into a one year Employment Agreement with Richard H. Papalian (the Employment Agreement), pursuant to which Mr. Papalian has been appointed as the Chief Executive Officer of the Company and elected to fill a vacancy on the Companys board of directors. Mr. Papalian will not receive a cash salary or any fringe benefits under the Employment Agreement. Instead, pursuant to a Notice of Grant of Stock Option and a Stock Option Agreement dated December 19, 2007, the Company granted to Mr. Papalian a five year option to purchase up to 8,539,312 shares the Companys Common Stock at an exercise price of $0.25 per share of which 30% vest immediately and the remaining 70% vest based upon certain market capitalization values (the Papalian Option); which on the date of the Employment Agreement represented 5% of the outstanding shares of the Companys Common Stock on a fully diluted basis. The fair value of the options was $587,440 at the date of issuance and was calculated using the Black Sholes option valuation model with the following assumptions: risk free interest rates of 3.46%; expected volatility of 264%; dividend yields of 0%; and expected term of 5 years.

Agreements with Mark Maron

On December 19, 2007, the Company entered into a one year Consulting Agreement with Mark Maron (the



61



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Consulting Agreement), pursuant to which Mr. Maron has been appointed as Special Adviser to the Company. Mr. Maron will not receive cash remuneration under the Consulting Agreement. Instead, pursuant to a Notice of Grant of Stock Option and a Stock Option Agreement dated December 19, 2007, the Company granted to Mr. Maron a five year option to purchase up to 8,539,312 shares of the Companys Common Stock at an exercise price of $0.25 per share (the Maron Option) of which 8,199,312 vest immediately, which represented 5% of the outstanding shares of the Companys Common Stock on a fully diluted basis. The fair value of the options was $1,880,168 at the date of issuance and was calculated using the Black Sholes option valuation model with the following assumptions: risk free interest rates of 3.46%; expected volatility of 264%; dividend yield of 0%; and expected term of 5 years.

Issuance of $425,000 in 10% Subordinated Notes Payable and Related Warrants

During January 2008, the Company completed an offering of $425,000 in subordinated debentures to a group of institutional and accredited investors. The notes mature on December 31, 2008 and bear an interest at the rate of 10% per annum.

As part of the offering, the Company issued warrants to purchase 850,000 shares of Common Stock at $0.40 per share. The fair value of the warrants was $175,952 at the date of issuance and was calculated using the Black-Sholes option pricing model, using the following assumptions: risk free rate of return of 2.64% to 3.06% expected volatility of 248%, dividend yield of 0% and expected term of five years.

Issuance of $750,000 in Common Stock and Related Warrants

Between March 14 and May 28, 2008, the Company completed an offering of 7,500,000 shares of Common Stock at $0.10 per share to a group of institutional and accredited investors, for a total of $750,000.

As part of the offering, the Company issued warrants to purchase 15,000,000 shares of Common Stock at $0.10 per share. The grant date fair value of the warrants was $2,182,233 and was calculated using the Black-Sholes option pricing model, using the following assumptions: risk free rate of return of 1.80% to 2.50%, expected volatility of 242% to 245%, dividend yield of 0% and expected term of three years.

Termination of Lease

On August 30, 2007, the Company entered into a five year lease agreement beginning October 1, 2007. On March 18, 2008, the Company successfully negotiated the termination of the lease by committing to issue 748,750 shares of the Companys Common Stock, plus termination of all claims to its $100,000 security deposit. For the three months ended March 31, 2008, the Company wrote-off $29,166 of leasehold improvements and $100,000 of security deposit. The 748,750 shares of Common Stock to be issued represented $89,850 in rent expense.

Conversion of Debt Into Shares of Common Stock

From April 2008 to June 2008 $754,667 of principal and $74,587 of accrued interest of Convertible Notes were converted into 10,363,796 shares of Common Stock of the Company. Conversion rates were between $0.01 and $0.22.

Issuance of Warrants to Director

On July 11, 2008, the Company issued an option to purchase 500,000 shares of common stock to the Chief Financial Officer, who is also a member of the Board of Directors, at an exercise price of $0.25. The option expires December 13, 2012.

Operating Lease

On July 21, 2008, the Company entered into a three year agreement beginning August 1, 2008, for a 12,000 square foot industrial facility in Anaheim, California for research and development, and manufacturing and distribution of water filtration systems. Monthly lease payments are $8,650 for fiscal year 2009, $8,995 for fiscal year 2010, and $9,355 for fiscal year 2011.

Issuance of $1,000,000 in Subordinated Convertible Notes Payable and Related Warrants

On July 29, 2008, the Company completed an offering of $1,000,000 in subordinated debentures to a group of institutional and accredited investors. The notes mature on December 31, 2008, bear an interest at the rate of 12%



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per annum, and are convertible into shares of Common Stock of the Company at $0.25 per share.

As part of the offering, the Company issued warrants to purchase 3,333,333 shares of Common Stock at $0.30 per share.

NOTE 16. RESTATEMENT

On December 11, 2007 the Company received a comment letter from the Securities & Exchange Commission. In responding to the comment letter, the Company recalculated the number of shares of common stock available for issuance and determined that as of September 30, 2007, the number of shares of common stock that would be required to be issued if all of the Companys convertible securities, including debt securities, options and warrants, were converted or exercised would exceed the number of shares of authorized common stock. The difference between the original calculation and the recalculation is illustrated below.

|                                                                      |  |                          |              |   |                 |  |              |  
|--------------------------------------------------------------------- |  | ------------------------ | ------------ | - | --------------- |  | ------------ | -
|                                                                      |  | As
Originally
Calculated |              |   | As
Recalculated | 
|                                                                      |  |                          |              |  
|                                                                      |  |                          |              |  
|                                                                      |  |                          |              |   |                 | 
|Authorized shares per Articles of Incorporation                       |  |                          | 150,000,000  |   |                 |  | 150,000,000  |  
|Outstanding shares                                                    |  |                          | (106,635,201 | ) |                 |  | (106,635,201 | )
|Available shares                                                      |  |                          | 43,364,799   |   |                 |  | 43,364,799   |  
|                                                                      |  |                          |              |   |                 |  |              |  
|Securities convertible or exercisable into common stock shares:       |  |                          |              |   |                 |  |              |  
|2001 Executive Officers Stock Option Plan                             |  |                          | 7,343,032    |   |                 |  | 7,034,140    |  
|Advisory Board Compensation                                           |  |                          |              |   |                 |  | 11,520,000   |  
|2004 Stock Purchase Agreement                                         |  |                          |              |   |                 |  | 1,463,336    |  
|Warrants Related to 2004 Stock Purchase Agreement                     |  |                          |              |   |                 |  | 1,463,336    |  
|Warrants Issued for Services                                          |  |                          |              |   |                 |  | 1,010,000    |  
|Beneficial Conversion Features                                        |  |                          | 32,009,087   |   |                 |  | 36,606,318   |  
|Warrants Related to $1,025,000 of Subordinated Convertible Debentures |  |                          | 2,159,088    |   |                 |  | 2,795,454    |  
|                                                                      |  |                          | 41,511,207   |   |                 |  | 61,892,584   |  



Adjustments to the original calculation included the following:

1.

In 2001, the Company adopted the 2001 Executive Officers Stock Option Plan. The plan has issued options to purchase 7,034,140 shares of common stock. The original calculation included options to purchase 7,343,032 shares of common stock, an overstatement of 308,892 shares of common stock.

2.

On October 1, 2004, the Company formed an advisory board consisting of four members. In exchange for his services, each member was to receive $5,000 monthly from October 1, 2004 to February 22, 2007 (for a total of $576,000 to be paid to all members). Each member, in his sole discretion, was entitled to convert some or all of the cash amount owed to him into shares of common stock at the rate of $0.05 per share. If all of the members of the advisory board converted the total amount of cash compensation due to them into shares of common stock, the Company would be required to issue 11,520,000 shares. The accrued expense convertible into shares of common stock was not included in the original calculation.

3.

Under the terms of a 2004 Stock Purchase Agreement, the Company was to issue 1,463,336 shares of common stock to certain investors that had previously remitted funds to the Company from February 9, 2004 to August 25, 2004. The shares were not included in the original calculation.

4.

Under the terms of the 2004 Stock Purchase Agreement, the Company issued warrants to purchase 1,463,336 shares of common stock to these investors at an exercise price of $0.03 per share. The warrants were not included in the original calculation.

5.

As of September 30, 2007, the Company had Convertible Notes outstanding totaling $1,861,000 that included embedded beneficial conversion features that allowed for the conversion of the notes into shares of common stock at rates between $0.01 and $0.22, and matured between June 2008 and December 2008. The Convertible Notes accrue interest at rates between 8% and 10%, and any accrued but unpaid interest is also convertible into shares of common stock. The original calculation



63



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of the beneficial conversion feature did not include accrued interest of $209,843 that could be converted into 4,597,231 shares of common stock at maturity.

6.

On July 18, 2007 the Company completed an offering of $1,025,000 in principal amount of Subordinated Convertible Debentures (the Convertible Debentures) to a group of institutional and accredited investors. As part of this offering the Company issued warrants to purchase 2,795,454 shares of common stock at a price of $0.50 per share. The number of warrant shares in the original calculation was 2,159,088.

The Company analyzed the effect of the recalculation on the balance sheet and the statements of operations and cash flows as of September 30, 2007. The analysis and results were as follows:

2001 Executive Officers Stock Option Plan

In October 2000, the Company amended its employment agreements with its executive officers. In conjunction with the amendments the Company adopted the 2001 Executive Officers Stock Option Plan. The plan has reserved 7,576,680 shares of common stock and has issued options for the purchase of 7,034,140 shares of common stock. The options expire 5 years from the date of issuance.

Balance Sheet

On the grant date, the Company applied Financial Accounting Standard Board (SFAS) Statement No. 133, Accounting for Derivative Instruments and Hedging Activities, paragraph 6 to determine if the options were within the scope and definition of a derivative. The options: had one or more underlings and one or more notional amounts, required no initial investment, and required or permitted net settlement. Therefore, the options were determined to be derivatives. In order to determine how to classify the options, the Company followed the guidance of paragraphs 7 and 8 of Emerging Issues Task Force (EITF) 00-19, Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Companys Own Stock, which states that contractsthat require settlement in shares are equity instruments. In order to determine the value of the options, the Company applied EITF 00-19, paragraph 9, which states that contracts that require a company to deliver shares as part of a physical settlement or net-share settlement should be initially measured at fair value. In accordance with EITF 00-19, the options were recorded in additional paid-in capital at fair value on the date of issuance.

The Company began the analysis for the restatement by following the guidance of SFAS 133, paragraph 6 to ascertain if the options issued remained derivatives as of September 30, 2007. All of the criteria in the original analysis were met, and the options issued were determined to be within the scope and definition of a derivative. The Company next followed the guidance of EITF 00-19, paragraph 19, which states that if a company is required to obtain shareholder approval to increase the companys authorized shares in order to net-share or physically settle a contract, share settlement is not controlled by the company, and the contract is required to be classified as a liability. The Company next applied EITF 00-19, paragraph 10, which states that if classification changes as the result of an event, the contract should be reclassified as of the date of the event at fair value. The event responsible for the change in classification was the issuance of the Convertible Debentures on July 17, 2007.

In accordance with EITF 00-19, the options were reclassified as of July 17, 2007 from additional paid-in capital to warrant liabilities on the balance sheet, at the fair value of $2,271,879 using the Black Sholes model with the following assumptions: risk free rate of return of 5.02%; volatility of 219.89%; dividend yield of 0%; and an expected term of 3.67 years.

The Company followed the guidance of EITF 00-19, paragraph 9, which states that all contracts classified as liabilities should be measured at fair value at each balance sheet date, with changes in fair value reported in earnings and disclosed in the financial statements as long as the contracts remain classified as liabilities.

The fair value of the options was $1,926,914 as of September 30, 2007, calculated using the Black Sholes model with the following assumptions: risk free rate of return of 4.05%; volatility of 126.94%; dividend yield of 0%; and an expected term of 3.5 years.

The decrease in the fair value of the options was recorded by decreasing warrant liability on the balance sheet by $344,965.



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Statement of Operations

Prior to the reclassification, the Company applied EITF 00-19, paragraph 9, which states that subsequent changes in fair value of contracts should not be recognized as long as the contracts continue to be classified as equity. Therefore, changes in the fair value of the options prior to the reclassification were not recorded. Subsequent to reclassifying the contracts as liabilities, the Company again followed the guidance of EITF 00-19, paragraph 9, which requires all contracts classified as liabilities to be measured at fair value, with changes in fair value reported in earnings as long as the contracts remain classified as liabilities.

From July 17 to September 30, 2007, the fair value of the options decreased by $344,965. This amount is included in decrease in warrant liability in the other income (expense) section of the statement of operations.

Statement of Cash Flows

The change in the statement of cash flows was the result of the decrease of $344,965 in the fair value the options.

The reclassification of the options from additional paid-in capital to warrant liabilities was a non-cash transaction.

Advisory Board Compensation

On October 1, 2004, the Company formed an advisory board consisting of four members. In exchange for his services, each member was to receive $5,000 monthly from October 1, 2004 to February 22, 2007, for a total of $576,000 to be paid to all members. Each member, in his sole discretion, was entitled to convert some or all of the cash amount owed to him into shares of common stock at a rate of $0.05 per share. If all of the members of the advisory board converted the total amount of cash compensation due to them into shares of common stock, the Company would be required to issue 11,520,000 shares. The Company determined that: the accrued expense, embedded beneficial conversion features, embedded beneficial conversion feature discount, and related amortization expense were not recorded at the date of issuance or prior to the restatement. No payments have been made to any advisory board members and there has been no conversion by any advisory board members of the accrued liability into shares of common stock.

Balance Sheet

The Company began the analysis for the restatement by applying paragraph 6 of SFAS 133 to ascertain if the embedded beneficial conversion features were derivatives at the date of issuance. The embedded beneficial conversion features had one or more underlings and one or more notional amounts, required no initial investment, and required or permitted net settlement. Therefore, the embedded beneficial conversion features were determined to be within the scope and definition of a derivative at the date of issuance. Next, the Company followed the guidance of SFAS 133, paragraph 12, to determine if the embedded beneficial conversion features should be bifurcated from the accrued expense. The Company determined that: the economic characteristics of the embedded beneficial conversion features are not clearly and closely related to the accrued expense, the embedded beneficial conversion feature and accrued expense are not remeasured at fair value at each balance sheet date and a separate contract with the same terms would be a derivative pursuant to SFAS 133, paragraphs 6-11. Therefore, the embedded beneficial conversion features were bifurcated from the accrued expense to determine the classification and valuation. To determine the classification, the Company followed the guidance of EITF 00-19, paragraphs 7 and 8 which states that contractsthat require settlement in shares are equity instruments. To determine the value, the Company followed the guidance of EITF 00-19, paragraph 9, which states that contracts that require the company to deliver shares as part of a physical settlement or net-share settlement should be initially measured at fair value. The Company next followed the guidance of EITF 00-19, paragraph 19, which states that if a company is required to obtain shareholder approval to increase the companys authorized shares in order to net-share or physically settle a contract, share settlement is not controlled by the company, and the contract is required to be classified as a liability. The Company next applied EITF 00-19, paragraph 10, which states that if classification changes as the result of an event, the contract should be reclassified as of the date of the event at fair value. The event responsible for the change in classification was the issuance of the Convertible Debentures on July 17, 2007.

The fair value of the monthly embedded beneficial conversion features was calculated using the Black Sholes model with the following assumptions: risk free rate of return of 2.28% to 5.21%; volatility of 144.19% to 270.5%; dividend yield of 0% and an expected term of 5 years. The sum of the monthly accrued expenses and embedded beneficial conversion features from October 1, 2004 to September 30, 2006, was $480,000 and $210,149, respectively, and considered earned prior to October 1, 2006. Therefore, as of September 30, 2006, $480,000 was



65



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recorded to accrued expenses and deficit accumulated during development stage, $210,149 was recorded to beneficial conversion features liability and netted against accrued expenses as a discount, and $49,192 was recorded to accrued expenses and deficit accumulated during development stage for the amortization of the beneficial conversion features discount.

The fair value of the monthly embedded beneficial conversion features was $480,000 as of September 30, 2006, which the Company calculated using the Black Sholes model with the following assumptions: risk free rate of return of 4.91%; volatility of 270.5%; dividend yield of 0%; and an expected term of 3.08 to 5 years. The increase in the fair value of the embedded beneficial conversion feature was recorded by increasing beneficial conversion feature liability and deficit accumulated during development stage on the balance sheet by $269,851.

During the year ended September 30, 2007, the Company incurred and recorded to accrued expenses $96,000 for advisory board compensation until February 22, 2007, the date the Companys Board of Directors terminated the compensation. The fair value of the monthly embedded beneficial conversion features was calculated using the Black Sholes model with the following assumptions: risk free rate of return of 4.94% to 5.09%; volatility of 268.59% to 277.2%; dividend yield of 0% and an expected term of 5 years. The sum of the embedded beneficial conversion features from October 1, 2006 to February 22, 2007 was $91,956 and was recorded to beneficial conversion features liability and netted against accrued expenses. As of September 30, 2007, total amortization for the beneficial conversion features discount was $106,546 ($49,192 from October 1, 2004 to September 30, 2006, and $57,354 for the year ended September 30, 2007), and was recorded to accrued expenses.

The fair value of the monthly embedded beneficial conversion features was $576,000 as of September 30, 2007, which the Company calculated using the Black Sholes model with the following assumptions: risk free rate of return of 4.05%; volatility of 126.94%; dividend yield of 0%; and an expected term of 2.08 to 4.42 years.

The increase in the fair value of the embedded beneficial conversion feature was recorded by increasing beneficial conversion features liability on the balance sheet by $4,044.

Statement of Operations

The Company followed the guidance of EITF 00-19, paragraph 9, which requires all contracts classified as liabilities to be measured at fair value, with changes in fair value reported in earnings as long as the contracts remain classified as liabilities.

The increase in the fair value of the beneficial conversion features was $4,044 and included in increase in beneficial conversion feature in the other income (expense) section of the statement of operations.

The amortization expense for the beneficial conversion feature discount was $57,354 and included in general and administrative expenses in the operating expenses section of the statement of operations for the year ended September 30, 2007.

Statement of Cash Flows

Changes in the statement of cash flows were the result of the advisory board compensation accrued expense of $480,000 and $96,000, beneficial conversion features liability of $576,000 and unamortized beneficial conversion features discount of $380,441 on the balance sheet, and change in fair value of the liability of $269,851 and $4,044 and amortization of the beneficial conversion features discount of $49,193 on the statement of operations.

Warrants Related to 2004 Stock Purchase Agreement

Under the terms of a 2004 Stock Purchase Agreement, the Company issued warrants to purchase 1,463,336 shares of common stock at an exercise price of $0.03 which expired between February 9, 2007 and August 25, 2007. The Company determined that the warrants and related expense were not recorded at the date of issuance or prior to the restatement and there has been no exercise of the warrants into shares of common stock.

Balance Sheet

The Company followed the guidance of SFAS 133, paragraph 6, to determine if the warrants were within the scope and definition of a derivative at the date of issuance. The warrants had one or more underlings and one or more notional amounts, required no initial investment and required or permitted net settlement. Therefore, the warrants were determined to be derivatives at the date of issuance. In order to determine how to classify the warrants, the



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Company followed the guidance of EITF 00-19, paragraphs 7 and 8, which state that contractswhich require settlement in shares are equity instruments. In order to determine the value of the options, the Company followed the guidance of EITF 00-19, paragraph 9, which states that contracts which require the company to deliver shares as part of a physical settlement or net-share settlement should be initially measured at fair value.

The fair value of the warrants was $24,367 at the date of issuance, which the Company calculated using the Black Sholes model with the following assumptions: risk free rate of return of 1.21% to 2.14%; volatility of 141.91% to 170.27%; dividend yield of 0% and an expected term of 3 years. The warrants were considered an expense prior to October 1, 2006, therefore, $24,367 was recorded to additional paid-in capital and deficit accumulated during development stage.

The Company then applied EITF 00-19, paragraph 19, which states that if a company is required to obtain shareholder approval to increase the companys authorized shares in order to net-share or physically settle a contract, share settlement is not controlled by the company and the contract is required to be classified as a liability. The Company applied EITF 00-19, paragraph 10, which states that if a classification changes as the result of an event, the contract should be reclassified as of the date of the event at fair value. The event responsible for the change in classification was the issuance of the Convertible Debentures on July 17, 2007.

In accordance with EITF 00-19, the warrants were reclassified as of July 17, 2007 from additional paid-in capital to warrant liabilities on the balance sheet at the fair value of $70,029, which the Company calculated using the Black Sholes model with the following assumptions: risk free rate of return of 5.02%; volatility of 219.89%; dividend yield of 0%; and an expected term of .08 years.

The Company then applied EITF 00-19, paragraph 9, which states that all contracts classified as liabilities are to be measured at fair value at each balance sheet date, with changes in fair value reported in earnings and disclosed in the financial statements as long as the contracts remain classified as liabilities.

The Company determined that the fair value of the warrants was $0 as of September 30, 2007, due to their expiration.

The $70,029 decrease in the fair value of the warrants was recorded to warrant liability.

Statement of Operations

Prior to the reclassification, the Company followed EITF 00-19, paragraph 9, which states that subsequent changes in the fair value of contracts should not be recognized as long as the contracts continue to be classified as equity. Therefore, changes in the fair value of the warrants prior to the reclassification were not recorded. Subsequent to reclassifying the warrants as liabilities, the Company again followed EITF 00-19, paragraph 9, which requires all contracts classified as liabilities to be measured at fair value, with changes in fair value reported in earnings as long as the contracts remain classified as liabilities.

The change in the fair value of the warrants from July 17, 2007 to September 30, 2007 was $70,029 and is included in decrease in warrant liability in the other income (expense) section of the statement of operations.

Statement of Cash Flows

Changes in the statement of cash flows were the result of the change in fair value of the warrants of $70,029 on the statement of operations.

The reclassification of the warrants from additional paid-in capital to warrant liability was a non-cash transaction.

Beneficial Conversion Features

As of September 30, 2007, the Company had Convertible Notes outstanding totaling $1,861,000 that were issued between October 17, 2006 and July 17, 2007. The convertible notes included an embedded beneficial conversion feature that allowed the holders of the convertible notes to convert their notes into common stock shares at rates between $0.01 and $0.22. The convertible notes mature between June 17, 2008 and December 31, 2008. The convertible notes accrue interest at rates between 8% and 10%, and any accrued but unpaid interest is also convertible by the holder of the convertible notes into shares of common stock at the same rate.



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Balance Sheet

On the date of issuance, the Company applied SFAS 133, paragraph 6 to determine if the embedded beneficial conversion features were within the scope and definition of a derivative. The embedded beneficial conversion features: had one or more underlings and one or more notional amounts, required no initial investment and required or permitted net settlement. Therefore, the embedded beneficial conversion features were determined to be derivatives. Next, the Company followed the guidance of SFAS 133, paragraph 12 to determine if the embedded beneficial conversion features should be bifurcated from the convertible notes. The Company determined that: the economic characteristics of the embedded beneficial conversion features are not clearly and closely related to the convertible notes; the embedded beneficial conversion feature and convertible notes are not remeasured at fair value at each balance sheet date; and a separate contract with the same terms would be a derivative pursuant to SFAS 133, paragraphs 6-11. Therefore, the embedded beneficial conversion features were bifurcated from the convertible notes to determine the classification and valuation. The Company followed the guidance of paragraphs 7 and 8 of EITF 00-19, which state that contractsthat require settlement in shares are to be classified as equity instruments. The Company then applied paragraph 9 of EITF 00-19 to determine the value of the embedded beneficial conversion features. Paragraph 9 of EITF 00-19 states that contracts which require the company to deliver shares as part of a physical settlement or net-share settlement should be initially measured at fair value. Based on the analysis at the date of issuance, the embedded beneficial conversion features were recorded in additional paid-in capital at fair value on the date of issuance.

The fair value of the embedded beneficial conversion features was $1,021,569 computed using the Black Sholes model with the following assumptions: risk free rate of return of 6%; volatility of 122.67% to 195.97%; dividend yield of 0% and an expected term of 1 to 1.5 years. The embedded beneficial conversion features discount was $706,186 as of September 30, 2007, net of amortization of $315,383, prior to the restatement.

The Company began the analysis for the restatement by applying SFAS 133, paragraph 6, to ascertain if the embedded beneficial conversion features remained derivatives as of September 30, 2007. All of the criteria in the original analysis were met, and the embedded beneficial conversion features issued were determined to be within the scope and definition of a derivative. The Company followed the guidance of SFAS 133, paragraph 12, to determine if the embedded beneficial conversion features should be bifurcated from the convertible notes. All of the criteria in the original analysis were met, and the embedded beneficial conversion features were bifurcated from the convertible notes. In order to determine the classification of the embedded conversion features, the Company applied paragraphs 7 and 8 of EITF 00-19. Paragraph 7 states that contracts which require net-cash settlement are liabilities, and paragraph 8 states that contracts which give the counterparty (holders of the convertible notes) a choice of net-cash settlement or settlement in shares are liabilities. Therefore the embedded conversion features were determined to be liabilities. The change in the determination of the classification from equity to a liability was based on the contractual right granted to the holders of the convertible notes to convert the notes to shares of common stock. Therefore, share settlement is not controlled by the Company. In order to determine the value of the embedded conversion features, the Company followed the guidance of EITF 00-19, paragraph 9, which states that all contracts classified as liabilities are to be measured at fair value at each balance sheet date, with changes in fair value reported in earnings and disclosed in the financial statements as long as the contracts remain classified as liabilities.

The fair value of the embedded beneficial conversion features was recalculated and determined to be $1,430,812 at the date of issuance using the Black Sholes model with the following assumptions: risk free rate of return of 2.02% to 5.09%; volatility of 108.5% to 274.86%; dividend yield of 0% and an expected term of 1 to 1.5 years. Based on the recalculation, the embedded beneficial conversion features discount was $779,300 at September 30, 2007, net of amortization of $651,511, subsequent to the restatement.

The increase in the fair value of $409,242 ($1,430,811-$1,021,569) of the embedded beneficial conversion features was recorded to the beneficial conversion features and netted against convertible notes on the balance sheet. The increase in the amortization of the beneficial conversion features discount of $336,129 ($651,511-$315,382) was recorded to convertible notes.

The fair value of the embedded beneficial conversion features was $1,430,812 as of September 30, 2007, which was calculated using the Black Sholes model with the following assumptions: risk free rate of return of 4.05%; volatility of 126.94%; dividend yield of 0% and an expected term of .58 to 1.25 years.



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Statement of Operations

Prior to the reclassification, the Company applied EITF 00-19, paragraph 9 which states that subsequent changes in fair value of contracts are not to be recognized as long as the contracts continue to be classified as equity. Therefore, the Company did not record changes in the fair value of the beneficial conversion features. Subsequent to reclassifying the beneficial conversion features, the Company again followed the guidance of paragraph 9 of EITF 00-19, which requires all contracts classified as liabilities to be measured at fair value, with changes in fair value reported in earnings as long as the contracts remain classified as liabilities. There was no change in the fair value of the beneficial conversion features from the date of issuance and September 30, 2007.

The increase in the amortization of the beneficial conversion features discount of $336,129 was included in interest expense in the other income (expense) section of the statement of operations.

Statement of Cash Flows

Changes in the statement of cash flows were the result of the change in the amortization of the beneficial conversion features discounts of $336,129 on the statement of operations.

Warrants related to Convertible Debentures

On July 17, 2007 the Company completed an offering of $1,025,000 of Convertible Debentures to a group of institutional and accredited investors which included warrants to purchase 2,795,454 shares of common stock (2,329,546 shares of common stock to holders of the Convertible Debentures and 465,908 shares of common stock as a placement fee) at an exercise price of $0.50 per share.

Balance Sheet

On the grant date, the Company applied SFAS 133, paragraph 6 to determine if the warrants were within the scope and definition of a derivative. The warrants: had one or more underlings and one or more notional amounts, required no initial investment and required or permitted net settlement. Therefore, the warrants were determined to be derivatives. In order to determine the classification of the warrants, the Company followed the guidance of paragraphs 7 and 8 of EITF 00-19, which state that contractswhich require settlement in shares are equity instruments. In order to determine the value of the warrants, the Company followed the guidance of paragraph 9 of EITF 00-19, which states that contracts which require the company to deliver shares as part of a physical settlement or net-share settlement are to be initially measured at fair value. In accordance with EITF 00-19, the warrants were recorded in additional paid-in capital at fair value on the date of issuance.

The fair value of the warrants was calculated as $340,583 ($304,259 attributable to the holders of the Convertible Debentures and $36,324 attributable to the placement fee) at the date of issuance prior to the restatement using the Black Sholes model with the following assumptions: risk free rate of return of 6%; volatility of 122.67% to 195.97%; dividend yield of 0% and an expected term of 5 years.

The Company began the analysis for the restatement by applying SFAS 133, paragraph 6 to ascertain if the warrants issued remained derivatives as of September 30, 2007. All of the criteria in the original analysis were met, and the warrants issued were determined to be within the scope and definition of a derivative. In order to determine the classification of the warrants, the Company followed the guidance of paragraph 19 of EITF 00-19, which states that if a company is required to obtain shareholder approval to increase the companys authorized shares in order to net-share or physically settle a contract, share settlement is not controlled by the company and the contract is required to be classified as a liability. In order to determine the value of the warrants, the Company followed the guidance of paragraph 9 of EITF 00-19, which states that all contracts classified as liabilities are to be measured at fair value at each balance sheet date, with changes in fair value reported in earnings and disclosed in the financial statements as long as the contracts remain classified as liabilities.

Based on the change in the determination of the classification of the warrants, $340,583 was reclassified from additional paid-in capital to warrant liabilities.

The fair value of the warrants was recalculated and was determined to be $554,249 ($430,189 attributable to the holders of the Convertible Debentures and $124,060 attributable to the placement fee) at the date of issuance calculated using the Black Sholes model with the following assumptions: risk free rate of return of 4.96% to 5.02%; volatility of 219.89% to 226.04%; dividend yield of 0% and an expected term of 5 years.



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The increase in the fair value of the warrants attributable to the holders of the Convertible Debentures was $125,930 ($430,189-$304,259) and was recorded to warrant liabilities and netted against convertible notes. The increase in the fair value of the warrants attributable to the placement fee was $87,736 ($124,060-$36,324) and was recorded in warrant liability and general and administrative expenses.

Based on the increase in the warrant discount, the amortization of warrant discount increased by $55,179, and was recorded to convertible notes.

The fair value of the warrants was determined to be $499,932 ($379,672 attributable to the holders of the Convertible Debentures and $120,260 attributable to the placement fee) as of September 30, 2007, which was calculated using the Black Sholes model with the following assumptions: risk free rate of return of 4.05%; volatility of 126.94%; dividend yield of 0%; and an expected term of 4.67 to 4.75 years.

The decrease in the fair value of the warrants was recorded by decreasing warrant liabilities on the balance sheet by $54,317 ($50,518 attributable to the holders of the Convertible Debentures and $3,799 attributable to the placement fee).

Statement of Operations

The Company followed the guidance of EITF 00-19, paragraph 9, which requires all contracts classified as liabilities to be measured at fair value, with changes in fair value reported in earnings as long as the contracts remain classified as liabilities. The change in the fair value of the warrants was $54,317 for the year ended September 30, 2007, and recorded in decrease in warrants in the other income (expense) section of the statement of operations.

The increase in the amortization of the warrant discount of $124,961 is included in interest expense in the other income (expense) section of the statement of operations.

Statement of Cash Flows

Changes in the statement of cash flows were the result of the decrease in the fair value of the warrant liability of $54,317, increase in the amortization of the warrant discount of $55,179 on the balance sheet, and the change in fair value of the warrants at the date of issuance of $87,736 on the statement of operations.

In addition to the analysis of the securities exercisable or convertible into common stock, the Company analyzed the classification of general and administrative expenses for the year ended September 30, 2007, and determined that research and development costs of $526,466, a legal settlement of $89,654 and income tax expense of $2,592 were incorrectly classified as general and administrative expenses.  See below for the specific line items affected in the statement of operations by the reclassification.



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Table 1 shows the effect of each of the changes discussed above on the Companys balance sheet, statement of operation, statement of equity, and statement of cash flows for the year ended September 30, 2007.



Table 1  2007



|                                                                |  |                      |             |                                     |  |            |                             |   |         |                                                   |   |  |                                                                            |         |   |                                                                                 |           |            |                     |         |         |             |   |   |           |          |         |           |             |            |  
|--------------------------------------------------------------- |  | -------------------- | ----------- | ----------------------------------- |  | ---------- | --------------------------- | - | ------- | ------------------------------------------------- | - |  | -------------------------------------------------------------------------- | ------- | - | ------------------------------------------------------------------------------- | --------- | ---------- | ------------------- | ------- | ------- | ----------- | - | - | --------- | -------- | ------- | --------- | ----------- | ---------- | -
|                                                                |  | As
Previously
Stated |             | 2001
Executive
Officers
Option
Plan |  |            | Advisory
Board
Compensation |   |         | Warrants
Related to
2004 Stock
Purchase
Agreement |   |  | Beneficial
Conversion
Features
and
Beneficial
Conversion
Features
Discount |         |   | Warrants
Related to
$1,025,000
of Convertible
Bridge Notes
and
Warrant
Discount |           |            | Reclassifi-
cations |         |         | As
Restated |  
|Balance Sheet                                                   |  |                      |             |                                     |  |            |                             |   |         |                                                   |   |  |                                                                            |         |   |                                                                                 |           |            |                     |         |         |             |  
|Accrued expenses                                                |  | $                    | 1,687,673   |                                     |  |            |                             | $ | 380,441 |                                                   |   |  |                                                                            |         |   |                                                                                 |           |            |                     |         |         |             |   | $ | 2,068,114 |         
|Convertible Notes, net                                          |  |                      | 920,337     |                                     |  |            |                             |   |         |                                                   |   |  |                                                                            |         |   | (73,114                                                                         | )         |            |                     | (70,751 | )       |             |   |   |           |          | 776,472 |          
|Warrant liability                                               |  |                      |           |                                     |  | 1,926,914  |                             |   |         |                                                   |   |  |                                                                            |         |   |                                                                                 |           |            |                     |         | 499,932 |             |   |   |           |          |         | 2,426,846 |            
|Beneficial conversion feature liability                         |  |                      |             |                                     |  |            |                             |   |         | 576,000                                           |   |  |                                                                            |         |   |                                                                                 | 1,430,812 |            |                     |         |         |             |   |   |           |          |         | 2,006,812 |            
|Additional paid-in capital                                      |  |                      | 14,712,527  |                                     |  | (2,271,879 | )                           |   |         | (269,851                                          | ) |  |                                                                            | (45,663 | ) |                                                                                 |           | (1,021,569 | )                   |         |         | (340,583    | ) |   |           |          |         |           | 10,762,982  |           
|Deficit accumulated during development stage                    |  |                      | (17,300,147 | )                                   |  | 344,965    |                             |   |         | (686,590                                          | ) |  |                                                                            | 45,663  |   |                                                                                 |           | (336,129   | )                   |         |         | (88,598     | ) |   |           |          |         |           | (18,020,836 | )         
|                                                                |  |                      |             |                                     |  |            |                             |   |         |                                                   |   |  |                                                                            |         |   |                                                                                 |           |            |                     |         |         |             |   |   |           |          |         |           |             |           
|Statement of Operations (for the year ended September 30, 2007) |  |                      |             |                                     |  |            |                             |   |         |                                                   |   |  |                                                                            |         |   |                                                                                 |           |            |                     |         |         |             |   |   |           |          |         |           |             |           
|General and administrative                                      |  | $                    | 1,423,347   |                                     |  |            |                             |   | $       | 153,354                                           |   |  |                                                                            |         |   |                                                                                 |           |            |                     |         | $       | 87,736      |   |   | $         | (618,712 | )       |           | $           | 1,045,725  |  
|Research and development                                        |  |                      |           |                                     |  |            |                             |   |         |                                                   |   |  |                                                                            |         |   |                                                                                 |           |            |                     |         |         |             |   |   |           | 526,466  |         |           |             | 526,466    |  
|Interest expense                                                |  |                      | (550,935    | )                                   |  |            |                             |   |         |                                                   |   |  |                                                                            |         |   |                                                                                 |           | (336,129   | )                   |         |         | (55,179     | ) |   |           |          |         |           |             | (942,243   | )
|Decrease in warrant liability                                   |  |                      |           |                                     |  | 344,965    |                             |   |         |                                                   |   |  |                                                                            | 70,029  |   |                                                                                 |           |            |                     |         |         | 54,317      |   |   |           |          |         |           |             | 469,311    |  
|Increase in beneficial conversion feature                       |  |                      |             |                                     |  |            |                             |   |         | (4,044                                            | ) |  |                                                                            |         |   |                                                                                 |           |            |                     |         |         |             |   |   |           |          |         |           |             | (4,044     | )
|Legal settlement                                                |  |                      |           |                                     |  |            |                             |   |         |                                                   |   |  |                                                                            |         |   |                                                                                 |           |            |                     |         |         |             |   |   |           | (89,654  | )       |           |             | (89,654    | )
|Income tax expense                                              |  |                      |             |                                     |  |            |                             |   |         |                                                   |   |  |                                                                            |         |   |                                                                                 |           |            |                     |         |         |             |   |   |           | 2,592    |         |           |             | 2,592      |  
|Basic and dilutive loss per share                               |  |                      | 0.02        |                                     |  |            |                             |   |         |                                                   |   |  |                                                                            |         |   |                                                                                 |           |            |                     |         |         |             |   |   |           |          |         |           |             | 0.02       |  
|                                                                |  |                      |             |                                     |  |            |                             |   |         |                                                   |   |  |                                                                            |         |   |                                                                                 |           |            |                     |         |         |             |   |   |           |          |         |           |             |            |  
|Statement of Operations (since inception)                       |  |                      |             |                                     |  |            |                             |   |         |                                                   |   |  |                                                                            |         |   |                                                                                 |           |            |                     |         |         |             |   |   |           |          |         |           |             |            |  
|General and administrative                                      |  | $                    | 13,585,568  |                                     |  |            |                             |   | $       | 250,546                                           |   |  | $                                                                          | 24,367  |   |                                                                                 |           |            |                     |         | $       | 87,736      |   |   | $         | (618,712 | )       |           | $           | 13,329,505 |  
|Research and development                                        |  |                      | 1,449,474   |                                     |  |            |                             |   |         |                                                   |   |  |                                                                            |         |   |                                                                                 |           |            |                     |         |         |             |   |   |           | 526,466  |         |           |             | 1,975,940  |  
|Interest expense                                                |  |                      | (785,621    | )                                   |  |            |                             |   |         |                                                   |   |  |                                                                            |         |   |                                                                                 |           | (336,129   | )                   |         |         | (55,179     | ) |   |           |          |         |           |             | (1,176,929 | )
|Decrease in warrant liability                                   |  |                      |           |                                     |  | 344,965    |                             |   |         |                                                   |   |  |                                                                            | 70,029  |   |                                                                                 |           |            |                     |         |         | 54,317      |   |   |           |          |         |           |             | 469,311    |  
|Increase in beneficial conversion feature                       |  |                      |             |                                     |  |            |                             |   |         | (4,044                                            | ) |  |                                                                            |         |   |                                                                                 |           |            |                     |         |         |             |   |   |           |          |         |           |             | (4,044     | )
|Legal settlement                                                |  |                      | 434,603     |                                     |  |            |                             |   |         |                                                   |   |  |                                                                            |         |   |                                                                                 |           |            |                     |         |         |             |   |   |           | (89,654  | )       |           |             | 344,949    |  
|Income tax expense                                              |  |                      | 9,900       |                                     |  |            |                             |   |         |                                                   |   |  |                                                                            |         |   |                                                                                 |           |            |                     |         |         |             |   |   |           | 2,592    |         |           |             | 12,492     |  







71



---





Table 1  2007 (continued)



|                                                                                      |  |                      |             |                                     |   |          |                             |  |   |                                                   |   |  |                                                                            |         |   |                                                                                 |   |          |                     |  |   |             |   |  |  |          |   |  |   |             |  
|------------------------------------------------------------------------------------- |  | -------------------- | ----------- | ----------------------------------- | - | -------- | --------------------------- |  | - | ------------------------------------------------- | - |  | -------------------------------------------------------------------------- | ------- | - | ------------------------------------------------------------------------------- | - | -------- | ------------------- |  | - | ----------- | - |  |  | -------- | - |  | - | ----------- | -
|                                                                                      |  | As
Previously
Stated |             | 2001
Executive
Officers
Option
Plan |   |          | Advisory
Board
Compensation |  |   | Warrants
Related to
2004 Stock
Purchase
Agreement |   |  | Beneficial
Conversion
Features
and
Beneficial
Conversion
Features
Discount |         |   | Warrants
Related to
$1,025,000
of Convertible
Bridge Notes
and
Warrant
Discount |   |          | Reclassifi-
cations |  |   | As
Restated |  
|Statement of Cash Flows (for the year ended September 30, 2007)                       |  |                      |             |                                     |   |          |                             |  |   |                                                   |   |  |                                                                            |         |   |                                                                                 |   |          |                     |  |   |             |   |  |  |          |   |  |   |             |  
|Net loss                                                                              |  | $                    | (2,001,095  | )                                   | $ | 344,965  |                             |  | $ | (157,398                                          | ) |  | $                                                                          | 70,029  |   |                                                                                 | $ | (336,129 | )                   |  | $ | (88,598     | ) |  |  |          |   |  | $ | (2,168,226  | )
|Other                                                                                 |  |                      |             |                                     |   |          |                             |  |   | (799,044                                          | ) |  |                                                                            |         |   |                                                                                 |   |          |                     |  |   |             |   |  |  |          |   |  |   | (799,044    | )
|Stock based compensation expense- consultant                                          |  |                      | 84,292      |                                     |   |          |                             |  |   |                                                   |   |  |                                                                            |         |   |                                                                                 |   |          |                     |  |   | 124,697     |   |  |  |          |   |  |   | 208,989     |  
|Decrease in warrant liability                                                         |  |                      |           |                                     |   | (344,965 | )                           |  |   |                                                   |   |  |                                                                            | (70,029 | ) |                                                                                 |   |          |                     |  |   | (54,317     | ) |  |  |          |   |  |   | (469,311    | )
|Increase in beneficial conversion feature liaiblity                                   |  |                      |             |                                     |   |          |                             |  |   | 4,044                                             |   |  |                                                                            |         |   |                                                                                 |   |          |                     |  |   |             |   |  |  |          |   |  |   | 4,044       |  
|Accrued expenses                                                                      |  |                      | 566,278     |                                     |   |          |                             |  |   | 895,044                                           |   |  |                                                                            |         |   |                                                                                 |   |          |                     |  |   |             |   |  |  | (15,376  | ) |  |   | 1,445,946   |  
|Accrual of liquidating damages                                                        |  |                      |           |                                     |   |          |                             |  |   |                                                   |   |  |                                                                            |         |   |                                                                                 |   |          |                     |  |   |             |   |  |  | 15,375   |   |  |   | 15,375      |  
|                                                                                      |  |                      |             |                                     |   |          |                             |  |   |                                                   |   |  |                                                                            |         |   |                                                                                 |   |          |                     |  |   |             |   |  |  |          |   |  |   |             |  
|Statement of Cash Flows (since inception)                                             |  |                      |             |                                     |   |          |                             |  |   |                                                   |   |  |                                                                            |         |   |                                                                                 |   |          |                     |  |   |             |   |  |  |          |   |  |   |             |  
|Net loss                                                                              |  | $                    | (17,030,296 | )                                   | $ | 344,965  |                             |  |   | (956,441                                          |   |  |                                                                            | 45,663  |   |                                                                                 |   | (336,129 | )                   |  |   | (88,598     | ) |  |  |          |   |  |   | (18,020,836 | )
|Other                                                                                 |  |                      |             |                                     |   |          |                             |  |   | (799,044                                          | ) |  |                                                                            |         |   |                                                                                 |   |          |                     |  |   |             |   |  |  |          |   |  |   | (799,044    | )
|Stock based compensation expense-consultant                                           |  |                      | 2,840,172   |                                     |   |          |                             |  |   |                                                   |   |  |                                                                            |         |   |                                                                                 |   |          |                     |  |   | 124,697     |   |  |  |          |   |  |   | 2,964,869   |  
|Decrease in warrant liability                                                         |  |                      |           |                                     |   |        |                             |  |   |                                                   |   |  |                                                                            |       |   |                                                                                 |   |          |                     |  |   |           |   |  |  |          |   |  |   |           |  
|Increase in beneficial conversion feature liaiblity                                   |  |                      |             |                                     |   |          |                             |  |   |                                                 |   |  |                                                                            |         |   |                                                                                 |   |          |                     |  |   |             |   |  |  |          |   |  |   |           |  
|Amoritzation of consulting fees                                                       |  |                      | 13,075      |                                     |   |          |                             |  |   |                                                   |   |  |                                                                            |         |   |                                                                                 |   |          |                     |  |   |             |   |  |  | (13,075  | ) |  |   |           |  
|Increase in warranty liability                                                        |  |                      |           |                                     |   | (344,965 | )                           |  |   |                                                 |   |  |                                                                            | (70,029 | ) |                                                                                 |   |          |                     |  |   | (54,317     | ) |  |  |          |   |  |   | (469,311    | )
|Decrease in other assets                                                              |  |                      | 40,370      |                                     |   |          |                             |  |   |                                                   |   |  |                                                                            |         |   |                                                                                 |   |          |                     |  |   |             |   |  |  | (40,370  | ) |  |   |           |  
|Increase in advances to employees                                                     |  |                      | (512,077    | )                                   |   |          |                             |  |   |                                                   |   |  |                                                                            |         |   |                                                                                 |   |          |                     |  |   |             |   |  |  | 512,077  |   |  |   |           |  
|Decrease in other receivables                                                         |  |                      | 3,000       |                                     |   |          |                             |  |   |                                                   |   |  |                                                                            |         |   |                                                                                 |   |          |                     |  |   |             |   |  |  | (3,000   | ) |  |   |           |  
|Increase in deposits                                                                  |  |                      | (104,600    | )                                   |   |          |                             |  |   |                                                   |   |  |                                                                            |         |   |                                                                                 |   |          |                     |  |   |             |   |  |  | 104,600  |   |  |   |           |  
|Other current assets                                                                  |  |                      |           |                                     |   |          |                             |  |   |                                                   |   |  |                                                                            |         |   |                                                                                 |   |          |                     |  |   |             |   |  |  | (1,350   |   |  |   | (1,350      | )
|Other assets                                                                          |  |                      |           |                                     |   |          |                             |  |   |                                                   |   |  |                                                                            |         |   |                                                                                 |   |          |                     |  |   |             |   |  |  | (104,600 |   |  |   | (104,600    | )
|Accrued expenses                                                                      |  |                      | 2,021,239   |                                     |   |          |                             |  |   |                                                   |   |  |                                                                            |         |   |                                                                                 |   |          |                     |  |   |             |   |  |  | (14,427  |   |  |   | 2,006,812   |  
|Accrual of liquidating damages                                                        |  |                      |             |                                     |   |          |                             |  |   |                                                   |   |  |                                                                            |         |   |                                                                                 |   |          |                     |  |   |             |   |  |  | 15,375   |   |  |   | 15,375      |  
|Proceeds from issuance of notes                                                       |  |                      | 2,318,433   |                                     |   |          |                             |  |   |                                                   |   |  |                                                                            |         |   |                                                                                 |   |          |                     |  |   |             |   |  |  | (457,433 |   |  |   | 1,861,000   |  
|Proceeds from notes payable, related                                                  |  |                      |           |                                     |   |          |                             |  |   |                                                   |   |  |                                                                            |         |   |                                                                                 |   |          |                     |  |   |             |   |  |  | 457,433  |   |  |   | 457,433     |  
|Increase in fair value of beneficial conversion features discount at date of issuance |  |                      |             |                                     |   |          |                             |  |   |                                                   |   |  |                                                                            |         |   |                                                                                 |   | 4,044    |                     |  |   |             |   |  |  |          |   |  |   | 4,044       |  
|Issuance of common stock for cash                                                     |  |                      | 7,376,094   |                                     |   |          |                             |  |   |                                                   |   |  |                                                                            |         |   |                                                                                 |   |          |                     |  |   |             |   |  |  | 10,000   |   |  |   | 7,386,094   |  
|Receipt of cash for stock to be issued                                                |  |                      | 53,900      |                                     |   |          |                             |  |   |                                                   |   |  |                                                                            |         |   |                                                                                 |   |          |                     |  |   |             |   |  |  | (10,000  |   |  |   | 43,900      |  



Table 2 - 2006



|                                                                |  |                      |          |                                     |  |  |                             |  |   |                                                   |   |  |                                                                            |  |  |                                                                                 |  |  |                     |  |  |             |  |  |  |  |  |  |   |            |  
|--------------------------------------------------------------- |  | -------------------- | -------- | ----------------------------------- |  |  | --------------------------- |  | - | ------------------------------------------------- | - |  | -------------------------------------------------------------------------- |  |  | ------------------------------------------------------------------------------- |  |  | ------------------- |  |  | ----------- |  |  |  |  |  |  | - | ---------- | -
|                                                                |  | As
Previously
Stated |          | 2001
Executive
Officers
Option
Plan |  |  | Advisory
Board
Compensation |  |   | Warrants
Related to
2004 Stock
Purchase
Agreement |   |  | Beneficial
Conversion
Features
and
Beneficial
Conversion
Features
Discount |  |  | Warrants
Related to
$1,025,000
of Convertible
Bridge Notes
and
Warrant
Discount |  |  | Reclassifi-
cations |  |  | As
Restated | 
|Statement of Operations (for the year ended September 30, 2006) |  |                      |          |                                     |  |  |                             |  |   |                                                   |   |  |                                                                            |  |  |                                                                                 |  |  |                     |  |  |             |  |  |  |  |  |  |   |            |  
|General and administrative                                      |  | $                    | 639,259  |                                     |  |  |                             |  | $ | 274,432                                           |   |  |                                                                            |  |  |                                                                                 |  |  |                     |  |  |             |  |  |  |  |  |  | $ | 913,691    |  
|Basic and dilutive earnings per share                           |  |                      | 0.01     |                                     |  |  |                             |  |   |                                                   |   |  |                                                                            |  |  |                                                                                 |  |  |                     |  |  |             |  |  |  |  |  |  |   | 0.01       |  
|                                                                |  |                      |          |                                     |  |  |                             |  |   |                                                   |   |  |                                                                            |  |  |                                                                                 |  |  |                     |  |  |             |  |  |  |  |  |  |   |            |  
|Statement of Cash Flows (for the year ended September 30, 2006) |  |                      |          |                                     |  |  |                             |  |   |                                                   |   |  |                                                                            |  |  |                                                                                 |  |  |                     |  |  |             |  |  |  |  |  |  |   |            |  
|Net loss                                                        |  | $                    | (774,887 | )                                   |  |  |                             |  | $ | (274,432                                          | ) |  |                                                                            |  |  |                                                                                 |  |  |                     |  |  |             |  |  |  |  |  |  | $ | (1,049,319 | )
|Accrued expenses                                                |  |                      | 554,903  |                                     |  |  |                             |  |   | 274,432                                           |   |  |                                                                            |  |  |                                                                                 |  |  |                     |  |  |             |  |  |  |  |  |  |   | 829,335    |  









72



---





NOTE 17. SUBSEQUENT RESTATEMENT TO PREVIOUS RESTATEMENT

As discussed above in note 16, the Company restated its September 30, 2007 financial statements due to a comment letter received from the Securities and Exchange Commission. However, the restatement did not properly account for certain derivative transactions as discussed below.

The Company issued approximately 25 secured convertible promissory notes between October 17, 2006 and February 27, 2007 for total proceeds to the Company of $750,000 (Convertible Notes 1). Convertible Notes 1 could be converted into shares of the Companys common stock at a conversion price of $0.05 per share. Convertible Notes 1 contained a provision that would automatically adjust the conversion price if equity securities or instruments convertible into equity securities were issued at a conversion price of less than $0.05.

On June 6, 2007, the Company issued 5 convertible promissory notes for a total of $86,000 (Convertible Notes 2). No warrants were issued in connection with Convertible Notes 2. Convertible Notes 2 matures on or about December 31, 2008, and is convertible into common stock at $0.01 per share.

As a result of the issuance of Convertible Notes 2, the conversion price for Convertible Notes 1 was adjusted down from $0.05 to $0.01. The decrease in the conversion price increased the potential dilutive shares from 15,000,000 to 75,000,000, and this subsequently increased the total outstanding and potential dilutive shares over the authorized common share limit of 150,000,000. Because there were insufficient authorized shares to fulfill all potential conversions, the Company should have classified all potentially dilutive securities as derivative liabilities as of June 6, 2007. The Company researched its debt and equity instruments and determined that the potentially dilutive securities are as follows:

·

2001 Executive Officers Stock Option Plan

·

Advisory Board Compensation

·

Warrants Related to 2004 Stock Purchase Agreement

·

Convertible Notes 1

·

Convertible Notes 2

·

Subordinated Convertible Notes 3

·

Warrants related to Subordinated Convertible Notes 3

The Company analyzed the effect of the recalculation on the balance sheet and the statements of operations and cash flows as of June 30, 2007. The analysis and results were as follows:

2001 Executive Officers Stock Option Plan

In October 2000, the Company amended the employment agreements with its executive officers. In conjunction with the amendments, the Company adopted the 2001 Executive Officers Stock Option Plan (Plan). The Plan has reserved 7,576,680 shares of common stock and has issued options for the purchase of 7,034,140 shares of common stock. The options vest over 5 years and expire ten 10 years from the date of issuance.

Balance Sheet

The Company determined that because there were not sufficient authorized shares available, the embedded conversion feature met the definition of a derivative based on Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities, (SFAS 133) as of June 6, 2007.

The Company determined the fair value of the stock options to be $2,454,597 using the Black Sholes model with the following assumptions:

·

risk free rate of return of 5.03%;

·

volatility of 285%;

·

dividend yield of 0%; and

·

expected term of 3.87 years.



73



---





Therefore, at June 6, 2007 the Company recorded on the accompanying balance sheet an accrued liability of $2,454,597 for the fair value of the options and a reduction to additional paid in capital (APIC) of $2,454,597.

The Company followed the guidance of SFAS 133, which requires all contracts classified as liabilities to be measured at fair value with changes in fair value reported in earnings as long as the contracts remain classified as liabilities.

At September 30, 2007, the Company determined the fair value of the options to be $2,240,124 using the Black Sholes model with the following assumptions:

·

risk free rate of return of 4.03%;

·

volatility of 283%;

·

dividend yield of 0%;

·

expected term of 3.56 years.

In order to adjust the liability to the proper balance, the Company recorded an increase in the liability of $130,491 that was recorded as a change in accrued derivative liability in the accompanying statement of operations.

Statement of Operations

At September 30, 2007, the Company recorded $130,491 as a change in accrued derivative liability in the accompanying statement of operations.

Statement of Cash Flows

Changes in the statement of cash flows were the result of the change in fair value of the liability of $130,491.

Advisory Board Compensation

On October 1, 2004, the Company formed an advisory board consisting of four members. In exchange for their services, each member was to receive $5,000 monthly from October 1, 2004 to February 22, 2007, for a total of $576,000 to be paid to all members. Each member, in his sole discretion, was entitled to convert some or all of the cash amount owed to him into shares of common stock at a rate of $0.05 per share. If all of the members of the advisory board converted the total amount of cash compensation due to them into shares of common stock, the Company would be required to issue 11,520,000 shares. The Company determined that the accrued expense, embedded beneficial conversion features, embedded beneficial conversion feature discount, and related amortization expense were not recorded at the date of issuance or prior to the restatement. No payments have been made to any advisory board members and there has been no conversion by any advisory board members of the accrued liability into shares of common stock.

Balance Sheet

The Company determined that because there were not sufficient authorized shares available that the embedded conversion feature met the definition of a derivative based on SFAS 133 as of June 6, 2007.

The Company determined the fair value of the embedded conversion feature to be $3,614,932 using the Black Sholes model with the following assumptions:

·

risk free rate of return of 4.99%;

·

volatility between 186% and 277%;

·

dividend yield of 0%; and

·

an expected term of 0.52 years to 1.30 years.

Therefore, at June 6, 2007, the Company recorded on the accompanying balance sheet an accrued liability of $576,000 for the accrued compensation and an embedded conversion derivative liability of $3,614,932.



74



---





The Company followed the guidance of SFAS 133, which requires all contracts classified as liabilities to be measured at fair value, with changes in fair value reported in earnings as long as the contracts remain classified as liabilities.

At September 30, 2007, the Company determined the fair value of the embedded conversion feature to be $3,128,617 using the Black Sholes model with the following assumptions:

·

risk free rate of return of 4.09%;

·

volatility of 121%;

·

dividend yield of 0%; and

·

expected term of 0.20 years to 0.98 years.

Statement of Operations

The Company recorded an adjustment of $4,037,578 to compensation expense, which is the accrued advisory board compensation related to the fiscal year ended September 30, 2007 plus the fair value of the embedded derivative.

At September 30, 2007, the Company recorded $1,289,402 as a gain on change in fair value of the beneficial conversion option in the accompanying statement of operations.

Statement of Cash Flows

Changes in the statement of cash flows were the result of the advisory board compensation accrued expense of $576,000, additional compensation expense for beneficial conversion features liability of $3,461,578 (total compensation expense of $4,037,578 less $576,000 that is shown as a change in accrued expenses), and a decrease in fair value of beneficial conversion liability of $1,289,402.

Warrants Related to 2004 Stock Purchase Agreement

Under the terms of a 2004 Stock Purchase Agreement, the Company issued warrants to purchase 1,463,336 shares of common stock at an exercise price of $0.03, which expired between February 9, 2007 and August 25, 2007. The Company determined that the warrants and related expense were not recorded at the date of issuance or prior to the restatement and there has been no exercise of the warrants into shares of common stock. As of September 30, 2007, all of the warrants had expired.

Convertible Notes 1

As of June 6, 2007, the Company had Convertible Notes 1 outstanding totaling $750,000 that were issued between October 17, 2006 and February 27, 2007. Convertible Notes 1 included an embedded beneficial conversion feature that allowed the holders to convert the Convertible Notes 1 into common stock at an initial rate of $0.05. Convertible Notes 1 matures between April 2008 and December 2008, accrues interest at 10%, and any accrued but unpaid interest is also convertible into common stock at $0.05. Because of the price protection offered holders of Convertible Notes 1 and the subsequent issuance of Convertible Notes 2, the conversion price was decreased from $0.05 to $0.01.

Balance Sheet

The Company determined that because there were not sufficient authorized shares available that the embedded conversion feature met the definition of a derivative based on SFAS 133 as of June 6, 2007.

The Company determined the fair value of the embedded conversion feature to be $27,057,645 using the Black Sholes model with the following assumptions:

·

risk free rate of return of 4.99%;

·

volatility between 186% and 277%;

·

dividend yield of 0%; and

·

expected term of 0.87 years to 1.23 years.



75



---





Therefore, at June 6, 2007, the Company recorded on the accompanying balance sheet an accrued embedded conversion derivative liability of $27,057,645, a reduction to additional paid in capital of $619,513 (the amount that had been previously recorded to APIC) and financing costs of $26,438,132.

At September 30, 2007, the Company determined the fair value of the embedded conversion feature to be $25,292,237 using the Black Sholes model with the following assumptions:

·

risk free rate of return of 4.09%;

·

volatility of189%;

·

dividend yield of 0%; and

·

expected term of 0.55 years to 0.91 years.

Statement of Operations

The Company recorded the $26,438,132 as interest and financing costs and recorded the decrease of $2,576,707 as a gain on change in fair value of beneficial conversion liability in the accompanying statement of operations.

Statement of Cash Flows

Changes in the statement of cash flows were the result of the non-cash financing charge of $26,438,132 and the $2,576,707 decrease in fair value of beneficial conversion option.

Convertible Notes 2

On June 6, 2007, the Company issued5 convertible promissory notes for a total of $86,000. No warrants were issued in connection with Convertible Notes 2. The Convertible Notes 2 matures on or about December 31, 2008, accrues interest at 10% and are convertible at $0.01.

Balance Sheet

The Company determined that because there were not sufficient authorized shares available that the embedded conversion feature met the definition of a derivative based on SFAS 133 as of June 6, 2007.

The Company determined the fair value of the embedded conversion feature to be $2,982,540 using the Black Sholes model with the following assumptions:

·

risk free rate of return of 4.99%;

·

volatility of 277%;

·

dividend yield of 0%; and

·

expected term of 1.57 years.

Therefore, at June 6, 2007, the Company recorded on the accompanying balance sheet an accrued embedded conversion derivative liability of $2,982,540 and financing costs of $2,982,540.

At September 30, 2007, the Company determined the fair value of the embedded conversion feature to be $2,787,690 using the Black Sholes model with the following assumptions:

·

risk free rate of return of 4.05%;

·

volatility of 241%;

·

dividend yield of 0%; and

·

expected term of 1.25 years.

Statement of Operations

The Company recorded the $2,982,540 as interest and financing costs and the decrease of $194,850 as a gain on change in fair value of beneficial conversion liability in the accompanying statement of operations.



76



---





Statement of Cash Flows

Changes in the statement of cash flows were the result of the non-cash financing charge of $2,982,540 and the $194,850 decrease in fair value of beneficial conversion option.

Subordinated Convertible Notes 3

From June 21, 2007 through July 17, 2007, the Company issued 11 subordinated convertible promissory notes (Subordinated Convertible Notes 3) for a total of $1,025,000. The Company issued to the investors 2,329,546 five year warrants with an exercise price of $0.50. In addition, the Company issued 465,908 warrants as a placement fee, which have the same terms as the warrants issued to the investors. The Subordinated Convertible Notes 3 mature one year from date of issuance, accrue interest at 8% and are convertible at $0.22.

Balance Sheet

The Company determined that because there were not sufficient authorized shares available that the embedded conversion feature met the definition of a derivative based on SFAS 133 as of June 6, 2007.

The Company determined the fair value of the embedded conversion feature to be $1,116,030 using the Black Sholes model with the following assumptions:

·

risk free rate of return between 4.96% and 5%;

·

volatility between 196% and 198%;

·

dividend yield of 0%; and

·

expected term of 1 year.

Therefore, the Company recorded on the accompanying balance sheet an accrued embedded conversion derivative liability of $1,116,030 and financing costs of $1,116,030.

At September 30, 2007, the Company determined the fair value of the embedded conversion features to be $1,008,368 using the Black Sholes model with the following assumptions:

·

risk free rate of return of 4.09%;

·

volatility of 189%;

·

dividend yield of 0%; and

·

expected term between 0.72 years and 0.80 years.

Statement of Operations

The Company recorded the $1,116,030 as financing costs and recorded the decrease of $107,662 as a gain on change in fair value of beneficial conversion liability in the accompanying statement of operations.

Statement of Cash Flows

Changes in the statement of cash flows were the result of the non-cash financing charge of $1,116,030 and the decrease in fair value of beneficial conversion option of $107,662.

Warrants related to Subordinated Convertible Notes 3

Pursuant to the Subordinated Convertible Notes 3 issued during June and July 2007, the Company issued to the investors 2,329,546 five year warrants with an exercise price of $0.50. In addition, the Company issued 465,908 warrants as a placementfee, which have the same terms as the warrants issued to the investors.

Balance Sheet

The Company determined that because there were not sufficient authorized shares available that the warrants met the definition of a derivative based on SFAS 133 as of June 6, 2007.



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The Company calculated the fair value of the 2,795,454 warrants to be $897,793 using the Black Sholes model with the following assumptions:

·

risk free rate of return between 5.00% and 5.06%;

·

volatility between 265% and 266%;

·

dividend yield of 0%; and

·

expected term of 5 years.

The Company recorded an accrued warrant derivative liability of $897,793 and interest and financing costs of $897,793.

The Company followed the guidance of SFAS 133, which requires all contracts classified as liabilities to be measured at fair value, with changes in fair value reported in earnings as long as the contracts remain classified as liabilities.

At September 30, 2007, the Company determined the fair value of the warrant liability to be $890,607 using the Black Sholes model with the following assumptions:

·

risk free rate of return of 4.23%;

·

volatility of 265%;

·

dividend yield of 0% and

·

expected term between 4.73 and 4.80 years.

Statement of Operations

The Company recorded as financing costs the $897,793 and recorded the increase of $10,347 as a loss on change in fair value of beneficial conversion liability in the accompanying statement of operations.

Statement of Cash Flows

Changes in the statement of cash flows were the result of the non-cash financing charge of $897,793 and a change in the warrant and option liability of $10,347.

The following table shows the effect of each of the changes discussed above on the Companys balance sheet, statement of operation, and statement of cash flows for the year ended September 30, 2007.



78



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|                                                                       |  |   |                      |   |   |                                |   |   |                       |   |   |                            |  
|---------------------------------------------------------------------- |  | - | -------------------- | - | - | ------------------------------ | - | - | --------------------- | - | - | -------------------------- | -
|                                                                       |  |   | As
Previously
Stated |   |   | Benficial
Conversion 
Features |   |   | Warrants
and
 Options |   |   | As Restated
June 30,
 2007 |  
|Balance Sheet                                                          |  |   |                      |   |   |                                |   |   |                       |   |   |                            |  
|Accrued expenses                                                       |  | $ | 2,068,114            |   | $ | 195,559                        |   | $ |                     |   | $ | 2,263,673                  |  
|Warrant and option liability                                           |  |   | 2,426,846            |   |   |                              |   |   | 703,885               |   |   | 3,130,731                  |  
|Beneficial conversion liability                                        |  |   | 2,006,812            |   |   | 30,210,100                     |   |   |                     |   |   | 32,216,912                 |  
|Additional paid-in capital                                             |  |   | 10,762,982           |   |   |                              |   |   | 334,746               |   |   | 11,097,728                 |  
|Deficit accumulated during developmental stage                         |  |   | (18,020,836          | ) |   | (30,405,659                    | ) |   | (1,038,631            | ) |   | (49,465,126                | )
|                                                                       |  |   |                      |   |   |                                |   |   |                       |   |   |                            |  
|Statement of Operations (for the year ended September 30, 2007)        |  |   |                      |   |   |                                |   |   |                       |   |   |                            |  
|Gain (loss) on change in fair value of warrant and option liability    |  | $ | 469,311              |   | $ |                              |   | $ | (140,838              | ) | $ | 328,473                    |  
|Gain (loss) on change in fair value of beneficial conversion liability |  |   | (4,044               | ) |   | 4,168,621                      |   |   |                     |   |   | 4,164,577                  |  
|General and administrative                                             |  |   | 1,045,725            |   |   | 4,037,578                      |   |   |                     |   |   | 5,083,303                  |  
|Interest and financing costs                                           |  |   | (942,243             | ) |   | (30,536,702                    | ) |   | (897,793              | ) |   | (32,376,738                | )
|                                                                       |  |   |                      |   |   |                                |   |   |                       |   |   |                            |  
|Statement of Operations (since inception)                              |  |   |                      |   |   |                                |   |   |                       |   |   |                            |  
|Gain (loss) on change in fair value of warrant and option liability    |  | $ | 469,311              |   | $ |                              |   | $ | (140,838              | ) | $ | 328,473                    |  
|Gain (loss) on change in fair value of beneficial conversion liability |  |   | (4,044               | ) |   | 3,918,075                      |   |   |                     |   |   | 3,914,031                  |  
|General and administrative                                             |  |   | 13,329,505           |   |   | 3,787,032                      |   |   |                     |   |   | 17,116,537                 |  
|Interest and financing costs                                           |  |   | (1,176,929           | ) |   | (30,536,702                    | ) |   | (897,793              | ) |   | (32,611,424                | )
|                                                                       |  |   |                      |   |   |                                |   |   |                       |   |   |                            |  
|Statement of Cash Flows (for the year ended September 30, 2007)        |  |   |                      |   |   |                                |   |   |                       |   |   |                            |  
|Net loss                                                               |  | $ | (2,168,226           | ) | $ | (30,405,659                    | ) | $ | (1,038,631            | ) | $ | (33,612,516                | )
|(Gain) loss on change in fair value of warrant and option liability    |  |   | (469,311             | ) |   |                              |   |   | 140,838               |   |   | (328,473                   | )
|(Gain) loss on change in fair value of beneficial conversion liability |  |   | 4,044                |   |   | (4,168,621                     | ) |   |                     |   |   | (4,164,577                 | )
|Change in accrued expenses                                             |  |   | 1,445,946            |   |   | 576,000                        |   |   |                     |   |   | 2,021,946                  |  
|Non-cash compensation expense                                          |  |   |                    |   |   | 3,461,578                      |   |   |                     |   |   | 3,461,578                  |  
|Non-cash financing costs                                               |  |   |                    |   |   | 30,536,702                     |   |   | 897,793               |   |   | 31,434,495                 |  
|                                                                       |  |   |                      |   |   |                                |   |   |                       |   |   |                            |  
|Statement of Cash Flows (since inception)                              |  |   |                      |   |   |                                |   |   |                       |   |   |                            |  
|Net loss                                                               |  | $ | (18,020,836          | ) | $ | (30,405,659                    | ) | $ | (1,038,631            | ) | $ | (49,465,126                | )
|(Gain) loss on change in fair value of warrant and option liability    |  |   | (469,311             | ) |   |                              |   |   | 140,838               |   |   | (328,473                   | )
|(Gain) loss on change in fair value of beneficial conversion liability |  |   | 4,044                |   |   | (4,168,621                     | ) |   |                     |   |   | (4,164,577                 | )
|Change in accrued expenses                                             |  |   | 2,006,812            |   |   | 576,000                        |   |   |                     |   |   | 2,582,812                  |  
|Non-cash compensation expense                                          |  |   |                    |   |   | 3,461,578                      |   |   |                     |   |   | 3,461,578                  |  
|Non-cash financing costs                                               |  |   |                    |   |   | 30,536,702                     |   |   | 897,793               |   |   | 31,434,495                 |  



ITEM 8

CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

None

ITEM 8A

CONTROLS AND PROCEDURES

Regulations under the Securities Exchange Act of 1934 require public companies to maintain disclosure controls and procedures, which are defined to mean a companys controls and other procedures that are designed to ensure that information required to be disclosed in the reports that it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported, within the time periods specified in the Commissions rules and forms.

We conducted an evaluation, with the participation of our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended, or the Exchange Act, as of September 30, 2007, to ensure that information required to be disclosed by us in the reports filed or submitted by us under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities Exchange Commissions rules and forms, including to ensure that information required to be disclosed by us in the reports filed or submitted by us under the Exchange Act is accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure. Based on that evaluation, our Chief



79



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Executive Officer and Chief Financial Officer have concluded that as of September 30, 2007, our disclosure controls and procedures were not effective at the reasonable assurance level due to the material weaknesses described below.

In light of the material weaknesses described below, we performed additional analysis and other post-closing procedures to ensure our financial statements were prepared in accordance with generally accepted accounting principles. We have determined that our financial statements for the annual period ended September 30, 2007 could no longer be relied upon and, as described in Notes 16 and 17 to the restated financial statements, have restated our financial position as of September 30, 2007 and results of operations, changes in stockholders equity and cash flows for the year ended September 30, 2007 and the cumulative period from October 3, 1994 (inception) to September 30, 2007.

A material weakness is a control deficiency (within the meaning of the Public Company Accounting Oversight Board (PCAOB) Auditing Standard No. 5) or combination of control deficiencies, that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected. Management has identified the following three material weaknesses which have caused management to conclude that, as of September 30, 2007, our disclosure controls and procedures were not effective at the reasonable assurance level:

1.

We do not have written documentation of our internal control policies and procedures. Written documentation of key internal controls over financial reporting is a requirement of Section 404 of the Sarbanes-Oxley Act and will be applicable to us for the year ending December 31, 2009. Management evaluated the impact of our failure to have written documentation of our internal controls and procedures on our assessment of our disclosure controls and procedures and has concluded that the control deficiency that resulted represented a material weakness.

2.

We do not have sufficient segregation of duties within accounting functions, which is a basic internal control. Due to our size and nature, segregation of all conflicting duties may not always be possible and may not be economically feasible. However, to the extent possible, the initiation of transactions, the custody of assets and the recording of transactions should be performed by separate individuals. Management evaluated the impact of our failure to have segregation of duties on our assessment of our disclosure controls and procedures and has concluded that the control deficiency that resulted represented a material weakness.

3.

We have had, and continue to have, a significant number of audit adjustments. Audit adjustments are the result of a failure of the internal controls to prevent or detect misstatements of accounting information. We believe this failure is related to our lack of a sufficient number of internal personnel possessing the appropriate knowledge, experience and training in applying US GAAP and in reporting financial information in accordance with the requirements of the SEC and our lack of an audit committee to oversee our accounting and financial reporting processes. Management evaluated the impact of our significant number of audit adjustments and has concluded that the control deficiency that resulted represented a material weakness.

To address these material weaknesses, management performed additional analyses and other procedures to ensure that the financial statements included herein fairly present, in all material respects, our financial position, results of operations and cash flows for the periods presented.

Remediation of Material Weaknesses

We have attempted to remediate the material weaknesses in our disclosure controls and procedures identified above by working with our independent registered public accounting firm and by hiring consultants and employees who are experienced in financial accounting and reporting. We are continuing to redesign poorly conceived accounting systems.

Changes in Internal Control over Financial Reporting

During the last fiscal quarter, the Company has not made any change to internal control over financial reporting that has materially affected, or is reasonably likely to materially affect, the Companys internal control over financial reporting.

ITEM 8B

OTHER INFORMATION

None



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PART III

ITEM 9

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

Set forth below is certain information regarding our directors, executive officers and key personnel.

|                    |     |                                      |               
|------------------- | --- | ------------------------------------ | --------------
|Name                | Age | Position                             | Director Since
|                    |     |                                      |               
|Dr. John H. Foster  | 60  | Chairman of the Board of Directors   | 2007          
|                    |     |                                      |               
|Richard H. Papalian | 52  | Chief Executive Officer and Director | 2007          
|                    |     |                                      |               
|James J. Houtz      | 69  | President and Director               | 1998          
|                    |     |                                      |               
|Robert E. McCray    | 72  | Chief Financial Officer and Director | 1998          
|                    |     |                                      |               
|Rodney Anderson     | 81  | Director                             | 2001          
|                    |     |                                      |               
|David Ross          | 69  | Director                             | 2007          
|                    |     |                                      |               
|Dr W. Richard Laton | 43  | Director                             | 2007          
|                    |     |                                      |               
|Mark S. Maron       | 51  | Special Advisor                      | N/A           



Dr. Foster has been a consultant to Sionix since early 2004, and has served as Chairman of the Board of Directors since 2007. He is a Professor at California State University, Fullerton where he has taught for over 15 years. Prior to teaching he was employed as a senior geologist for the Irvine Consulting Group and Schaefer Dixon Associates, where he supervised the environmental division.

Mr. Papalian became Chief Executive Officer in December 2007. He founded Papalian Capital Partners, Inc., a real estate investment and development firm, in January 2007 and has served as its CEO since then. Prior to founding Papalian Capital Partners, Mr. Papalian was Co-President and COO of JRK Asset Management Inc., a privately held owner and operator of hotels and multi-family housing complexes throughout the United States. Prior to joining JRK, Mr. Papalian was COO and co-founder of Waybid Technologies LLC, a business-to-business Internet multi-listing service that utilized dynamic pricing models to optimize pricing for its clients. Previously, from 1977 to 1994, Mr. Papalian was founder CEO of The Promotion Agency, Inc., a marketing consulting/sales promotion agency with international clients.

Mr. Houtz has been President and a director of the Company since March 1998.

Mr. McCray has been Chief Financial Officer and a director of the Company since July 1998.

Mr. Anderson was President of R.J. Metal Products, Anaheim, California, a high technology research and development machine shop operation focused on commercial and military aircraft and aerospace projects, for more than 20 years. Sionix acquired RJ Metal Products in November of 2007. He has served on the Company's Board of Directors since 2001.

Mr. Ross has consulted with the Company since 2004, and has served on the Board of Directors since 2007. He is a principal of Ross/Katagiri and Associates, a management consulting practice, specializing in early stage technology-driven organizations. He is a board member and former chairman of the Orange County Taxpayers Association, a member of the Water Advisory Committee of Orange County, a former member of the Orange County Sanitation District Bio-solids Advisory Committee and sits on the boards of several Orange County charitable organizations. He is a graduate of the University of Colorado with a B. S. in Finance and brings over 40 years of widely diversified national and international business experience.

Dr. Laton has served on the Board of Directors since 2007. He brings over 15 years of water related experience, including consulting, sales and education. Dr. Laton is an Associate Professor of Hydrogeology at California State University, Fullerton. He has served as a director of the National Ground Water Association and has published, presented and taught water- related research throughout the world.

Mr. Maron was appointed as Special Advisor to the Board of Directors in December of 2007. He is a principal with



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Birchmont Capital Advisors, LLC, a real estate private equity firm founded in September 2005. Prior to joining Birchmont, Mr. Maron served as a Managing Director of investment banking in the Los Angeles office of Lehman Brothers, Inc. from 2000 to 2005. Previously, Mr. Maron was with Credit Suisse First Boston Corporation from 1983 to 2000 where he was responsible for managing the firm's western region investment banking effort and coverage of CSFB's financial institution clients in the western United States. Mr. Maron is a member of the Board of Directors of True Religion Apparel, Inc., a company whose securities are traded on Nasdaq.

Directors serve for one year and until their successors are duly elected and qualified. The Company has not established an executive committee of the Board of Directors or any committee that would serve similar functions such as an audit, incentive compensation or nominating committee.

SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE

Section 16(a) of the Securities Exchange Act of 1934, as amended, and the rules thereunder require the Companys officers and directors, and persons who own more than 10% of a registered class of the Companys equity securities, to file reports of ownership and changes in ownership with the Securities and Exchange Commission and to furnish the Company with copies. Based solely on its review of the copies of the Section 16(a) forms received by it, or written representations from certain reporting persons, the Company believes that, during the last fiscal year, all Section 16(a) filing requirements applicable to its officers, directors and greater than 10% beneficial owners were complied with.

ITEM 10

EXECUTIVE COMPENSATION.

Summary Compensation Table

The following table sets forth the information required by Securities and Exchange Commission Regulation S-B Item 402 as to the compensation paid or accrued by us for the years ended September 30, 2007 and 2006 for services rendered in all capacities, by all persons who served as our Chief Executive Officer or Chief Financial Officer and the other most highly compensated executive officer during the fiscal year ended September 30, 2007 (the Named Executive Officers).

|                                             |  |                          |         |  |                                          |   |         |                            |  |   |         |  |  |      |         |  |      |   |        |      |  |   |        |  |  |   |         |  |  |   |         | 
|-------------------------------------------- |  | ------------------------ | ------- |  | ---------------------------------------- | - | ------- | -------------------------- |  | - | ------- |  |  | ---- | ------- |  | ---- | - | ------ | ---- |  | - | ------ |  |  | - | ------- |  |  | - | ------- | 
|Name                                         |  | James J. Houtz
President |         |  | Robert E. McCray
Chief Financial Officer |   |         | Joan C. Horowitz
Secretary |  |   | Total   | 
|Fiscal Year                                  |  | 2007                     |         |  | 2006                                     |   |         | 2007                       |  |   | 2006    |  |  | 2007 |         |  | 2006 |   |        | 2007 |  |   | 2006   | 
|Salary (1)                                   |  | $                        | 172,446 |  |                                          | $ | 159,673 |                            |  | $ | 151,200 |  |  | $    | 144,000 |  |      | $ | 36,867 |      |  | $ | 34,136 |  |  | $ | 360,623 |  |  | $ | 337,809 | 
|Bonus                                        |  |                          |       |  |                                          |   |         |                            |  |   |         |  |  |      |         |  |      |   |      |      |  |   |      |  |  |   |       |  |  |   |       | 
|Stock Awards                                 |  |                          |       |  |                                          |   |         |                            |  |   |         |  |  |      |         |  |      |   |      |      |  |   |      |  |  |   |       |  |  |   |       | 
|Option Awards                                |  |                          |       |  |                                          |   |         |                            |  |   |         |  |  |      |         |  |      |   |      |      |  |   |      |  |  |   |       |  |  |   |       | 
|Non-Equity Incentive Plan Compensation       |  |                          |       |  |                                          |   |         |                            |  |   |         |  |  |      |         |  |      |   |      |      |  |   |      |  |  |   |       |  |  |   |       | 
|Non-Qualified Deferred Compensation Earnings |  |                          |       |  |                                          |   |         |                            |  |   |         |  |  |      |         |  |      |   |      |      |  |   |      |  |  |   |       |  |  |   |       | 
|All Other Compensation                       |  |                          | 20,582  |  |                                          |   | 18,711  |                            |  |   | 15,000  |  |  |      | 7,200   |  |      |   |      |      |  |   |      |  |  |   | 35,582  |  |  |   | 25,911  | 
|Total                                        |  | $                        | 193,028 |  |                                          | $ | 178,384 |                            |  | $ | 166,200 |  |  | $    | 151,200 |  |      | $ | 36,867 |      |  | $ | 34,136 |  |  | $ | 396,205 |  |  | $ | 363,720 | 



(1)

All amounts shown represent accrued salary. None of the amounts shown have been paid.



The following table sets forth certain information as of September 30, 2007 with respect to options held by the Named Executive Officers. The Company has no outstanding stock appreciation rights, either freestanding or in tandem with options. No options were issued during the past fiscal year.





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Outstanding Equity Awards at Fiscal Year-End



The following table sets forth for each named executive officer certain information concerning the outstanding equity awards as of September 30, 2007.



|                                                                                                                       |  |                |           |  |                  |   |         |                  |  |   |         |  |  |   |           | 
|---------------------------------------------------------------------------------------------------------------------- |  | -------------- | --------- |  | ---------------- | - | ------- | ---------------- |  | - | ------- |  |  | - | --------- | 
|Name                                                                                                                   |  | James J. Houtz |           |  | Robert E. McCray |   |         | Joan C. Horowitz |  |   | Total   | 
|Option Awards:                                                                                                         |  |                |           |  |                  |   |         |                  |  |   |         | 
|Number of Securities Underlying Unexercised Options Exercisable                                                        |  |                | 6,171,000 |  |                  |   | 583,200 |                  |  |   | 279,940 |  |  |   | 7,034,140 | 
|Number of Securities Underlying Unexercised Options Unexercisable                                                      |  |                |         |  |                  |   |       |                  |  |   |       |  |  |   |         | 
|Equity Incentive Plan Awards; Number of Securities Underlying Unexercised Unearned Options                             |  |                |         |  |                  |   |       |                  |  |   |       |  |  |   |         | 
|Option Exercise Price                                                                                                  |  | $              | 0.15      |  |                  | $ | 0.15    |                  |  | $ | 0.15    |  |  | $ | 0.15      | 
|Option Expiration Date                                                                                                 |  | April 20, 2011 |          
|Stock Awards:                                                                                                          |  |                |           |  |                  |   |         |                  |  |   |         |  |  |   |           | 
|Number of Shares, or Units of Stock that have not Vested                                                               |  |                |         |  |                  |   |       |                  |  |   |       |  |  |   |         | 
|Market Value of Shares or Units of Stock that have not Vested                                                          |  |                |         |  |                  |   |       |                  |  |   |       |  |  |   |         | 
|Equity Incentive Plan Awards: Number of Unearned Shares, or Units or Other Rights that have not Vested                 |  |                |         |  |                  |   |       |                  |  |   |       |  |  |   |         | 
|Equity Incentive Plan Awards: Market or Payout Value of Unearned Shares, or Units or Other Rights that have not Vested |  |                |         |  |                  |   |       |                  |  |   |       |  |  |   |         | 



Compensation of Directors

No director received any compensation during the fiscal year, except for consulting fees of $15,000 paid to Dr. W. Richard Laton for hydrogeology consulting.

ITEM 11.

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

The following table sets forth certain information regarding the beneficial ownership of our common stock as of September 30, 2007. The table sets forth the beneficial ownership of each person who, to our knowledge, beneficially owns more than 5% of the outstanding shares of common stock, each of our directors and executive officers, and all of our directors and executive officers as a group.



|                                                      |  |                                                   |  |                  |           |  |            |  |     |  
|----------------------------------------------------- |  | ------------------------------------------------- |  | ---------------- | --------- |  | ---------- |  | --- | -
|Name                                                  |  | Address                                           |  | Number of
Shares |           |  | Percentage | 
|E. David Kailbourne                                   |  | 3830 Hillcrest Drive, Brighton, MI 48116          |  |                  | 8,473,044 |  |            |  | 5.6 | %
|                                                      |  |                                                   |  |                  |           |  |            |  |     |  
|Calico Capital Management (2)                         |  | 767 3rdAvenue, 38thFloor, New York, NY 10017      |  |                  | 8,233,025 |  |            |  | 5.4 | %
|                                                      |  |                                                   |  |                  |           |  |            |  |     |  
|James J. Houtz (1)                                    |  | 2082 Michelson Drive, Suite 306, Irvine, CA 92612 |  |                  | 6,268,167 |  |            |  | 4.1 | %
|                                                      |  |                                                   |  |                  |           |  |            |  |     |  
|Robert E. McCray * (1)                                |  | 2082 Michelson Drive, Suite 306, Irvine, CA 92612 |  |                  | 933,200   |  |            |  | 0.6 | %
|                                                      |  |                                                   |  |                  |           |  |            |  |     |  
|Joan C. Horowitz *                                    |  | 2082 Michelson Drive, Suite 306, Irvine, CA 92612 |  |                  | 346,607   |  |            |  | 0.2 | %
|                                                      |  |                                                   |  |                  |           |  |            |  |     |  
|Rodney Anderson *                                     |  | 2082 Michelson Drive, Suite 306, Irvine, CA 92612 |  |                  | 300,901   |  |            |  | 0.2 | %
|                                                      |  |                                                   |  |                  |           |  |            |  |     |  
|Dr. John H. Foster *                                  |  | 2082 Michelson Drive, Suite 306, Irvine, CA 92612 |  |                  | 150,000   |  |            |  | 0.1 | %
|                                                      |  |                                                   |  |                  |           |  |            |  |     |  
|David Ross *                                          |  | 2082 Michelson Drive, Suite 306, Irvine, CA 92612 |  |                  | 115,000   |  |            |  | 0.1 | %
|                                                      |  |                                                   |  |                  |           |  |            |  |     |  
|Dr. W. Richard Laton *                                |  | 2082 Michelson Drive, Suite 306, Irvine, CA 92612 |  |                  | 50,000    |  |            |  | 0.0 | %
|                                                      |  |                                                   |  |                  |           |  |            |  |     |  
|All Directors and Officers as a Group [6 Persons] (1) |  |                                                   |  |                  | 8,162,974 |  |            |  | 5.4 | %





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

* Less than 1%

(1)

Consists principally of shares issuable upon exercise of currently exercisable options.

(2)

A majority of shares issuable upon conversion convertible notes payable.

Beneficial ownership percentages are calculated based on common stock issued and outstanding as of September 30, 2007. Beneficial ownership is determined in accordance with Rule 13d-3 of the Exchange Act. The number of shares beneficially owned by a person includes shares of common stock underlying options or warrants held by that person that are currently exercisable or exercisable within 60 days of September 30, 2007. The shares issuable pursuant to the exercise of those options or warrants are deemed outstanding for computing the percentage ownership of the person holding those options and warrants but are not deemed outstanding for the purposes of computing the percentage ownership of any other person. The persons and entities named in the table have sole voting and sole investment power with respect to the shares set forth opposite that persons name, subject to community property laws, where applicable, unless otherwise noted in the applicable footnote.

ITEM 12

CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE.

None.

ITEM 13

EXHIBITS

The following exhibits are filed herewith or incorporated by reference:

|      |  |                                                                                                                  
|----- |  | -----------------------------------------------------------------------------------------------------------------
|No.   |  | Description                                                                                                      
|3.1   |  | Amended and Restated Articles of Incorporation of the Company (1)                                                
|3.2   |  | Amended and Restated Bylaws of the Company (1)                                                                   
|10.1  |  | Lease between the Company and J. C. Brown Enterprises, dated February 19, 2007 (2)                               
|10.2  |  | Employment Agreement, dated September 30, 2003, between the Registrant and James J. Houtz (2)                    
|10.3  |  | Employment Agreement, dated October 1, 2005 between the Registrant and Robert E. McCray (2)                      
|10.4  |  | Form of Securities Purchase Agreement, dated as of June 18, 2007, between the Company and certain investors (3)  
|10.5  |  | Form of Convertible Debenture, dated as of June 18, 2007, issued by the Company to certain investors. (3)        
|10.6  |  | Form of Registration Rights Agreement, dated as of June 18, 2007, between the Company and certain investors (3). 
|10.7  |  | Form of Warrant, dated as of June 18, 2007, issued by Sionix Corporation to certain investors. (3)               
|10.8  |  | Lease between the Company and  Klein Investments Family Limited Partnership, dated August 30, 2007 (4)           
|10.9  |  | Share Exchange Agreement, dated November 7, 2007, between the Company and the shareholders of RJ Metals, Inc. (4)
|10.10 |  | Employment Agreement, dated  December 19, 2007 between the Registrant and Richard H. Papalian (5)                
|31.1  |  | Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.              
|31.2  |  | Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.              
|32.1  |  | Certification of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.              
|32.2  |  | Certification of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.              



(1)

Incorporated by reference from Registrants Current Report on Form 8-K, filed with the Commission on July 15, 2003, and incorporated herein by reference.

(2)

Incorporated by reference from Registrant's Annual Report on Form 10-KSB, filed with the Commission on June 8, 2007, and incorporated herein by reference.

(3)

Incorporated by reference from Registrant's Current Report on Form 8-K, filed with the Commission on August 14, 2007, and incorporated herein by reference.

(4)

Incorporated by reference from Registrant's Registration Statement on Form SB-2, filed with the Commission on November 14, 2007, and incorporated herein by reference.

(5)

Incorporated by reference from Registrants Current Report on Form 8-K, filed with the Commission on December 20, 2007, and incorporated herein by reference.



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ITEM 14

PRINCIPAL ACCOUNTANT FEES AND SERVICES

|                   |  |             |        |  |             |   |        | 
|------------------ |  | ----------- | ------ |  | ----------- | - | ------ | 
|Fee Category       |  | Fiscal 2007 |        |  | Fiscal 2006 |  
|Audit fees         |  | $           | 72,250 |  |             | $ | 30,000 | 
|Audit-related fees |  |             |      |  |             |   |      | 
|Tax fees           |  |             |      |  |             |   |      | 
|All other fees     |  |             |      |  |             |   |      | 
|Total fees         |  | $           | 72,250 |  |             | $ | 30,000 | 



The following is a summary of the fees billed to the Company by Kabani & Company, Inc. for professional services rendered for the fiscal years ended September 30, 2007 and 2006:

Audit Fees consists of fees billed for professional services rendered for the audit of the Companys consolidated financial statements and review of the interim consolidated financial statements included in quarterly reports and services that are normally provided by Kabani & Company, Inc. in connection with statutory and regulatory filings or engagements.

Audit-Related Fees consists of fees billed for assurance and related services that are reasonably related to the performance of the audit or review of the Companys consolidated financial statements and are not reported under "Audit Fees." There were no Audit-Related services provided in fiscal 2006 or 2005.

Tax Fees consists of fees billed for professional services for tax compliance, tax advice and tax planning.

All Other Fees consists of fees for products and services other than the services reported above. There were no management consulting services provided in fiscal 2006 or 2005.

Policy On Audit Committee Pre-Approval Of Audit And Permissible Non-Audit Services Of Independent Auditors

The Company has no audit committee. The Board of Directors policy is to pre-approve all audit and permissible non-audit services provided by the independent auditors. These services may include audit services, audit-related services, tax services and other services. Pre-approval would generally be provided for up to one year and any pre-approval would be detailed as to the particular service or category of services, and would be subject to a specific budget. The independent auditors and management are required to periodically report to the Board of Directors regarding the extent of services provided by the independent auditors in accordance with this pre-approval, and the fees for the services performed to date. The Board of Directors may also pre-approve particular services on a case-by-case basis.





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SIGNATURES

In accordance with Section 13 or 15(d) of the Exchange Act, the Registrant caused this Amendment No. 3 to the Annual Report on Form 10-K to be signed on its behalf by the undersigned, thereunto duly authorized.

Dated: January 13, 2010

| |              |                                                                                                                      
| | ------------ | ---------------------------------------------------------------------------------------------------------------------
| | SIONIX, INC.
| |              |                                                                                                                      
| |              |                                                                                                                      
| | By:          | /s/ JAMES R. CURRIER                                                                                                 
| |              | James R. Currier
Chairman, Chief Executive Officer, Secretary and Principal Executive Officer                        
| |              |                                                                                                                      
| |              |                                                                                                                      
| | By:          | /s/ DAVID R. WELLS                                                                                                   
| |              | David R. Wells
President, Chief Financial Officer, Assistant Secretary and Principal Financial and Accounting Officer





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