UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549





FORM
10-K




(Mark
One)





x
            ANNUAL
      REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934





For the
Fiscal Year Ended September 30, 2008





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





For the
transition period from _______________ to ________________





Commission
File Number 002-95626-D





SIONIX
CORPORATION


(Exact
name of registrant as specified in its charter)





Nevada
              
              87-0428526(State
      or other jurisdiction
              
              (I.R.S.
      Employer Identification No.)of
      incorporation or organization)





3880 E.
Eagle Drive


Anaheim, California
92807


(Address
of principal executive offices)





Registrant’s
telephone number, including area code: (714) 678-1000





Securities
registered pursuant to Section 12(b) of the Act:





Title of each class
              
              Name of each exchange on which each is
      registeredN/A





Securities
registered pursuant to Section 12(g) of the Act:  Common Stock, $0.001
par value





Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined in
Rule 405 of the Securities Act.





Yes o No x





Indicate
by check mark if the registrant is not required to file reports pursuant to
Section 13 or Section 15(d) of the Act.





Yes o No x





Indicate
by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports); and (2) has been subject to such filing requirements for
the past 90 days. Yes x No o





Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K is not contained herein, and will not 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-K or any amendment to this
Form 10-K. o





Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting
company.





Large
      accelerated filer o
                Accelerated
      filer oNon-accelerated filer o (Do not check if
      a smaller reporting company)
                Smaller
      reporting company x




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





State the
aggregate market value of the voting and non-voting common equity held by
non-affiliates computed by reference to the price at which the common equity was
last sold, or the average bid and asked price of such common equity, as of the
last business day of the registrant’s most recently completed second fiscal
quarter.  As of March 31, 2008, the aggregate market value of the
voting and non-voting common equity held by non-affiliates computed by reference
to the price at which the common equity was sold was $15,049,212.





Indicate
the number of shares outstanding of each of the registrant’s classes of common
stock, as of the latest practicable date.  The number of shares of the
registrant’s common stock, $0.001 par value per share, outstanding as of January
7, 2009 was 136,684,616.





DOCUMENTS
INCORPORATED BY REFERENCE





None









TABLE
OF CONTENTS





PagePART
      IITEM
      1.
                      BUSINESS
                      
                      4ITEM
      1A.
                      RISK
      FACTORS
                      
                      11ITEM
      1B
                      UNRESOLVED
      STAFF COMMENTS
                      
                      15ITEM
      2.
                      PROPERTIES
                      
                      15ITEM
      3.
                      LEGAL
      PROCEEDINGS
                      
                      15ITEM
      4.
                      SUBMISSION
      OF MATTERS TO A VOTE OF SECURITY HOLDERS
                      
                      15PART
      IIITEM
      5.
                      MMARKET
      FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER
      PURCHASES OF EQUITY SECURITIES
                      
                      15ITEM
      6.
                      SELECTED
      FINANCIAL DATA
                      
                      17ITEM
      7.
                      MANAGEMENT’S
      DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
      OPERATIONS
                      
                      17ITEM
      7A.
                      QUANTITATIVE
      AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
                      
                      22ITEM
      8.
                      FINANCIAL
      STATEMENTS AND SUPPLEMENTARY DATA
                      
                      F-1ITEM
      9.
                      CHANGES
      IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
      DISCLOSURE
                      
                      23ITEM
      9A(T).
                      CONTROLS
      AND PROCEDURES
                      
                      23ITEM
      9B.
                      OTHER
      INFORMATION
                      
                      25PART
      IIIITEM
      10.
                      DIRECTORS,
      EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
                      
                      25ITEM
      11.
                      EXECUTIVE
      COMPENSATION
                      
                      28ITEM
      12.
                      SECURITY
      OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED
      STOCKHOLDER MATTERS
                      
                      30ITEM
      13.
                      CERTAIN
      RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR
      INDEPENDENCE
                      
                      31ITEM
      14.
                      PRINCIPAL
      ACCOUNTING FEES AND SERVICES
                      
                      35ITEM
      15.
                      EXHIBITS
                      
                      35




2




Note
Regarding Forward Looking Statements





This
Annual Report on Form 10-K contains “forward-looking
statements”.  These forward-looking statements are based on our
current expectations, assumptions, estimates and projections about our business
and our industry.  Words such as “believe,” “anticipate,” “expect,”
“intend,” “plan,” “may,” and other similar expressions identify forward-looking
statements.  In addition, any statements that refer to expectations,
projections or other characterizations of future events or circumstances are
forward-looking statements.  These forward-looking statements are
subject to certain risks and uncertainties that could cause actual results to
differ materially from those reflected in the forward-looking
statements.  Factors that might cause such a difference include, but
are not limited to, those discussed in the section of this Annual Report titled
“Risk Factors” as well as the following:






            The
      current economic crisis in the United States, which may reduce the funds
      available to businesses and government to purchase our
    system;






            whether
      we will be able to raise capital as and when we need
  it;






            whether
      our water purification system will generate significant
    sales;






            our
      overall ability to successfully compete in our market and our industry;
      and






            unanticipated
      increases in development, production or marketing expenses related to our
      product and our business
activities,





and other
factors, some of which will be outside 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.




3




PART
I





ITEM
      1.
            DESCRIPTION
      OF BUSINESS.





We design
and develop turn-key stand-alone water treatment systems intended for
municipalities (both potable and wastewater), industry (both make-up water and
wastewater), emergency response, military and small residential
communities.  We were initially incorporated in Utah in
1996.  We reincorporated in Nevada in 2003.  As of August 1,
2008, our executive offices and principal operations are located at 3880 E.
Eagle Dr., Anaheim, California 92807.  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
those who consume it.  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 consumer 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.  We believe 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 rapidly increasing.





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, but generally they require
extremely large areas, which are referred to as “footprints”.




4




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. Floc
attracts 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 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 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 amounts 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
safe (but costly) 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 the existing methods of
filtration.  Illnesses such as hepatitis, gastroenteritis and
Legionnaire's Disease, as well as increasingly pervasive chemical contaminants,
have become more 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 (5-7
microns).  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.




5




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)
are the most common, are thought to be health-threatening and possibly
cancer-causing.  The Safe Drinking Water Act regulations address
minimum acceptable levels of these byproducts, including
THMs.  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.





Products
and Technology





OUR BUSINESS
STRATEGY.  Our business is 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 1920s 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 we developed,
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.  Our system occupies a small footprint, is self-contained
and portable.




6




Our
Elixir system utilizes and refines DAF technology to provide a pre-treatment
process using ordinary oxygen that we believe is highly
efficient.  The water is treated by 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.





Our
system can help ordinary filters meet Safe Drinking Water Act regulations and we
believe that our system is effective in eliminating potentially cancer-causing
disinfection by-product precursors while reducing the risk of bacterial or
parasitic contamination, particularly THM, cryptosporidium and
giardia.





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.





Each of
our systems is completely modular, and 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.  It is important to note that per capita usage of water in the
United States 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.





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 assembled in a steel container which is sealed, thus preventing
tampering or incursion by bio-terrorism or airborne contaminants. 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.




7




Pilot
Program-Villa Park Dam





In
November 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.  We designed the
system placed at the dam site for research purposes.  It 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
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 2009.





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 help us market the ELIXIR system.  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
system, 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 consumer desire to improve the
taste and quality of their drinking water and by the expanded concern of
regulatory agencies.  According to industry analysts, water safety
concerns not only contributed to growth in the water filtration market, but also
helped drive the growth of consumer bottled water per capital consumption from
1.6 gallons in 1976 to 27.6 gallons in 2006, representing sales of approximately
$10.8 billion.





According
to industry data, it is estimated that one billion people in the world do not
have safe drinking water.  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, we initially plan to 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, we plan to market principally to
local water systems and international relief organizations.




8




Our
marketing efforts emphasize that our 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.  We plan to provide lease financing for all of our 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 product.





Pilot
study requirements and potential adverse environmental effects can generally be
more easily addressed with our prepackaged plant approach.  Our
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 we intend to market to:





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 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
processes 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
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.





WASTEWATER UTILITIES (SEWAGE
TREATMENT).  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.




9




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.  Initially we intend to utilize in-house
marketing in conjunction with outsourced marketing consultants and national and
international distributorships.





Patents





We hold 8
U.S. patents on technology incorporated into the Elixir system and related
components, with an additional 2 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 also rely on common law concepts of
confidentiality and trade secrets.





Competition





Due to
the economic barriers created by the investment necessary to tool a
manufacturing facility and employ the personnel necessary to develop and sell
the equipment, competition in the water purification and filtration industry may
grow slowly.  However, our products must compete with water filtration
and purification equipment produced by companies that are more established than
we are and have significantly greater resources than we have, such as General
Electric Co., Siemens Water Technologies and Cuno Incorporated.  We
also compete with large architectural/engineering firms that design and build
water treatment plants and wastewater facilities and with producers of 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.  We do not represent a significant presence in the
water treatment industry.





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 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 3 years, as well as specifying the“best available technology”
for treating each contaminant.




10




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, 2008 were $1,060,933
while 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
established our 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 nine full-time employees, none of whom are covered by any
collective bargaining agreement. The Company considers its relationship with its
employees to be good.





ITEM
      1A.
            RISK
      FACTORS.





In
addition to the factors discussed elsewhere in this report, the following risks
and uncertainties could materially adversely affect our business, financial
condition and results of operations.  Additional risks and
uncertainties not presently known to us or that we currently deem immaterial
also may impair our business operations and financial condition.





We
have never generated any revenues.





We have
been in business for more than ten years and never generated any revenues from
operations.  We have been in the development stage since inception,
and although we have received an order for two water treatment systems, revenue
from these systems has not been recognized.  All of our working
capital has been generated by sales of securities and loans.




11




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 $3,872,820 for the year ended
September 30, 2008.  As of September 30, 2008 our accumulated deficit
was $21,893,656.  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.





We do not have sufficient cash to
support our operations and we will need to find capital to
operate.  If
we are unable to raise capital as we need it, we may have to curtail, or even
cease, our operations.





We have
not recognized any revenues since the inception of our business and we do not
have enough cash to support our operations.  Our capital requirements
have been and will continue to be significant.  In order to fund
shortages of capital, we have borrowed money from our major stockholders and
sold our securities.  Our major stockholders are not under any
obligation to continue providing loans to us.





We will
need to raise additional capital to continue our operations.  If we
are unsuccessful in finding financing, we may be required to severely curtail,
or even to cease, our operations.





During
the 2009 fiscal year, approximately $2 million in debt will become
due.  We are not certain that we will have the funds to repay this
debt, which could subject us to legal action.  Any such actions would
adversely affect our business and financial condition.





By July
2009, approximately $2 million of debt securities that we issued will become
due.  We do not currently have the funds to repay this debt and we
cannot assure you that we will be able to raise the funds or to renegotiate the
terms of the loans.  If we default on these obligations and if our
investors refuse to renegotiate the terms of the loans, we may be subjected to
lawsuits which would further strain our finances and disrupt our business and
would adversely affect our business and 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, 2008 were
prepared on a going concern basis.  Our auditors have indicated that
our inability to generate revenue raises substantial doubt as to our ability to
continue as a going concern.  Through September 30, 2008, we incurred
cumulative losses of $21,893,656 including a loss for the year ended September
30, 2008 of $3,872,820.  We have negligible cash flow from operations
and our ability to transition from a development stage company to an operating
company is entirely dependent upon obtaining adequate cash to finance our
overhead, research and development activities, and acquisition of production
equipment.  We do not know if we will achieve a level of revenues
adequate to support our cost and expenses.  In order to meet our basic
financial obligations, including rent, salaries, debt service and operations, we
plan to seek additional equity or debt financing.  Because of our
history and current debt levels, there is considerable doubt that we will be
able to obtain financing.  Our ability to meet our cash requirements
for the next twelve months depends on our ability to obtain
financing.  There is no assurance that we will be able to implement
our business plan or continue our operations.





We
may be unable to compete successfully in our industry.





Many of
our competitors, such as General Electric Co., Cuno Incorporated and Siemens
Water Technologies, 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 may not be able to compete successfully against
them.  We do not represent a significant presence in the water
treatment industry.




12




Our industry is subject to
government regulation, which may increase our costs of doing
business.




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 by requiring us to
re-engineer our products or invest in new technologies.  This could
have a material adverse effect on our business by increasing our costs of doing
business.





We may be subject
to product liability claims for which we do not have
insurance.  If we were
required to pay a substantial product liability claim, our business and
financial condition would be materially adversely affected.





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.  In the event that we do not have adequate insurance,
product liability claims relating to defective products could have a material
adverse effect on our business and financial condition.





Our
water treatment system and the related technology are unproven and may not
achieve widespread market acceptance among our prospective customers. If we are
unable to sell our water treatment systems, our business will
suffer.





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 will depend on many factors
including:





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





·           the
safety and efficacy of our system;





·           the
availability of alternative water treatment solutions;





·           the
pricing and cost effectiveness of our system;





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





·           the
effectiveness of our sales and marketing efforts;





·           publicity
concerning our system and technology or competitive solutions;





·           timeliness
in assembling and installing our system on customer sites;





·           our
ability to respond to changes in regulations; and




13




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





If our
system or our 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 not be able to sell our systems.  If we are unable to
sell our systems, our business 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 fail to do
this, our business and operations will be adversely affected.





If we are
unable to develop or enhance our systems and services to satisfy evolving
customer demands, our business, operating results, financial condition and
prospects will be harmed significantly.





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.





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.




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





Our
common stock is currently quoted on the OTC Bulletin Board under the symbol
“SINX.” Our common
stock is not actively traded and there is a limited public market for our
shares. As a result, a shareholder 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 shares of our common stock
may not develop, or if one should develop, it may not be sustained.





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 considered to be a “penny stock” under federal securities
laws.  Penny stocks are 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 that we will pay dividends on our common stock any time in the
near future.





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.





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





As of
September 30, 2008, there were 134,756,213 shares of our common stock
outstanding.  In the future, we may be required to issue a total of
81,483,423 shares of common stock if all of our outstanding options, warrants
and convertible promissory notes are exercised or converted.  Many of
these shares may be issued below the market value of our shares on the date the
securities are exercised or converted.  The future issuance of any
such additional shares of our common stock or other securities we may issue for
raising capital or paying for services may create downward pressure on the
trading price of our common stock.  Holders of our common stock will
have their holdings diluted as a result of the issuance of additional shares of
our common stock.





We
have failed to file annual or quarterly reports on a timely basis two times
during the past two years.  If we fail to file one more report on a
timely basis, the OTCBB will no longer allow our common stock to be
quoted.





Section
6530(e)(1) of the FINRA Manual states,





Notwithstanding
the foregoing paragraphs, a member shall not be permitted to quote a security
if: (A) while quoted on the OTCBB, the issuer of the security has failed to file
a complete required annual or quarterly report by the due date for such report
(including, if applicable, any extensions permitted by SEC Rule 12b-25) three
times in the prior two-year period . . . .





If we
fail to file an annual or quarterly report on a timely basis prior to December
31, 2009, the OTCBB will no longer allow our common stock to be
quoted.  We cannot assure you that we will be able to file our reports
in accordance with the requirements of the OTCBB.




14




ITEM
      1B.
            UNRESOLVED
      STAFF COMMENTS.





As a
smaller reporting company we are not required to provide this
information.





ITEM
      2.
            PROPERTIES.





As of
August 1, 2008, we entered into a 36 month lease for an industrial site
consisting of approximately 12,000 square feet of administrative offices and a
manufacturing facility.  Monthly lease payments for the period from
August 1, 2008 through July 31, 2009 are $8,650 plus common area maintenance
charges; monthly lease payments for the period from August 1, 2009 through July
31, 2010 are $8,995 plus common area maintenance charges and monthly lease
payments for the period from August 1, 2010 through July 31, 2011 are $9,355
plus common area maintenance charges.  The lease agreement includes an
option to extend the lease for an additional 36 months. If the option is
exercised, monthly payments over the three year term would be $9,730 plus common
area maintenance charges from August 1, 2011 through July 31, 2012, $10,118 plus
common area maintenance charges from August 1, 2012 through July 31, 2012, and
$10,523 plus common area maintenance charges from August 1, 2013 through July
31, 2014.





ITEM
      3.
            LEGAL
      PROCEEDINGS





Not
applicable.





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





During
the fourth quarter of the 2008 fiscal year, no matter was submitted to a vote of
security holders through the solicitation of proxies or otherwise.





PART
II





ITEM
      5.
            MARKET
      FOR REGISTRANT’S COMMON EQUITY, RELATED STOCHOLDERMATTERS
      AND ISSUER PURCHASES OF EQUITY
SECURITIES.





Our
common stock is quoted on the OTC Bulletin Board under the symbol“SINX”.  The table
below sets forth the range of high and low bid quotes of our common stock for
each quarter for the last two fiscal years as reported by the OTC Bulletin
Board.  The bid prices represent inter-dealer quotations, without
adjustments for retail mark-ups, markdowns or commissions and may not
necessarily represent actual transactions.




High
                        
                        
                        LowFiscal
      Year Ended September 30, 2008:First
      Quarter
                        
                        
                        0.300
                        
                        
                        
                        0.220Second
      Quarter
                        
                        
                        0.245
                        
                        
                        
                        0.120Third
      Quarter
                        
                        
                        0.355
                        
                        
                        
                        0.100Fourth
      Quarter
                        
                        
                        0.220
                        
                        
                        
                        0.130Fiscal
      Year Ended September 30, 2007:First
      Quarter
                        
                        
                        0.145
                        
                        
                        
                        0.035Second
      Quarter
                        
                        
                        0.480
                        
                        
                        
                        0.095Third
      Quarter
                        
                        
                        0.400
                        
                        
                        
                        0.200Fourth
      Quarter
                        
                        
                        0.380
                        
                        
                        
                        0.260





As of
January 7, 2008, we had 827 shareholders of record. This number does not include
an indeterminate number of shareholders whose shares are held by brokers in
street name.




15




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 our equity compensation
plans as of September 30, 2008.




Plan Category
                                    
                                    Number of
                                      securities to be
                                      issued upon
                                      exercise of
                                      outstanding
                                      options, warrants
                                      and rights
                                    
                                    
                                    Weightedaverage
                                      exercise price of
                                      outstanding
                                      options, warrants
                                      and rights
                                    
                                    
                                    Number of
                                      securities
                                      remaining available
                                      for future issuance
                                      under equity
                                      compensation
                                      plans (excluding
                                      securities reflected
                                      in column 2)Equity
      Compensation Plan Approved by StockholdersNoneEquity
      Compensation Plan Not Approved by Stockholders2001
      Executive Officers Stock Option Plan
                                    
                                    
                                    7,034,140
                                    
                                    
                                    $
                                    0.15
                                    
                                    
                                    
                                    542,540
  Recent
Issuances of Unregistered Securities





On July
29, 2008, we sold and issued in a private placement (the “Private Placement”)
$1,000,000 in aggregate principal amount of our 12% Convertible Debentures
(each, a “Debenture”, collectively, the “Debentures”) along with warrants to
purchase an aggregate of 1,000,000 shares of our common stock (the
“Warrants”).





The
Debentures will be convertible into our common stock at a conversion price of
$0.25 per share (the “Conversion Price”) from and after such time as we increase
our authorized common stock in accordance with applicable federal and state
laws, which we plan to do as soon as commercially and legally
practicable.  Each Debenture has a maturity date one year from its
date of issuance and all outstanding principal and accrued interest of each
Debenture will be due and payable on such date unless sooner declared due and
payable by the holder upon the occurrence of an event of default.  The
Debentures accrue interest at the rate of 12% per year.  In the event
that we sell our common stock, or securities convertible into common stock at a
conversion price or exercise price less than the Conversion Price (a “Dilutive
Issuance”), then the Conversion Price of any then outstanding Debentures will be
reduced to equal such lower price, except in connection with certain exempt
issuances.  In an event of default under the Debentures, the
Conversion Price will be reduced to $0.15 per share.




16




The
Warrants will be exercisable at an exercise price of $0.30 per share from and
after such time as we increase our authorized common stock.  The
Warrants have a term of five years and may be exercised on a cashless basis at
the election of the holder.  In the event of a Dilutive Issuance, the
exercise price of the Warrants will be reduced to equal the price of the
securities issued in the Dilutive Issuance, except in connection with certain
exempt issuances.





From the
$1,000,000 gross proceeds of the Private Placement, we paid a placement fee of
$120,000 and transaction expenses of $40,000.





The
Private Placement was exempt from registration under Section 4(2) of the
Securities Act of 1933, as amended, and Rule 506 of Regulation D promulgated
thereunder, inasmuch as the securities were issued to accredited investors only
without any form of general solicitation or general advertising.





ITEM
      6.
            SELECTED
      FINANCIAL DATA.





As a
smaller reporting company we are not required to provide this
information.





ITEM
      7.
            MANAGEMENT’S
      DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONAND
      RESULTS OF OPERATIONS.





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.




Application
of Critical Accounting Policies and Estimates




The
preparation of our 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 the 2008 fiscal year. Management believes the
following critical accounting policies reflect its more significant estimates
and assumptions.




Revenue
Recognition. Although the Company has yet to complete 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 sales 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.




17




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.




Legal
Contingencies. From time to time we may be a defendant in litigation. As
required by Financial Accounting Standards Board Statement No. 5“Accounting for
Contingencies” (FAS 5), we are required to 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.




Warrant
Liability. The Company calculates the fair value of warrants and options using
the Black Sholes model. Assumptions used in the calculation include the risk
free interest rate, volatility of the stock price, and dividend yield. Estimates
used in the calculation include the expected term of the warrants or
options.




18




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. 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.




Restatement
of the Fiscal Year Ended September 30, 2007




On March
21, 2008 the Company received a letter from the Securities and Exchange
Commission (the “SEC”) regarding the Company’s Form 10-KSB for the period ended
September 30, 2007 and its Form 10-QSB for the period ended December 31,
2007.  In response to the SEC’s letter, the Company restated its
financial statements for the fiscal year ended September 30, 2007.  As
a result of the restatement, the following adjustments were made to the
Company’s financial statements for the fiscal year ended September 30,
2007:




Balance
Sheet:




·           Total
current liabilities were restated from $2,956,380 to $7,626,614;
and




·           Stockholders’
deficit was restated from $(2,437,085) to $(7,107,319).




Statement
of Operations:




·           Total
operating expenses were restated from $1,455,045 to $1,603,890;




·           Other
expenses were restated from $(546,049) to $(561,744);




·           Loss
before income taxes was restated from $(2,001,094) to $(2,165,634);
and




·           Net
loss was restated from $(2,001,094) to $(2,168,226).




Statement
of Stockholders’ Equity (Deficit):




·           Total
stockholders’ deficit was restated from $(2,437,085) to $(7,107,319);
and




·           Additional paid-in capital was restated
from $14,712,527 to $10,762,982.




Please
see Note 17 of our financial statements for a more complete discussion of the
restatement.




Results
of Operations




Year
Ended September 30, 2008 Compared To Year Ended September 30, 2007




Revenues
for the fiscal year ended September 30, 2008 and 2007 were
zero.  Although we received an order and deposit for two water
treatment systems during the 2008 fiscal year, revenue from this order has not
been recognized because the units have not been completed and delivered. The
Company incurred operating expenses of $8,531,978 during the fiscal year ended
September 30, 2008, an increase of $6,928,088 or approximately 432%, as compared
to $1,603,890 for the fiscal year ended September 30, 2007.  General
and administrative expenses of $7,445,775 during the fiscal year ended September
30, 2008, an increase of $6,400,050 or approximately 612%, as compared to
$1,045,725 for the fiscal year ended September 30, 2007, contributed to the
significant increase in operating expenses. The increase in general and
administrative expenses resulted primarily from options and warrants issued to
employees and consultants, finance placement fees for debt issued and personnel
costs. Research and development expenses of $1,060,933 during the fiscal year
ended September 30, 2008, an increase of $534,467 or approximately 102%, as
compared to $526,466 for the fiscal year ended September 30, 2007, also
contributed to the increase in operating expenses.  The increase in
research and development expenses resulted primarily from additional personnel
costs associated with employees hired to continue design and refinement of the
ELIXIR water treatment system, and the research and development of the two water
treatment systems ordered during the 2008 fiscal year.




19




Other
income (expense) totaled $4,660,058 during the fiscal year ended September 30,
2008, an increase of $5,221,802 or approximately 930%, as compared to $(561,744)
for the fiscal year ended September 30, 2007. The Company earned interest income
of $7,830 during the fiscal year ended September 30, 2008, an increase of $2,944
or 60%, as compared to $4,886 during the fiscal year ended September 30,
2007.  The Company incurred interest expense of $1,122,188 during the
fiscal year ended September 30, 2008, an increase of $179,945 or approximately
19%, as compared to $942,243 for the fiscal year ended September 30, 2007.
The  increase in interest expense was due primarily to the issuance of
additional debt securities and the amortization of the beneficial conversion
features discount and warrant discount of the convertible debt securities during
the fiscal year ended September 30, 2008. Decrease in warrant liability was
$4,748,929 during the fiscal year ended September 30, 2008, an increase of
$4,279,618 or approximately 912%, as compared to $469,311 during the fiscal year
ended September 30, 2007. The increase in decrease in warrant liability was due
to the decrease in the trading price of the Company’s stock and the decrease in
the expected term of the options and warrants. Decrease in beneficial conversion
features liability was $1,404,811 during the fiscal year ended September 30,
2008, an increase of $1,408,855 or approximately 34,838%, as compared to $4,044
in increase in beneficial conversion features liability during the fiscal year
ended September 30, 2007. The decrease in beneficial conversion features
liability was due to the expiration of the expected term of the beneficial
conversion feature. During the fiscal year ended September 30, 2008, the Company
recorded a loss on settlement of debt and loss on lease termination of $254,309
and $125,015, respectively. There were no comparable expenses recorded during
the fiscal year ended September 30, 2007. During the 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 expense was recorded
during the fiscal year ended September 30, 2008. As a result of these items, the
loss for the fiscal year ended September 30, 2008 was $3,872,820, an increase of
$1,704,594 or approximately 79% over the loss of $2,168,226 incurred for the
fiscal year ended September 30, 2007.




Liquidity and Capital
Resources.




The
Company had cash and cash equivalents of $1,220,588 and $372,511 at September
30, 2008 and 2007, respectively. The Company’s source of liquidity has been the
sale of its securities and deposits received from orders for two water treatment
systems. The Company expects to receive additional orders for water treatment
systems but if it does not receive additional orders or if these orders do not
satisfy its capital needs, the Company expects to sell its securities or obtain
loans to meet its capital requirements.  The Company has no binding
commitments for financing and, with the exception of the orders it received
during the 2008 fiscal year, for the sale of water treatment
systems.  There can be no assurance that sales of the Company’s
securities or of its water treatment systems, if such sales occur, will provide
sufficient capital for its operations or that the Company will not encounter
unforeseen difficulties that may deplete its capital resources more rapidly than
anticipated. As of September 30, 2008, a total of $1,018,333 in principal amount
of certain promissory notes issued by the Company, plus accrued interest, were
due.  The Company has not yet paid the notes and no demand for payment
has been made.




20




Operating
Activities




During
the fiscal year ended September 30, 2008, the Company used $1,168,775 of cash in
operating activities.  Non-cash adjustments included $25,270 for
depreciation, $1,164,321 for amortization of warrant and beneficial conversion
feature, $254,309 for loss on settlement of debt, $125,015 for loss on lease
termination, $114,850 in stock issued for services and rent, and $138,375 for
accrual of liquidating damages.  The Company also recorded an increase
of $137,545 in current assets, and $28,495 in deposits. Cash provided by
operating activities included $101,955 in accounts payable, $887,064 in accrued
liabilities, and $1,260,000 in customer deposits. Cash used in operating
activities included $4,748,929 for warrant liability and $1,980,812 for
beneficial conversion feature liability. Stock based compensation to employees
was $1,842,945 and stock based compensation to nonemployees was
$3,685,722.




During
the fiscal year ended September 30, 2007, the Company used $1,117,861 of cash in
operating activities. Non-cash adjustments included $31,699 for depreciation,
$833,826 for amortization of warrant and beneficial conversion feature, and
$15,375 for accrual of liquidating damages. The Company also recorded an
increase of $1,350 in current assets and an increase of $104,600 in deposits.
Cash provided by operating activities included $1,445,946 in accrued expenses
and $4,044 in beneficial conversion features liability. Cash used in operating
activities included $115,209 in accounts payable, and $469,311 in warrant
liability. Stock based compensation to nonemployees was $208,989.




Investing
Activities




During
the fiscal year ended September 30, 2008, the Company acquired property and
equipment totaling $96,552, as compared to property acquisitions of $27,772
during the fiscal year ended September 30, 2007.




Financing
Activities




Financing
activities provided $2,113,404 to the Company during the fiscal year ended
September 30, 2008. The Company received $1,425,000 in notes payable, and
$750,000 from the issuance of stock. The Company made payments of $19,260 to an
officer for a loan payable, $15,000 to a related party for loan payable, and
$27,336 on an equity line of credit.




Financing
activities provided $1,117,861 to the Company during the fiscal year ended
September 30, 2007. The Company received $1,861,000 in notes
payable.  The Company made payments of $47,400 to an officer for a
loan payable and $300,000 on an equity line of credit




As of
September 30, 2008, the Company had an accumulated deficit of $21,893,656.
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.




Going Concern
Opinion.




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, 2008, the Company has incurred
cumulative losses of $21,893,656, including a loss for the year ended September
30, 2008 of $3,872,820. As the Company has limited 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 the Company will have for its
operations. Accordingly, there is no assurance that the Company will be able to
implement its plans.




21




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, as
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 significant revenues over the long term. If the Company
is unable to obtain financing, it would likely discontinue
operations.




ITEM
      7A.
            QUANTITATIVE
      AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK.





As a
smaller reporting company we are not required to provide this
information.




22




ITEM
      8.
            FINANCIAL
      STATEMENTS AND SUPPLEMENTARY DATA.





SIONIX
CORPORATION


INDEX
TO FINANCIAL STATEMENTS




Report
      of Independent Registered Public Accounting Firm
                                                                                  
                                                                                  
                                                                                  F-2Balance
      Sheets as of September 30, 2008 and 2007
                                                                                  
                                                                                  
                                                                                  F-3Statements
      of Operations for the years ended September 30, 2008 and September 30,
      2007 and Cumulative from Inception (October 3, 1994) to September 30,
      2008
                                                                                  
                                                                                  
                                                                                  F-4Statements
      of Stockholders’ Equity (Deficit) from Inception (October 3, 1994) to
      September 30, 2008
                                                                                  
                                                                                  
                                                                                  F-5Statements
      of Cash Flows for the years ended September 30, 2008 and September 30,
      2007 and Cumulative From Inception (October 3, 1994) to September 30,
      2008
                                                                                  
                                                                                  
                                                                                  F-8Notes
      to Financial Statements
                                                                                  
                                                                                  
                                                                                  F-9




F-1




REPORT OF INDEPENDENT
REGISTERED PUBLIC ACCOUNTING FIRM





To the
Board of Directors and Stockholders


Sionix
Corporation





We have
audited the accompanying balance sheets of Sionix Corporation (a development
stage entity) (a Nevada corporation) as of September 30, 2008 and 2007 and the
related statements of operations, stockholders' equity (deficit), and cash flows
for the years ended September 30, 2008 and 2007 and for the period from October
3, 1994 (inception) to September 30, 2008. 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, 2008 and 2007 and the results of its operations and its cash flows for the
years ended September 30, 2008 and 2007 and for the period from October 3, 1994
(inception) to September 30, 2008, 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 $21,893,656 at September 30, 2008 including a net loss of $3,872,820
incurred in the year ended September 30, 2008. These factors as discussed in
Note 15 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 15.  The financial
statements do not include any adjustments that might result from the outcome of
this uncertainty.




As
discussed in note 17, the financial statements for the year ended September 30,
2007 have been restated.





Kabani
& Company, Inc.


Certified
Public Accountants





Los
Angeles, California.





December
23, 2008





F-2





SIONIX
CORPORATION


(A
DEVELOPMENT STAGE COMPANY)


BALANCE
SHEETS





September
      30,2008
                        
                        
                        2007
      (Restated)ASSETSCURRENT
      ASSETSCash
      and cash equivalents
                        
                        $
                        1,220,588
                        
                        
                        $
                        372,511Other
      current assets
                        
                        
                        138,895
                        
                        
                        
                        1,350TOTAL
      CURRENT ASSETS
                        
                        
                        1,359,483
                        
                        
                        
                        373,861PROPERTY
      AND EQUIPMENT, net
                        
                        
                        87,101
                        
                        
                        
                        40,834DEPOSITS
                        
                        
                        33,095
                        
                        
                        
                        104,600TOTAL
      ASSETS
                        
                        $
                        1,479,679
                        
                        
                        $
                        519,295LIABILITIES
      AND STOCKHOLDERS' DEFICITCURRENT
      LIABILITIESAccounts
      payable
                        
                        $
                        259,355
                        
                        
                        $
                        157,399Accrued
      expenses
                        
                        
                        2,721,970
                        
                        
                        
                        2,068,114Customer
      deposits
                        
                        
                        1,260,000
                        
                        
                        
                        -Liquidated
      damages liability
                        
                        
                        153,750
                        
                        
                        
                        15,375Notes
      payable to related parties
                        
                        
                        114,000
                        
                        
                        
                        129,000Notes
      payable to officers
                        
                        
                        -
                        
                        
                        
                        19,260Equity
      line of credit
                        
                        
                        -
                        
                        
                        
                        27,336Convertible
      notes, net
                        
                        
                        2,041,443
                        
                        
                        
                        776,47210%
      subordinated notes payable, net
                        
                        
                        400,796
                        
                        
                        
                        -Warrant
      and option liability
                        
                        
                        3,446,823
                        
                        
                        
                        2,426,846Beneficial
      conversion features liability
                        
                        
                        26,000
                        
                        
                        
                        2,006,812TOTAL
      CURRENT LIABILITIES
                        
                        
                        10,424,137
                        
                        
                        
                        7,626,614STOCKHOLDERS'
      DEFICITCommon
      Stock (150,000,000 shares authorized; 134,756,213 and 107,117,101 shares
      issued; 134,274,313 and 106,635,201 shares outstanding
      respectively)
                        
                        
                        134,274
                        
                        
                        
                        106,635Additional
      paid-in capital
                        
                        
                        12,688,495
                        
                        
                        
                        10,762,982Shares
      to be issued
                        
                        
                        126,429
                        
                        
                        
                        43,900Deficit
      accumulated during development stage
                        
                        
                        (21,893,656
                        )
                        
                        
                        (18,020,836
                        )TOTAL
      STOCKHOLDERS' DEFICIT
                        
                        
                        (8,944,458
                        )
                        
                        
                        (7,107,319
                        )TOTAL
      LIABILITIES AND STOCKHOLDERS' DEFICIT
                        
                        $
                        1,479,679
                        
                        
                        $
                        519,295





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


F-3


SIONIX
CORPORATION


(A
DEVELOPMENT STAGE COMPANY)


STATEMENTS
OF OPERATIONS





CummulativefromInceptionFor
      the year ended September 30,
                                                  
                                                  
                                                  Years
      Ended September 30,
                                                  
                                                  
                                                  (October
      3, 1994) to2008
                                                  
                                                  
                                                  2007
      (Restated)
                                                  
                                                  
                                                  September
      30, 2008Net
      revenue
                                                  
                                                  $
                                                  -
                                                  
                                                  
                                                  $
                                                  -
                                                  
                                                  
                                                  $
                                                  -Operating
      expensesGeneral
      and administrative
                                                  
                                                  
                                                  7,445,775
                                                  
                                                  
                                                  
                                                  1,045,725
                                                  
                                                  
                                                  
                                                  20,775,280Research
      and development
                                                  
                                                  
                                                  1,060,933
                                                  
                                                  
                                                  
                                                  526,466
                                                  
                                                  
                                                  
                                                  3,036,873Depreciation
      and amortization
                                                  
                                                  
                                                  25,270
                                                  
                                                  
                                                  
                                                  31,699
                                                  
                                                  
                                                  
                                                  557,375Total
      operating expenses
                                                  
                                                  
                                                  8,531,978
                                                  
                                                  
                                                  
                                                  1,603,890
                                                  
                                                  
                                                  
                                                  24,369,528Loss
      from Operations
                                                  
                                                  
                                                  (8,531,978
                                                  )
                                                  
                                                  
                                                  (1,603,890
                                                  )
                                                  
                                                  
                                                  (24,369,528
                                                  )Other
      income (expense)Interest
      income
                                                  
                                                  
                                                  7,830
                                                  
                                                  
                                                  
                                                  4,886
                                                  
                                                  
                                                  
                                                  66,373Interest
      expense
                                                  
                                                  
                                                  (1,502,629
                                                  )
                                                  
                                                  
                                                  (942,243
                                                  )
                                                  
                                                  
                                                  (2,299,117
                                                  )Decrease
      in warrant liability
                                                  
                                                  
                                                  4,748,929
                                                  
                                                  
                                                  
                                                  469,311
                                                  
                                                  
                                                  
                                                  5,218,240Decrease
      (increase) in beneficial conversion features liability
                                                  
                                                  
                                                  1,404,811
                                                  
                                                  
                                                  
                                                  (4,044
                                                  )
                                                  
                                                  
                                                  1,400,767Impairment
      of intangibles
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  (1,267,278
                                                  )Inventory
      obsolesence
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  (365,078
                                                  )Legal
      settlement
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  (89,654
                                                  )
                                                  
                                                  
                                                  344,949Loss
      on settlement of debt
                                                  
                                                  
                                                  (254,309
                                                  )
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  (484,577
                                                  )Loss
      on lease termination
                                                  
                                                  
                                                  (125,015
                                                  )
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  (125,015
                                                  )Write-off
      of beneficial conversion feature
                                                  
                                                  
                                                  380,441
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  380,441Total
      Other Income (Expense)
                                                  
                                                  
                                                  4,660,058
                                                  
                                                  
                                                  
                                                  (561,744
                                                  )
                                                  
                                                  
                                                  2,489,264Loss
      before income taxes
                                                  
                                                  
                                                  (3,871,920
                                                  )
                                                  
                                                  
                                                  (2,165,634
                                                  )
                                                  
                                                  
                                                  (21,880,264
                                                  )Income
      Taxes
                                                  
                                                  
                                                  900
                                                  
                                                  
                                                  
                                                  2,592
                                                  
                                                  
                                                  
                                                  13,392Net
      Loss
                                                  
                                                  $
                                                  (3,872,820
                                                  )
                                                  
                                                  $
                                                  (2,168,226
                                                  )
                                                  
                                                  $
                                                  (21,893,656
                                                  )Basic
      an dilutive loss per share
                                                  
                                                  $
                                                  (0.03
                                                  )
                                                  
                                                  $
                                                  (0.02
                                                  )Basic
      and diluted weighted average nubmer of shares of Common Stock
      outstanding*
                                                  
                                                  
                                                  112,419,861
                                                  
                                                  
                                                  
                                                  106,207,706





* -
Weighted averag diluted number of share are considered the same as the basic
weighted average nuimber of shares as the effect is
anti-dilutive.




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


F-4





SIONIX
CORPORATION


(A
DEVELOPMENT STAGE COMPANY)


STATEMENTS
OF STOCKHOLDERS’ EQUITY (DEFICIT)





Deficit
                                                    
                                                    
                                                    TotalCommon
      Stock
                                                    
                                                    
                                                    Additional
                                                    
                                                    
                                                    Stock
                                                    
                                                    
                                                    Stock
                                                    
                                                    
                                                    Shares
                                                    
                                                    
                                                    Unamortized
                                                    
                                                    
                                                    Accumulated
                                                    
                                                    
                                                    Stockholders'Number
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    Paid-in
                                                    
                                                    
                                                    to
      be
                                                    
                                                    
                                                    Subscription
                                                    
                                                    
                                                    to
      be
                                                    
                                                    
                                                    Consulting
                                                    
                                                    
                                                    from
                                                    
                                                    
                                                    Equityof
      Shares
                                                    
                                                    
                                                    Amount
                                                    
                                                    
                                                    Capital
                                                    
                                                    
                                                    Issued
                                                    
                                                    
                                                    Receivable
                                                    
                                                    
                                                    Cancelled
                                                    
                                                    
                                                    Fees
                                                    
                                                    
                                                    Inception
                                                    
                                                    
                                                    (Deficit)Stock
      issued for cashOctober
      3, 1994
                                                    
                                                    
                                                    10,000
                                                    
                                                    
                                                    $
                                                    10
                                                    
                                                    
                                                    $
                                                    90
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    $
                                                    100Net
      loss from October 3,1994,
      to December 31, 1994
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    (1,521
                                                    )
                                                    
                                                    
                                                    (1,521
                                                    )Balance
      at December 31, 1994
                                                    
                                                    
                                                    10,000
                                                    
                                                    
                                                    
                                                    10
                                                    
                                                    
                                                    
                                                    90
                                                    
                                                    
                                                    
                                                    -
                                                    
                                                    
                                                    
                                                    -
                                                    
                                                    
                                                    
                                                    -
                                                    
                                                    
                                                    
                                                    -
                                                    
                                                    
                                                    
                                                    (1,521
                                                    )
                                                    
                                                    
                                                    (1,421
                                                    )Shares
      issued forassignment
      rights
                                                    
                                                    
                                                    1,990,000
                                                    
                                                    
                                                    
                                                    1,990
                                                    
                                                    
                                                    
                                                    (1,990
                                                    )
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    -Shares
      issued for services
                                                    
                                                    
                                                    572,473
                                                    
                                                    
                                                    
                                                    572
                                                    
                                                    
                                                    
                                                    135,046
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    135,618Shares
      issued for debt
                                                    
                                                    
                                                    1,038,640
                                                    
                                                    
                                                    
                                                    1,038
                                                    
                                                    
                                                    
                                                    1,164,915
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    1,165,953Shares
      issued for cash
                                                    
                                                    
                                                    232,557
                                                    
                                                    
                                                    
                                                    233
                                                    
                                                    
                                                    
                                                    1,119,027
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    1,119,260Shares
      issued forsubscription
      receivable
                                                    
                                                    
                                                    414,200
                                                    
                                                    
                                                    
                                                    414
                                                    
                                                    
                                                    
                                                    1,652,658
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    (1,656,800
                                                    )
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    (3,728
                                                    )Shares
      issued forproductions
      costs
                                                    
                                                    
                                                    112,500
                                                    
                                                    
                                                    
                                                    113
                                                    
                                                    
                                                    
                                                    674,887
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    (675,000
                                                    )
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    -Net
      loss for the year endedDecember
      31, 1995
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    (914,279
                                                    )
                                                    
                                                    
                                                    (914,279
                                                    )Balance
      at December 31, 1995
                                                    
                                                    
                                                    4,370,370
                                                    
                                                    
                                                    
                                                    4,370
                                                    
                                                    
                                                    
                                                    4,744,633
                                                    
                                                    
                                                    
                                                    -
                                                    
                                                    
                                                    
                                                    (2,331,800
                                                    )
                                                    
                                                    
                                                    -
                                                    
                                                    
                                                    
                                                    -
                                                    
                                                    
                                                    
                                                    (915,800
                                                    )
                                                    
                                                    
                                                    1,501,403Shares
      issued for reorganization
                                                    
                                                    
                                                    18,632,612
                                                    
                                                    
                                                    
                                                    18,633
                                                    
                                                    
                                                    
                                                    (58,033
                                                    )
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    (39,400
                                                    )Shares
      issued for cash
                                                    
                                                    
                                                    572,407
                                                    
                                                    
                                                    
                                                    573
                                                    
                                                    
                                                    
                                                    571,834
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    572,407Shares
      issued for services
                                                    
                                                    
                                                    24,307
                                                    
                                                    
                                                    
                                                    24
                                                    
                                                    
                                                    
                                                    24,283
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    24,307Net
      loss for the year endedSeptember
      30, 1996
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    (922,717
                                                    )
                                                    
                                                    
                                                    (922,717
                                                    )Balance
      at September 30, 1996
                                                    
                                                    
                                                    23,599,696
                                                    
                                                    
                                                    
                                                    23,600
                                                    
                                                    
                                                    
                                                    5,282,717
                                                    
                                                    
                                                    
                                                    -
                                                    
                                                    
                                                    
                                                    (2,331,800
                                                    )
                                                    
                                                    
                                                    -
                                                    
                                                    
                                                    
                                                    -
                                                    
                                                    
                                                    
                                                    (1,838,517
                                                    )
                                                    
                                                    
                                                    1,136,000Shares
      issued for cash
                                                    
                                                    
                                                    722,733
                                                    
                                                    
                                                    
                                                    723
                                                    
                                                    
                                                    
                                                    365,857
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    366,580Shares
      issued for services
                                                    
                                                    
                                                    274,299
                                                    
                                                    
                                                    
                                                    274
                                                    
                                                    
                                                    
                                                    54,586
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    54,860Cancellation
      of shares
                                                    
                                                    
                                                    (542,138
                                                    )
                                                    
                                                    
                                                    (542
                                                    )
                                                    
                                                    
                                                    (674,458
                                                    )
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    675,000
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    -Net
      loss for the year endedSeptember
      30, 1997
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    (858,915
                                                    )
                                                    
                                                    
                                                    (858,915
                                                    )Balance
      at September 30, 1997
                                                    
                                                    
                                                    24,054,590
                                                    
                                                    
                                                    
                                                    24,055
                                                    
                                                    
                                                    
                                                    5,028,702
                                                    
                                                    
                                                    
                                                    -
                                                    
                                                    
                                                    
                                                    (1,656,800
                                                    )
                                                    
                                                    
                                                    -
                                                    
                                                    
                                                    
                                                    -
                                                    
                                                    
                                                    
                                                    (2,697,432
                                                    )
                                                    
                                                    
                                                    698,525Shares
      issued for cash
                                                    
                                                    
                                                    2,810,000
                                                    
                                                    
                                                    
                                                    2,810
                                                    
                                                    
                                                    
                                                    278,190
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    281,000Shares
      issued for services
                                                    
                                                    
                                                    895,455
                                                    
                                                    
                                                    
                                                    895
                                                    
                                                    
                                                    
                                                    88,651
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    89,546Shares
      issued for compensation
                                                    
                                                    
                                                    2,200,000
                                                    
                                                    
                                                    
                                                    2,200
                                                    
                                                    
                                                    
                                                    217,800
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    220,000Cancellation
      of shares
                                                    
                                                    
                                                    (2,538,170
                                                    )
                                                    
                                                    
                                                    (2,538
                                                    )
                                                    
                                                    
                                                    (1,534,262
                                                    )
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    1,656,800
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    120,000Net
      loss for the year endedSeptember
      30, 1998
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    (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
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    392,925Shares
      issued for services
                                                    
                                                    
                                                    705,746
                                                    
                                                    
                                                    
                                                    706
                                                    
                                                    
                                                    
                                                    215,329
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    216,035Shares
      issued for cash
                                                    
                                                    
                                                    9,383,000
                                                    
                                                    
                                                    
                                                    9,383
                                                    
                                                    
                                                    
                                                    928,917
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    938,300Net
      loss for the year endedSeptember
      30, 1999
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    (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
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    1,030,350Shares
      issued for compensation
                                                    
                                                    
                                                    1,517,615
                                                    
                                                    
                                                    
                                                    1,518
                                                    
                                                    
                                                    
                                                    1,218,598
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    1,220,116Shares
      issued for services
                                                    
                                                    
                                                    986,844
                                                    
                                                    
                                                    
                                                    986
                                                    
                                                    
                                                    
                                                    253,301
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    254,287Net
      loss for the year endedSeptember
      30, 2000
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    (2,414,188
                                                    )
                                                    
                                                    
                                                    (2,414,188
                                                    )





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


F-5





SIONIX
CORPORATION


(A
DEVELOPMENT STAGE COMPANY)


STATEMENTS
OF STOCKHOLDERS’ EQUITY (DEFICIT) - Continued




Deficit
                                                                                                    
                                                                                                    
                                                                                                    TotalCommon
      Stock
                                                                                                    
                                                                                                    
                                                                                                    Additional
                                                                                                    
                                                                                                    
                                                                                                    Stock
                                                                                                    
                                                                                                    
                                                                                                    Stock
                                                                                                    
                                                                                                    
                                                                                                    Shares
                                                                                                    
                                                                                                    
                                                                                                    Unamortized
                                                                                                    
                                                                                                    
                                                                                                    Accumulated
                                                                                                    
                                                                                                    
                                                                                                    Stockholders'Number
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    Paid-in
                                                                                                    
                                                                                                    
                                                                                                    to
      be
                                                                                                    
                                                                                                    
                                                                                                    Subscription
                                                                                                    
                                                                                                    
                                                                                                    to
      be
                                                                                                    
                                                                                                    
                                                                                                    Consulting
                                                                                                    
                                                                                                    
                                                                                                    from
                                                                                                    
                                                                                                    
                                                                                                    Equityof
      Shares
                                                                                                    
                                                                                                    
                                                                                                    Amount
                                                                                                    
                                                                                                    
                                                                                                    Capital
                                                                                                    
                                                                                                    
                                                                                                    Issued
                                                                                                    
                                                                                                    
                                                                                                    Receivable
                                                                                                    
                                                                                                    
                                                                                                    Cancelled
                                                                                                    
                                                                                                    
                                                                                                    Fees
                                                                                                    
                                                                                                    
                                                                                                    Inception
                                                                                                    
                                                                                                    
                                                                                                    (Deficit)Balance
      at September 30, 2000
                                                                                                    
                                                                                                    
                                                                                                    54,166,322
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    54,166
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    8,104,350
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    -
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    -
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    -
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    -
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    (8,168,751
                                                                                                    )
                                                                                                    
                                                                                                    
                                                                                                    (10,235
                                                                                                    )Shares
      issued for servicesand
      prepaid expenses
                                                                                                    
                                                                                                    
                                                                                                    2,517,376
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    2,517
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    530,368
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    (141,318
                                                                                                    )
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    391,567Shares
      issued for cash
                                                                                                    
                                                                                                    
                                                                                                    6,005,000
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    6,005
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    594,495
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    600,500Shares
      to be issued for cash(100,000
      shares)
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    10,000
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    10,000Shares
      to be issued fordebt
      (639,509 shares)
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    103,295
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    103,295Net
      loss for the year endedSeptember
      30, 2001
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    (1,353,429
                                                                                                    )
                                                                                                    
                                                                                                    
                                                                                                    (1,353,429
                                                                                                    )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 servicesand
      prepaid expenses
                                                                                                    
                                                                                                    
                                                                                                    1,111,710
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    1,112
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    361,603
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    54,400
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    417,115Shares
      issued as a contribution
                                                                                                    
                                                                                                    
                                                                                                    100,000
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    100
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    11,200
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    11,300Shares
      issued for compensation
                                                                                                    
                                                                                                    
                                                                                                    18,838
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    19
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    2,897
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    2,916Shares
      issued for cash
                                                                                                    
                                                                                                    
                                                                                                    16,815,357
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    16,815
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    1,560,782
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    (10,000
                                                                                                    )
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    1,567,597Shares
      issued for debt
                                                                                                    
                                                                                                    
                                                                                                    1,339,509
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    1,340
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    208,639
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    (103,295
                                                                                                    )
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    106,684Shares
      to be issued forservices
      related to raisingequity
      (967,742 shares)
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    (300,000
                                                                                                    )
                                                                                                    
                                                                                                    
                                                                                                    300,000
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    -Cancellation
      of shares
                                                                                                    
                                                                                                    
                                                                                                    (7,533,701
                                                                                                    )
                                                                                                    
                                                                                                    
                                                                                                    (7,534
                                                                                                    )
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    (7,534
                                                                                                    )Net
      loss for the year endedSeptember
      30, 2002
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    (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
                                                                                                    )
                                                                                                    
                                                                                                    
                                                                                                    596,467Shares
      issued for servicesand
      prepaid expenses
                                                                                                    
                                                                                                    
                                                                                                    2,467,742
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    2,468
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    651,757
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    (300,000
                                                                                                    )
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    354,225Shares
      issued for capitalequity
      line
                                                                                                    
                                                                                                    
                                                                                                    8,154,317
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    8,154
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    891,846
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    900,000Amortization
      of consulting fees
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    86,918
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    86,918Cancellation
      of shares
                                                                                                    
                                                                                                    
                                                                                                    (50,000
                                                                                                    )
                                                                                                    
                                                                                                    
                                                                                                    (50
                                                                                                    )
                                                                                                    
                                                                                                    
                                                                                                    50
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    -Shares
      to be cancelled(7,349,204
      shares)
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    7,349
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    (7,349
                                                                                                    )
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    -Net
      loss for the year endedSeptember
      30, 2003
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    (1,721,991
                                                                                                    )
                                                                                                    
                                                                                                    
                                                                                                    (1,721,991
                                                                                                    )Balance
      at September 30, 2003
                                                                                                    
                                                                                                    
                                                                                                    85,112,470
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    85,112
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    12,625,336
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    -
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    -
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    (7,349
                                                                                                    )
                                                                                                    
                                                                                                    
                                                                                                    -
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    (12,487,480
                                                                                                    )
                                                                                                    
                                                                                                    
                                                                                                    215,619Shares
      issued for capitalequity
      line
                                                                                                    
                                                                                                    
                                                                                                    19,179,016
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    19,179
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    447,706
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    466,885Shares
      issued for services
                                                                                                    
                                                                                                    
                                                                                                    5,100,004
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    5,100
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    196,997
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    (13,075
                                                                                                    )
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    189,022Share
      to be issued for cash(963,336
      shares)
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    28,900
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    28,900Shares
      to be issued for debt(500,000
      shares)
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    15,000
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    15,000Cancellation
      of shares
                                                                                                    
                                                                                                    
                                                                                                    (7,349,204
                                                                                                    )
                                                                                                    
                                                                                                    
                                                                                                    (7,349
                                                                                                    )
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    7,349
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    -Issuance
      of warrants relatedto
      2004 stock purchase
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    24,366
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    24,366Net
      loss for the year endedSeptember
      30, 2004
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    (1,593,136
                                                                                                    )
                                                                                                    
                                                                                                    
                                                                                                    (1,593,136
                                                                                                    )


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


F-6





SIONIX
CORPORATION


(A
DEVELOPMENT STAGE COMPANY)


STATEMENTS
OF STOCKHOLDERS’ EQUITY (DEFICIT) - Continued





Deficit
                                                                            
                                                                            
                                                                            TotalCommon
      Stock
                                                                            
                                                                            
                                                                            Additional
                                                                            
                                                                            
                                                                            Stock
                                                                            
                                                                            
                                                                            Stock
                                                                            
                                                                            
                                                                            Shares
                                                                            
                                                                            
                                                                            Unamortized
                                                                            
                                                                            
                                                                            Accumulated
                                                                            
                                                                            
                                                                            Stockholders'Number
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            Paid-in
                                                                            
                                                                            
                                                                            to
      be
                                                                            
                                                                            
                                                                            Subscription
                                                                            
                                                                            
                                                                            to
      be
                                                                            
                                                                            
                                                                            Consulting
                                                                            
                                                                            
                                                                            from
                                                                            
                                                                            
                                                                            Equityof
      Shares
                                                                            
                                                                            
                                                                            Amount
                                                                            
                                                                            
                                                                            Capital
                                                                            
                                                                            
                                                                            Issued
                                                                            
                                                                            
                                                                            Receivable
                                                                            
                                                                            
                                                                            Cancelled
                                                                            
                                                                            
                                                                            Fees
                                                                            
                                                                            
                                                                            Inception
                                                                            
                                                                            
                                                                            (Deficit)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
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            13,075Net
      loss for the year endedSeptember
      30, 2005
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            (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 for the year endedSeptember
      30, 2006
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            (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
                                                                            )Shares
      issued for services
                                                                            
                                                                            
                                                                            4,592,915
                                                                            
                                                                            
                                                                            
                                                                            4,593
                                                                            
                                                                            
                                                                            
                                                                            80,336
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            84,929Reclassification
      of 2001Executive
      Option Planas
      of July 17, 2007
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            (2,271,879
                                                                            )
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            (2,271,879
                                                                            )Reclassification
      ofbeneficial
      conversionfeatures
      liability related toadvisory
      boardcompensation
      as of July 17, 2007
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            (269,851
                                                                            )
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            (269,851
                                                                            )Reclassification
      of warrantsrelated
      to 2004 stockpurchase
      agreementas
      of July 17, 2007
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            (70,029
                                                                            )
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            (70,029
                                                                            )Net
      loss for the year endedSeptember
      30, 2007
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            (2,168,226
                                                                            )
                                                                            
                                                                            
                                                                            (2,168,226
                                                                            )Balance
      at September 30, 2007 (Restated),
                                                                            
                                                                            
                                                                            106,635,201
                                                                            
                                                                            
                                                                            
                                                                            106,635
                                                                            
                                                                            
                                                                            
                                                                            10,762,982
                                                                            
                                                                            
                                                                            
                                                                            43,900
                                                                            
                                                                            
                                                                            
                                                                            -
                                                                            
                                                                            
                                                                            
                                                                            -
                                                                            
                                                                            
                                                                            
                                                                            -
                                                                            
                                                                            
                                                                            
                                                                            (18,020,836
                                                                            )
                                                                            
                                                                            
                                                                            (7,107,319
                                                                            )Shares
      issued for services
                                                                            
                                                                            
                                                                            1,539,750
                                                                            
                                                                            
                                                                            
                                                                            1,540
                                                                            
                                                                            
                                                                            
                                                                            254,330
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            255,870Shares
      to be issued for services
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            126,029
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            126,029Shares
      converted from debt
                                                                            
                                                                            
                                                                            17,149,359
                                                                            
                                                                            
                                                                            
                                                                            17,149
                                                                            
                                                                            
                                                                            
                                                                            886,633
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            903,782Shares
      issued for cash
                                                                            
                                                                            
                                                                            8,950,003
                                                                            
                                                                            
                                                                            
                                                                            8,950
                                                                            
                                                                            
                                                                            
                                                                            784,550
                                                                            
                                                                            
                                                                            
                                                                            (43,500
                                                                            )
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            750,000Net
      loss for the year endedSeptember
      30, 2008
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            (3,872,820
                                                                            )
                                                                            
                                                                            
                                                                            (3,872,820
                                                                            )Balance
      at September 30, 2008
                                                                            
                                                                            
                                                                            134,274,313
                                                                            
                                                                            
                                                                            $
                                                                            134,274
                                                                            
                                                                            
                                                                            $
                                                                            12,688,495
                                                                            
                                                                            
                                                                            $
                                                                            126,429
                                                                            
                                                                            
                                                                            $
                                                                            -
                                                                            
                                                                            
                                                                            $
                                                                            -
                                                                            
                                                                            
                                                                            $
                                                                            -
                                                                            
                                                                            
                                                                            $
                                                                            (21,893,656
                                                                            )
                                                                            
                                                                            $
                                                                            (8,944,458
                                                                            )





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


F-7





SIONIX
CORPORATION


(A
DEVELOPMENT STAGE COMPANY)


STATEMENTS
OF CASH FLOWS





CummulativefromInceptionYears
      Ended September 30,
                                
                                
                                (October
      3, 1994) to2008
                                
                                
                                2007
      (Restated)
                                
                                
                                September
      30,2008Operating
      activities:Net
      loss
                                
                                $
                                (3,872,820
                                )
                                
                                $
                                (2,168,226
                                )
                                
                                $
                                (21,893,656
                                )Adjustments
      to reconcile net loss to net cash used inoperating
      activities:Depreciation
                                
                                
                                25,270
                                
                                
                                
                                31,699
                                
                                
                                
                                644,292Amortization
      of beneficial conversion features discount andwarrant
      discount
                                
                                
                                1,164,321
                                
                                
                                
                                833,826
                                
                                
                                
                                2,047,339Stock
      based compensation expense - employee
                                
                                
                                1,842,945
                                
                                
                                
                                -
                                
                                
                                
                                3,678,902Stock
      based compensation expense - nonemployee
                                
                                
                                3,685,722
                                
                                
                                
                                208,989
                                
                                
                                
                                6,650,591Impairment
      of assets
                                
                                
                                -
                                
                                
                                
                                -
                                
                                
                                
                                514,755Write-down
      of obsolete assets
                                
                                
                                -
                                
                                
                                
                                -
                                
                                
                                
                                38,862Impairment
      of intangible assets
                                
                                
                                -
                                
                                
                                
                                -
                                
                                
                                
                                1,117,601Loss
      on settlement of debt
                                
                                
                                254,309
                                
                                
                                
                                -
                                
                                
                                
                                384,577Loss
      on lease termination
                                
                                
                                125,015
                                
                                
                                
                                
                                
                                
                                
                                125,015Write-off
      of beneficial conversion feature
                                
                                
                                (576,000
                                )
                                
                                
                                
                                
                                
                                
                                (576,000
                                )Stock
      issued for services and rent
                                
                                
                                114,850
                                
                                
                                
                                
                                
                                
                                
                                114,850Accrual
      of liquidating damages
                                
                                
                                138,375
                                
                                
                                
                                15,375
                                
                                
                                
                                153,750Other
                                
                                
                                -
                                
                                
                                
                                (799,044
                                )
                                
                                
                                (799,044
                                )(Increase)
      decrease in assets:Other
      current assets
                                
                                
                                (137,545
                                )
                                
                                
                                (1,350
                                )
                                
                                
                                (138,895
                                )Other
      assets
                                
                                
                                (28,495
                                )
                                
                                
                                (104,600
                                )
                                
                                
                                (133,095
                                )Increase
      (decrease) in liabilities:Accounts
      payable
                                
                                
                                258,119
                                
                                
                                
                                (115,209
                                )
                                
                                
                                415,519Accrued
      expenses
                                
                                
                                730,900
                                
                                
                                
                                1,445,946
                                
                                
                                
                                2,960,040Customer
      deposits
                                
                                
                                1,260,000
                                
                                
                                
                                -
                                
                                
                                
                                1,260,000Warrant
      liability
                                
                                
                                (4,748,929
                                )
                                
                                
                                (469,311
                                )
                                
                                
                                (5,218,240
                                )Beneficial
      conversion features liability
                                
                                
                                (1,404,812
                                )
                                
                                
                                4,044
                                
                                
                                
                                (1,400,768
                                )Net
      cash used in operating activities
                                
                                
                                (1,168,775
                                )
                                
                                
                                (1,117,861
                                )
                                
                                
                                (10,429,683
                                )Investing
      activities:Acquisition
      of property and equipment
                                
                                
                                (96,552
                                )
                                
                                
                                (27,772
                                )
                                
                                
                                (468,007
                                )Acquisition
      of patents
                                
                                
                                -
                                
                                
                                
                                -
                                
                                
                                
                                (154,061
                                )Net
      cash used in investing activities
                                
                                
                                (96,552
                                )
                                
                                
                                (27,772
                                )
                                
                                
                                (622,068
                                )Financing
      activities:Payment
      on notes payable to officer
                                
                                
                                (19,260
                                )
                                
                                
                                (47,400
                                )
                                
                                
                                (218,502
                                )(Payments
      on ) proceeds from notes payable, related party
                                
                                
                                (15,000
                                )
                                
                                
                                -
                                
                                
                                
                                442,433Receipt
      from (payments to) equity line of credit
                                
                                
                                (27,336
                                )
                                
                                
                                (300,000
                                )
                                
                                
                                428,664Proceeds
      from notes payable
                                
                                
                                1,425,000
                                
                                
                                
                                1,861,000
                                
                                
                                
                                3,286,000Issuance
      of common stock for cash
                                
                                
                                750,000
                                
                                
                                
                                -
                                
                                
                                
                                8,179,594Receipt
      of cash for stock to be issued
                                
                                
                                -
                                
                                
                                
                                -
                                
                                
                                
                                400Net
      cash provided by financing activities
                                
                                
                                2,113,404
                                
                                
                                
                                1,513,600
                                
                                
                                
                                12,272,339Increase
      in cash and cash equivalents
                                
                                
                                848,077
                                
                                
                                
                                367,967
                                
                                
                                
                                1,220,588Cash
      and cash equivalents:Beginning
      of period
                                
                                
                                372,511
                                
                                
                                
                                4,544End
      of period
                                
                                $
                                1,220,588
                                
                                
                                $
                                372,511
                                
                                
                                $
                                1,220,588Cash
      paid for:Interest
                                
                                $
                                -
                                
                                
                                $
                                -Income
      taxes
                                
                                $
                                -
                                
                                
                                $
                                -





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


F-8


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
systems 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




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 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 $105 and
$4,555 for the years ended September 30, 2008 and 2007,
respectively.


F-9


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




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




Year
      Ended September 30,2008
                                              
                                              
                                              2007Net
                                                Loss
                                              
                                              
                                              Shares
                                              
                                              
                                              Per
                                                Share
                                              
                                              
                                              Net
                                                Loss
                                              
                                              
                                              Shares
                                              
                                              
                                              Per
                                                ShareBasic
      Earnings Per ShareNet
      Loss Available to Stockholders
                                              
                                              $
                                              (3,872,820
                                              )
                                              
                                              
                                              112,419,861
                                              
                                              
                                              $
                                              (0.03
                                              )
                                              
                                              $
                                              (2,168,226
                                              )
                                              
                                              
                                              106,207,706
                                              
                                              
                                              $
                                              (0.02
                                              )Effect
      of Dilutive Securities
                                              
                                              
                                              -
                                              
                                              
                                              
                                              -
                                              
                                              
                                              
                                              -
                                              
                                              
                                              
                                              -
                                              
                                              
                                              
                                              -
                                              
                                              
                                              
                                              -Diluted
      Earnings Per Share
                                              
                                              $
                                              (3,872,820
                                              )
                                              
                                              
                                              112,419,861
                                              
                                              
                                              $
                                              (0.03
                                              )
                                              
                                              $
                                              (2,168,226
                                              )
                                              
                                              
                                              106,207,706
                                              
                                              
                                              $
                                              (0.02
                                              )




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.




CONCENTRATION
OF CREDIT RISK




As of
September 30, 2008, and during the 2008 fiscal year, the Company had deposits in
financial institutions over the federally insured limits of $100,000. The
Company does not believe there is any credit risk related to these deposits due
to the financial condition of the financial institution.




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.




F-10




Note
3      PROPERTY AND EQUIPMENT




Property
and equipment consisted of the following at September 30:




2008
                          
                          
                          2007Machinery
      and equipment
                          
                          $
                          243,712
                          
                          
                          $
                          213,166Furniture
      and fixtures
                          
                          
                          41,176
                          
                          
                          
                          24,594Leasehold
      improvement
                          
                          
                          24,408TOTAL
      PROPERTY AND EQUIPMENT
                          
                          
                          309,296
                          
                          
                          
                          237,760Less
      accumulated depreciation
                          
                          
                          (222,195
                          )
                          
                          
                          (196,926
                          )NET
      PROPERTY AND EQUIPMENT
                          
                          $
                          87,101
                          
                          
                          $
                          40,834


Depreciation
expenses for fiscal years ended September 30, 2008 and 2007 were $25,270 and
$31,699, respectively.




Property
and equipment are being depreciated and amortized on the straight-line basis
over the following estimated useful lives:




YearsMachinery
      and equipment
                                
                                
                                5Furniture
      and fixtures
                                
                                
                                3-5Leasehold
      improvements
                                
                                
                                3




Note
4      ACCRUED EXPENSES




Accrued
expenses consisted of the following at September 30:




2008
                              
                              
                              2007Accrued
      salaries
                              
                              $
                              1,493,444
                              
                              
                              $
                              1,381,981Advisory
      board compensation
                              
                              
                              576,000
                              
                              
                              
                              380,441Auto
      allowance accruals
                              
                              
                              94,408
                              
                              
                              
                              71,768Interest
      payable
                              
                              
                              272,016
                              
                              
                              
                              165,770Other
      accruals
                              
                              
                              286,102
                              
                              
                              
                              68,154TOTAL
      ACCRUED EXPENSES
                              
                              $
                              2,721,970
                              
                              
                              $
                              2,068,114




Note
5      CUSTOMER DEPOSITS




In May
2008, the Company received an order for two water filtration systems, which
required a deposit. The Company is in the design phase of the manufacturing
process, and has not recognized any revenue related to these water filtration
systems. As of September 30, 2008, customer deposits were
$1,260,000.




Note
6      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, 2008 and
2007, notes payable amounted to $114,000 and $129,000, respectively. Accrued
interest on the notes amounted to $74,482 and $64,548 at September 30, 2008 and
2007, respectively, and is included in accrued expenses. Interest expenses on
these notes for the years ended September 30, 2008 and 2007 amounted to $12,718
and $12,850, respectively.


F-11


Note
7      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, 2008 and 2007 was $0 and $19,260,
respectively.




Note
8      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 settled $900,000 in
principal amount of the notes 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 was $27,336, which was subsequently paid in October 2007.




Note
9      CONVERTIBLE NOTES




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 at the earlier of (i) 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 was not declared
effective within 180 days after the closing, the conversion price was to be
reduced by $0.0025 per share for each 30 day period that the effectiveness of
the registration statement was delayed but in no case could the conversion price
to be reduced below $0.04 per share. As of September 30, 2008 and 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 terms of the conversion feature only allow the
counterparty to convert the notes into shares of common stock. Therefore, EITF
00-19, paragraphs 12-33 were included in the analysis to determine the
classification of the conversion feature. 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.


F-12





The fair
value of the embedded beneficial conversion features was $750,000 at the date of
issuance using the Black Sholes modelwith 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 of 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, 2008, the outstanding principal amount of the convertible notes
was $533,333 and there was no unamortized embedded beneficial conversion feature
discount. As of August 27, 2008, the convertible notes had matured and the
outstanding principal amount of $533,333 and accrued interest of $75,224 were
due. The Company has not yet paid the notes and no demand for payment has been
made.




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, 2008, interest expense was $69,702, and amortization
expense for the embedded beneficial conversion feature discount was $290,556,
which was included in interest expense in the other income (expense) section of
the statement of operations.




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 are no registration rights associated with these
notes.




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 terms of the conversion feature only allow the
counterparty to convert the notes into shares of common stock. Therefore, EITF
00-19, paragraphs 12-33 were included in the analysis to determine the
classification of the conversion feature. 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.


F-13





The fair
value of the embedded beneficial conversion features was $86,000 at the date of
issuance using the Black Sholes modelwith 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, 2008, the outstanding principal amount of the convertible notes
was $26,000 and the unamortized embedded beneficial conversion feature discount
was $2,889, for a net convertible debt of $23,111.




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, 2008, interest expense was $8,084, and amortization
expense for the embedded beneficial conversion feature discount was $64,000,
which was included in interest expense in the other income (expense) section of
the statement of operations.




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.




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. Convertible Notes 3 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 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 of Common
Stock issuable upon conversion of the  Convertible Notes 3 and the
warrant shares (collectively, the "Registrable Securities"). If the Company did
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 was not declared effective by the Securities and Exchange
Commission within 90 days, then the Company was required to pay to each
purchaser damages equal to 1.5% of the purchase price paid by the purchaser for
Convertible Notes 3 for each 30 day period that followed 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 $153,750 for the fiscal year ended September 30,
2008, and $15,375 for a period of one month for the fiscal year ended September
30, 2007, as liquidated damages. No derivative liability is recorded as the
amount of liquidated damage is fixed with a maximum ceiling.


F-14


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 the 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 $430,189.




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 terms of the conversion feature only allow the
counterparty to convert the notes into shares of Common Stock. Therefore, EITF
00-19, paragraphs 12-33 were included in the analysis to determine the
classification of the conversion feature.  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 $594,811 at the date of
issuance using the Black Sholes modelwith 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
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.




As of
September 30, 2008, the outstanding principal amount of the convertible notes
was $485,000, there was no unamortized warrant discount or embedded beneficial
conversion feature discount, and the number of outstanding warrants was
2,329,546. As of July 16, 2008, the convertible notes had matured and the
outstanding principal amount of $485,000 and accrued interest of $67,417 were
due. No demand for payment has been made.


F-15


As of
September 30, 2007, the outstanding principal amount of the convertible notes
was $1,025,000, the unamortized warrant discount was $305,228, the unamortized
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, 2008, interest expense was $68,097, amortization
expense for the warrant discount was $305,228, 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
$396,543, which was also included in interest expense in the other income
(expense) section of the statement of operations.




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.




12%
SUBORDINATED CONVERTIBLE NOTES




On July
29, 2008, the Company completed an offering of $1,000,000 in principal amount of
Subordinated Debentures to a group of institutional and accredited
investors.  The 12% Subordinated Convertible Notes mature on July 29,
2009 orsooner
if declared due and payable by the holder upon the occurrence of an event of
default, and bear interest at the rate of 12% per annum. The Debentures will be
convertible into Common Stock at a conversion price of $0.25 per share (the
“Conversion Price”) from and after such time as the authorized Common Stock is
increased in accordance with applicable federal and state laws. In the event of
an offering of Common Stock, or securities convertible into Common Stock, at a
price, conversion price or exercise price less than the conversion price (a
“dilutive issuance”), then the conversion price of any then outstanding
subordinated convertible notes will be reduced to equal such lower price, except
in connection with certain exempt issuances.  In an event of default,
the conversion price will be reduced to $0.15 per share. As part of the above
offering, the Company issued warrants to purchase 3,333,333 shares of Common
Stock, which expire five years from the date of grant, are exercisable at an
exercise price of $0.30 per share from and after such time as the authorized
Common Stock is increased in accordance with applicable federal and state laws,
and may be exercised on a cashless basis at the election of the
holder.  In the event of a dilutive issuance, the exercise price of
the warrants will be reduced to equal the price of the securities issued in the
dilutive issuance, except in connection with certain exempt issuances. The note
will be converted into 4,000,000 shares of Common Stock at a conversion price of
$0.25 per share. These shares were excluded from the earnings per share
calculation as effect of dilutive securities is anti-dilutive.




The
requirement to increase the number of authorized shares of Common Stock is a
condition that has not occurred, is not certain to occur, and is outside the
control of the Company. Therefore, the Company has not recognized the related
beneficial conversion feature or the warrants related to these notes. If and
when this condition does occur, the Company will recognize the beneficial
conversion feature and warrants at fair value on the date the number of
authorized shares is increased.




Calico
Capital Management, LLC acted as a financial advisor for the Company and
received a fee of $40,000. LBS Financial Services, LLC acted as an agent for the
Company in arranging the transaction and received a fee of $120,000. The Company
recorded these fees as an expense during the period.




As of
September 30, 2008, the principal outstanding totaled $1,000,000.




For the
year ended September 30, 2008, interest expense was $21,041.




Note
10      10% SUBORDINATED NOTES PAYABLE




In
January 2008, the Company completed an offering of $425,000 in principal amount
of Subordinated Debentures to a group of institutional and accredited
investors.  The Subordinated Debentures mature on December 31, 2008,
and bear interest at the rate of 10% per annum. As part of the above offering,
the Company issued warrants to purchase 850,000 shares of Common Stock, which
expire five years from the date of grant.


F-16


The
Company applied APB 14, paragraphs 15 and 16, to determine the allocation of the
proceeds of the convertible debt. Paragraph 15 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 grant
date fair value of the warrants was determined to be $125,462 which was
calculated using the Black-Sholes option pricing model, using the following
assumptions: risk free rate of return ranging from 2.64% to 3.26%, volatility
ranging from 97.08% to 98.27%, dividend yield of 0% and expected life of six
years. As a result, the relative fair value of the warrants was
$96,814.




As of
September 30, 2008, the principal outstanding totaled $425,000, unamortized
warrant discount totaled $24,204, and the net amount of the note payable was
$400,796.




For the
year ended September 30, 2008, interest expense was $30,362, and amortization
expense for the warrant discount was $72,610, which was included in interest
expense in the other income (expense) section of the statement of
operations.




Note
11      WARRANT LIABILITY




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, 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.




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 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.


F-17


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 for the fiscal year ended September
30, 2007.




The
Company analyzed the options as of September 30, 2008 by following the guidance
of SFAS 133, paragraph 6 to ascertain if the options issued remained derivatives
as of September 30, 2008. 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 beclassified as a liability.  Following this guidance, the
Company classified the options as liabilities.




The fair
value of the options was $484,440 as of September 30, 2008, calculated using the
Black Sholes model with the following assumptions: risk free rate of return of
1.78%; volatility of 84.94%; dividend yield of 0%; and an expected term of 2.5
years.




The
decrease in the fair value of the options was recorded by decreasing warrant
liability on the balance sheet by $1,442,474 for the fiscal year ended September
30, 2008.




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 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 a 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 modelwith 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 beclassified 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.


F-18


The
Company determined that the fair value of the warrants was $0 as of September
30, 2008 and 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 Notes 3




On July
17, 2007 the Company completed an offering of $1,025,000 of Convertible Notes 3
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 Notes 3 and 465,908 shares of Common Stock as a
placement fee) at an exercise price of $0.50 per share. An amendment dated March
13, 2008 reduces the exercise price of the warrants to $0.30 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 contractsthat 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 the warrants was $554,249 ($430,189 attributable to the holders of the
Convertible Notes 3 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.




The
Company analyzed the warrants as of September 30, 2007 by following the guidance
of 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. 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 beclassified as a
liability.




The fair
value of the warrants was determined to be $499,932 ($379,672 attributable to
the holders of the Convertible Notes 3 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 for the fiscal year ended September
30, 2007 was recorded by decreasing warrant liabilities on the balance sheet by
$54,317 ($50,518 attributable to the holders of the Convertible Notes 3 and
$3,799 attributable to the placement fee).




The
Company analyzed the warrants as of September 30, 2008 by following the guidance
of SFAS 133, paragraph 6 to ascertain if the warrants issued remained
derivatives as of September 30, 2008. 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. 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 beclassified as a
liability.


F-19


The fair
value of the warrants was determined to be $153,789 ($125,440 attributable to
the holders of the Convertible Notes 3 and $28,349 attributable to the placement
fee)as of
September 30, 2008, which was calculated using the Black Sholes model with the
following assumptions: risk free rate of return of 1.78%; volatility of 84.94%;
dividend yield of 0%; and an expected term of 3.67 to 3.75 years.




The
decrease in the fair value of the warrants for the fiscal year ended September
30, 2008 was recorded by decreasing warrant liabilities on the balance sheet by
$346,143 ($254,232 attributable to the holders of the Convertible Notes 3 and
$91,911 attributable to the placement fee).




Warrants
Issued to Advisory Board Members




On
December 13, 2007, the Company’s Board of Directors approved the issuance of
five year warrants to the Company’s three advisory board members to purchase a
total of 8,640,000 shares of the Company’s Common Stock at an exercise price of
$0.25 per share.




The
Company followed the guidance of FASB 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 contractsthat 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 warrants, the Company followed the
guidance of EITF 00-19, paragraph 9, which states that contracts which require a
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 $1,557,705 at the date of issuance and was calculated
using the Black Sholes option valuation model with the following assumptions:
risk free interest rate of 3.22%, expected volatility of 99.86%, dividend yields
of 0% and 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.




The
Company analyzed the warrants by applying FASB 133,paragraph 6 to ascertain if
the warrants remained derivatives as of September 30, 2008. 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. EITF 00-19, paragraph 8 was
applied which states that if share settlement is not controlled by a company,
the contract is required to be classified as a liability. Paragraph 9 also
states that 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 warrants was determined to be $620,453 as of September 30, 2008,
using the Black Sholes model with the following assumptions: risk free rate of
return of 1.78%; volatility of 84.94%; dividend yield of 0%; and an expected
term of 4.17 years.




The
decrease in the fair value of the warrants was $937,252 for the year ended
September 30, 2008, and recorded by decreasing the warrant liability on the
balance sheet.




Option
Issued to Director




On
December 13, 2007, the Company’s Board of Directors approved the issuance of a
five year option to a Company director to purchase a total of 1,000,000 shares
of the Company’s common stock at an exercise price of $0.25 per
share.


F-20


The
Company followed the guidance of FASB 133, paragraph 6, to determine if the
option was within the scope and definition of a derivative at the date of
issuance. The option had one or more underlings and one or more notional
amounts, required no initial investment and required or permitted net
settlement. Therefore, the option was determined to be a derivative at the date
of issuance. In order to determine how to classify the option, the Company
followed the guidance of EITF 00-19, paragraphs 7 and 8, which state that
contractsthat 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 option, 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 option was $171,520 at the date of issuance and was calculated
using the Black Sholes option valuation model with the following assumptions:
risk free interest rate of 3.22%, expected volatility of 99.86%, dividend yields
of 0% and 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.




The
Company analyzed the option by applying FASB 133,paragraph 6 to ascertain if
the option remained a derivative as of September 30, 2008. All of the criteria
in the original analysis were met, and the option issued was determined to be
within the scope and definition of a derivative. EITF 00-19, paragraph 8 was
applied which states that if share settlement is not controlled by the company,
the contract is required to be classified as a liability. Paragraph 9 also
states that 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 option was determined to be $71,812 as of September 30, 2008, using
the Black Sholes model with the following assumptions: risk free rate of return
of 1.78%; volatility of 84.94%; dividend yield of 0%; and an expected term of
4.17 years.




The
decrease in the fair value of the option was $99,708 for the year ended
September 30, 2008, and recorded by decreasing the warrant liability on the
balance sheet.




Option
Issued to Former Chief Financial Officer




On
December 13, 2007, the Company’s Board of Directors approved the issuance of a
five year option to the Chief Financial Officer on that date to purchase a total
of 1,000,000 shares of the Company’s common stock at an exercise price of $0.25
per share.




The
Company followed the guidance of FASB 133, paragraph 6, to determine if the
option was within the scope and definition of a derivative at the date of
issuance. The option had one or more underlings and one or more notional
amounts, required no initial investment and required or permitted net
settlement. Therefore, the option was determined to be a derivative at the date
of issuance. In order to determine how to classify the option, the Company
followed the guidance of EITF 00-19, paragraphs 7 and 8, which state that
contractsthat 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 option, 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 option was $171,520 at the date of issuance and was calculated
using the Black Sholes option valuation model with the following assumptions:
risk free interest rate of 3.22%, expected volatility of 99.86%, dividend yields
of 0% and 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.


F-21


The
Company analyzed the option by applying FASB 133,paragraph 6 to ascertain if
the option remained a derivative as of September 30, 2008. All of the criteria
in the original analysis were met, and the option issued was determined to be
within the scope and definition of a derivative. EITF 00-19, paragraph 8 was
applied which states that if share settlement is not controlled by the company,
the contract is required to be classified as a liability. Paragraph 9 also
states that 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 option was determined to be $71,812 as of September 30, 2008, using
the Black Sholes model with the following assumptions: risk free rate of return
of 1.78%; volatility of 84.94%; dividend yield of 0%; and an expected term of
4.17 years.




The
decrease in the fair value of the option was $99,708 for the year ended
September 30, 2008, and recorded by decreasing the warrant liability on the
balance sheet.




Option
Issued to Former Chief Executive Officer




On December 19, 2007, the Company
entered into a one year Employment Agreement with Richard H. Papalian pursuant
to which Mr. Papalian had been appointed as the Company’s Chief Executive
Officer. As compensation for his services, the Company granted Mr. Papalian 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. As per the terms of the stock
option agreement, the right to purchase 340,000 shares of Common Stock is not
exercisable until the notes dated June 6, 2007 (Convertible Note 2 as discussed
in Note 9 above) are eligible for conversion into shares of Common Stock. These
options were not issued from the 2001 Executive Officers Stock Option
Plan. On August 14, 2008,
Mr. Papalian resigned as the Company’s Chief Executive
Officer




On the
grant date, the Company applied FASB 133, paragraph 6 to determine if
the option was within the scope and definition of a derivative. The option had
one or more underlings and one or more notional amounts, required no initial
investment, and required or permitted net settlement. Therefore, the option was
determined to be a derivative. In order to determine how to classify the option,
the Company followed the guidance of EITF 00-19, paragraphs 7 and 8, which state
that contractsthat 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 option, 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.




The fair
value of the option was $1,448,321 at the date of issuance, which was calculated
using the Black Sholes model with the following assumptions: risk free rate of
return of 3.26%; volatility of 98.01%; 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.




The
Company analyzed the option as of September 30, 2008 by applying FASB 133,paragraph 6 to ascertain if
the option issued remained a derivative as of September 30, 2008. All of the
criteria in the original analysis were met, and the option issued was determined
to be within the scope and definition of a derivative. EITF 00-19, paragraph 8
was applied which states that if share settlement is not controlled by a
company, the contract is required to be classified as a liability. Paragraph 9
also states that 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 option was $613,223 as of September 30, 2008, which was calculated
using the Black Sholes model with the following assumptions: risk free rate of
return of 1.78%; volatility of 84.94%; dividend yield of 0%; and an expected
term of 4.17 years.


F-22


The
decrease in the fair value of the option was $835,098 for the year ended
September 30, 2008, and was recorded by decreasing the warrant liability on the
balance sheet.




Warrant
Issued to Consultant




On
December 19, 2007, the Company entered into a one year Consulting Agreement with
Mark Maron pursuant to which Mr. Maron has been appointed as Special Adviser to
the Company. As compensation for his services, the Company granted Mr. Maron a
five year warrant to purchase up to 8,539,312 shares of the Company’s Common
Stock at an exercise price of $0.25 per share. As per the terms of the warrant
agreement, the right to purchase 340,000 shares of Common Stock is not
exercisable until the notes dated June 6, 2007 (Convertible Note 2 as discussed
in Note 9 above) are eligible for conversion into shares of Common
Stock.  The warrant was not issued from the 2001 Executive Officers
Stock Option Plan.




The
Company followed the guidance of FASB 133, paragraph 6, to determine if the
warrant was within the scope and definition of a derivative at the date of
issuance. The warrant had one or more underlings and one or more notional
amounts, required no initial investment and required or permitted net
settlement. Therefore, the warrant was determined to be a derivative at the date
of issuance. In order to determine how to classify the warrant, the Company
followed the guidance of EITF 00-19, paragraphs 7 and 8, which state that
contractsthat 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 warrant, 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 warrant was $1,448,321 at the date of issuance and was calculated
using the Black Sholes option valuation model with the following assumptions:
risk free interest rate of 3.26%, expected volatility of 98.01%, dividend yields
of 0% and 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.




The
Company analyzed the warrant by applying FASB 133,paragraph 6 to ascertain if
the warrant remained a derivative as of September 30, 2008. All of the criteria
in the original analysis were met, and the warrant issued was determined to be
within the scope and definition of a derivative. EITF 00-19, paragraph 8 was
applied which states that if share settlement is not controlled by the company,
the contract is required to be classified as a liability. Paragraph 9 also
states that 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 warrant was determined to be $613,223 as of September 30, 2008,
using the Black Sholes model with the following assumptions: risk free rate of
return of 1.78%; volatility of 84.94%; dividend yield of 0%; and an expected
term of 4.17 years.




The
decrease in the fair value of the warrant was $835,098 for the year ended
September 30, 2008, and recorded by decreasing the warrant liability on the
balance sheet.




Warrants
Related to 10% Subordinated Debentures




In
January 2008, the Company completed an offering of $425,000 in principal amount
of Subordinated Debentures to a group of institutional and accredited investors.
As part of the above offering, the Company issued warrants to purchase 850,000
shares of Common Stock.


F-23


The
Company followed the guidance of FASB 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 contractsthat
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
warrants, the Company followed the guidance of EITF 00-19, paragraph 9, which
states that contracts which require a 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 determined to be $96,814 at the date of issuance,
which was calculated using the Black-Sholes option pricing model, using the
following assumptions: risk free rate of return of ranging from 2.64% to 3.26%,
volatility ranging from 97.08% to 98.27%, dividend yield of 0% and expected life
of six 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 analyzed the warrants by applying FASB 133,paragraph 6 to ascertain if
the warrants remained derivatives as of September 30, 2008. 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. EITF 00-19, paragraph 8 was
applied which states that if share settlement is not controlled by the company,
the contract is required to be classified as a liability. Paragraph 9 also
states that 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 warrants was determined to be $52,609 as of September 30, 2008,
using the Black Sholes model with the following assumptions: risk free rate of
return of 1.78%; volatility of 84.94%; dividend yield of 0%; and an expected
term of 5.33 years.




The
decrease in the fair value of the options was $44,205 for the fiscal year ended
September 30, 2008, and recorded by decreasing the warrant liability on the
balance sheet.




Warrants
Related to $750,000 Stock Issuance




On May
28, 2008 the Company completed an offering of units consisting of Common Stock
and warrants to purchase shares of its Common Stock to a group of institutional
and accredited investors.  The Company raised a total of $750,000
through this offering.  The Company issued warrants to purchase
15,000,000 shares of Common Stock at an exercise price of $0.10 per share. The
warrants expire three years from the date of issuance.




The
Company followed the guidance of FASB 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 contractsthat 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 warrants, the Company followed the
guidance of EITF 00-19, paragraph 9, which states that contracts which require a
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 determined to be $483,476 at the date of issuance,
which was calculated using the Black Sholes option pricing model, using the
following assumptions: risk free rate of return of 1.32% to 2.17%, volatility of
72.4% to 77.86%, dividend yield of 0%, and expected term of 3
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.


F-24


The
Company analyzed the warrants by applying FASB 133,paragraph 6 to ascertain if
the warrants remained derivatives as of September 30, 2008. All of the criteria
in the original analysis were met, and the warrants were determined to be within
the scope and definition of a derivative. EITF 00-19, paragraph 8 was applied
which states that if share settlement is not controlled by the company, the
contract is required to be classified as a liability. Paragraph 9 also states
that 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 warrants was determined to be $468,079 as of September 30, 2008,
which was calculated using the Black-Sholes option pricing model, using the
following assumptions: risk free rate of return of 1.78%, volatility of 84.94%,
dividend yield of 0% and expected term of 2.42 to 2.58 years.




The
increase in the fair value of the warrants of $15,397 for the fiscal year ended
September 30, 2008 was recorded in decrease in warrant liability in the other
income (expense) section of the statement of operations.




Warrant
Issued to Legal Consultant




On June
24, 2008, the Company entered into an agreement with its legal counsel,
Richardson & Patel, LLP, to issue 600,139 shares of Common Stock and a six
year warrant to purchase up to 400,000 shares of Common Stock at an exercise
price of $0.15 per share for services previously rendered.




The
Company followed the guidance of FASB 133, paragraph 6, to determine if the
warrant was within the scope and definition of a derivative at the date of
issuance. The warrant had one or more underlings and one or more notional
amounts, required no initial investment and required or permitted net
settlement. Therefore, the warrant was determined to be a derivative at the date
of issuance. In order to determine how to classify the warrant, the Company
followed the guidance of EITF 00-19, paragraphs 7 and 8, which state that
contractsthat 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 warrant, the Company followed the
guidance of EITF 00-19, paragraph 9, which states that contracts which require a
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 warrant was $60,645 at the date of issuance and was calculated
using the Black Sholes option valuation model with the following assumptions:
risk free interest rate of 2.36%, expected volatility of 74.90%, dividend yields
of 0% and expected term of 6 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 analyzed the warrant by applying FASB 133,paragraph 6 to ascertain if
the warrant remained a derivative as of September 30, 2008. All of the criteria
in the original analysis were met, and the warrant issued was determined to be
within the scope and definition of a derivative. EITF 00-19, paragraph 8 was
applied which states that if share settlement is not controlled by the company,
the contract is required to be classified as a liability. Paragraph 9 also
states that 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 warrant was determined to be $38,802 as of September 30, 2008,
using the Black Sholes model with the following assumptions: risk free rate of
return of 1.78%; volatility of 84.94%; dividend yield of 0%; and an expected
term of 5.75 years.




The
decrease in the fair value of the warrant was $21,843 for the year ended
September 30, 2008, and recorded by decreasing the warrant liability on the
balance sheet.


F-25


Warrant
Issued to Director (John Pavia)




On July
11, 2008, the Company’s Board of Directors approved the issuance of a five year
warrant to a director to purchase a total of 500,000 shares of the Company’s
Common Stock at an exercise price of $0.25 per share.




The
Company followed the guidance of FASB 133, paragraph 6, to determine if the
warrant was within the scope and definition of a derivative at the date of
issuance. The warrant had one or more underlings and one or more notional
amounts, required no initial investment and required or permitted net
settlement. Therefore, the warrant was determined to be a derivative at the date
of issuance. In order to determine how to classify the warrant, the Company
followed the guidance of EITF 00-19, paragraphs 7 and 8, which state that
contractsthat 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 warrant, the Company followed the
guidance of EITF 00-19, paragraph 9, which states that contracts which require a
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 warrant was $51,582 at the date of issuance and was calculated
using the Black Sholes option valuation model with the following assumptions:
risk free interest rate of 2.30%, expected volatility of 71.69%, dividend yields
of 0% and 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.




The
Company analyzed the warrant by applying FASB 133,paragraph 6 to ascertain if
the warrant remained a derivative as of September 30, 2008. All of the criteria
in the original analysis were met, and the warrant issued was determined to be
within the scope and definition of a derivative. EITF 00-19, paragraph 8 was
applied which states that if share settlement is not controlled by the company,
the contract is required to be classified as a liability. Paragraph 9 also
states that 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 warrant was determined to be $38,759 as of September 30, 2008,
using the Black Sholes model with the following assumptions: risk free rate of
1.78%; volatility of 84.94%; dividend yield of 0%; and an expected term of 4.75
years.




The
decrease in the fair value of the warrant was $12,823 for the year ended
September 30, 2008, and recorded by decreasing the warrant liability on the
balance sheet.




Warrant
Issued to Director (Marcus Woods)




On July
11, 2008, the Company’s Board of Directors approved the issuance of a five year
warrant to a director to purchase a total of 500,000 shares of the Company’s
Common Stock at an exercise price of $0.25 per share.




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


F-26


The fair
value of the warrant was $51,582 at the date of issuance and was calculated
using the Black Sholes option valuation model with the following assumptions:
risk free interest rate of 2.30%, expected volatility of 71.69%, dividend yields
of 0% and 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.




The
Company analyzed the warrant by applying FASB 133,paragraph 6 to ascertain if
the warrant remained a derivative as of September 30, 2008. All of the criteria
in the original analysis were met, and the warrant was determined to be within
the scope and definition of a derivative. EITF 00-19, paragraph 8 was applied
which states that if share settlement is not controlled by the company, the
contract is required to be classified as a liability. Paragraph 9 also states
that 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 warrant was determined to be $38,759 as of September 30, 2008,
using the Black Sholes model with the following assumptions: risk free rate of
return of 1.78%; volatility of 84.94%; dividend yield of 0%; and an expected
term of 4.75 years.




The
decrease in the fair value of the warrant was $12,823 for the year ended
September 30, 2008, and recorded by decreasing the warrant liability on the
balance sheet.




Warrant
Issued to Legal Consultant




On July
22, 2008, the Company entered into an agreement with its legal counsel,
Richardson & Patel, LLP, to issue 641,000 shares of Common Stock and a six
year warrant to purchase up to 641,000 shares of Common Stock at an exercise
price of $0.15 per share for services previously rendered.




The
Company followed the guidance of FASB 133, paragraph 6, to determine if the
warrant was within the scope and definition of a derivative at the date of
issuance. The warrant had one or more underlings and one or more notional
amounts, required no initial investment and required or permitted net
settlement. Therefore, the warrant was determined to be a derivative at the date
of issuance. In order to determine how to classify the warrant, the Company
followed the guidance of EITF 00-19, paragraphs 7 and 8, which state that
contractsthat 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 warrant, the Company followed the
guidance of EITF 00-19, paragraph 9, which states that contracts which require a
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 warrant was $82,779 at the date of issuance and was calculated
using the Black Sholes option valuation model with the following assumptions:
risk free interest rate of 2.27%, expected volatility of 70.18%, dividend yields
of 0% and expected term of 6 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 analyzed the warrant by applying FASB 133,paragraph 6 to ascertain if
the warrant remained a derivative as of September 30, 2008. All of the criteria
in the original analysis were met, and the warrant issued was determined to be
within the scope and definition of a derivative. EITF 00-19, paragraph 8 was
applied which states that if share settlement is not controlled by the company,
the contract is required to be classified as a liability. Paragraph 9 also
states that 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.


F-27


The fair
value of the warrant was determined to be $62,512 as of September 30, 2008,
using the Black Sholes model with the following assumptions: risk free rate of
1.78%; volatility of 84.94%; dividend yield of 0%; and an expected term of 5.75
years.




The
decrease in the fair value of the warrant was $20,267 for the year ended
September 30, 2008, and recorded by decreasing the warrant liability on the
balance sheet.




Warrant
Issued to Advisory Board Member




On
September 23, 2008, the Company issued a five year warrant to a member of the
Company’s advisory board to purchase 1,500,000 shares of the Company’s Common
Stock at an exercise price of $0.25 per share.




The
Company followed the guidance of FASB 133, paragraph 6, to determine if the
warrant was within the scope and definition of a derivative at the date of
issuance. The warrant had one or more underlings and one or more notional
amounts, required no initial investment and required or permitted net
settlement. Therefore, the warrant was determined to be a derivative at the date
of issuance. In order to determine how to classify the warrant, the Company
followed the guidance of EITF 00-19, paragraphs 7 and 8, which state that
contractsthat 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 warrant, the Company followed the
guidance of EITF 00-19, paragraph 9, which states that contracts which require a
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 warrant was $144,641 at the date of issuance and was calculated
using the Black Sholes option valuation model with the following assumptions:
risk free interest rate of 2.01%, expected volatility of 78.92%, dividend yields
of 0% and 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.




The
Company analyzed the warrant by applying FASB 133,paragraph 6 to ascertain if
the warrant remained a derivative as of September 30, 2008. All of the criteria
in the original analysis were met, and the warrant issued was determined to be
within the scope and definition of a derivative. EITF 00-19, paragraph 8 was
applied which states that if share settlement is not controlled by the company,
the contract is required to be classified as a liability. Paragraph 9 also
states that 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 warrant was determined to be $118,551 as of September 30, 2008,
using the Black Sholes model with the following assumptions: risk free rate of
return of 1.78%; volatility of 84.94%; dividend yield of 0%; and an expected
term of 4.83 years.




The
decrease in the fair value of the warrant was $26,090 for the year ended
September 30, 2008, and recorded by decreasing the warrant liability on the
balance sheet.




Note
12      BENEFICIAL CONVERSION FEATURES
LIABILITY




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.


F-28


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 a 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 modelwith 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
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 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.




On
December 13, 2007, the Company’s Board of Directors approved amendments to the
agreements with the members of the advisory board. The Company remained liable
for the $576,000 of compensation, and granted five year options to purchase a
total of 10,140,000 shares of the Company’s Common Stock at an exercise price of
$0.25 in consideration of the ability to convert the compensation into the
Company’s Common Stock at a rate of $0.05 per share. Therefore, the compensation
was not convertible as of September 30, 2008.




Beneficial
Conversion Features




The
Company issued convertible notes between October 17, 2006, and July 17, 2007
that matured or mature between June 17, 2008 and December 31, 2008, and included
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 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.


F-29


The
Company followed the guidance of SFAS 133, paragraph 6, to ascertain if the
embedded beneficial conversion features were derivatives at the date of issue.
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. 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 modelwith 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
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 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.




The
Company followed the guidance of SFAS 133, paragraph 6, to ascertain if the
embedded beneficial conversion features remained derivatives as of September 30,
2008. 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 $26,000 as of September
30, 2008, which was calculated using the Black Sholes model with the following
assumptions: risk free rate of return of 1.78%; volatility of 84.94%; dividend
yield of 0% and an expected term of .25.




The
decrease in the fair value of the embedded beneficial conversion feature was
recorded by decreasing beneficial conversion features liability on the balance
sheet by $1,404,811.


F-30




Note 13
INCOME TAXES




Through
September 30, 2008, the Company incurred net operating losses for tax purposes
of approximately $21,740,000. The net operating loss carry forward for
federal and state purposes may be used to reduce taxable income through the year
2028. 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, 2008 is $8,347,000. 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 are as follows at September 30:





2008
                                            
                                            
                                            2007Deferred
      tax asset
                                            
                                            $
                                            8,347,000
                                            
                                            
                                            $
                                            4,740,000Less
      valuation allowance
                                            
                                            
                                            (8,347,000
                                            )
                                            
                                            
                                            (4,740,000
                                            )$
                                            -
                                            
                                            
                                            $
                                            -




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




2008
                                                                          
                                                                          
                                                                          2007Amount
                                                                          
                                                                          
                                                                          Rate
                                                                          
                                                                          
                                                                          Amount
                                                                          
                                                                          
                                                                          RateIncome
      tax expense (benefit) at statutory federal rate
                                                                          
                                                                          $
                                                                          (3,093,000
                                                                          )
                                                                          
                                                                          -34
                                                                          %
                                                                          
                                                                          $
                                                                          (819,000
                                                                          )
                                                                          
                                                                          
                                                                          -34
                                                                          %State
      income tax expense (benefit), net of federal income tax
                                                                          
                                                                          
                                                                          (514,000
                                                                          )
                                                                          
                                                                          -4
                                                                          %
                                                                          
                                                                          
                                                                          (136,000
                                                                          )
                                                                          
                                                                          
                                                                          -6
                                                                          %Valuation
      allowance
                                                                          
                                                                          
                                                                          3,607,000
                                                                          
                                                                          
                                                                          40
                                                                          %
                                                                          
                                                                          
                                                                          955,000
                                                                          
                                                                          
                                                                          
                                                                          40
                                                                          %$
                                                                          -
                                                                          
                                                                          
                                                                          0
                                                                          %
                                                                          
                                                                          $
                                                                          -
                                                                          
                                                                          
                                                                          
                                                                          0
                                                                          %




Details
of the Company’s deferred tax assets (liabilities) are as follows as of
September 30, 2008 and 2007:




2008
                                      
                                      2007Warrant
      amortization expense
                                      
                                      $
                                      155,000
                                      
                                      $
                                      45,000Beneficial
      conversion feature expense
                                      
                                      
                                      311,000
                                      
                                      
                                      134,000Increase
      in fair market value of warrants
                                      
                                      
                                      (1,480,000
                                      )
                                      
                                      (85,000
                                      )Decrease
      in fair market value of beneficial conversion feature
                                      
                                      
                                      (562,000
                                      )
                                      
                                      2,000Increase
      in fair market value of stock options
                                      
                                      
                                      (419,000
                                      )
                                      
                                      (138,000
                                      )Net
      operating loss carryforward
                                      
                                      
                                      10,342,000
                                      
                                      
                                      4,698,000Valuation
      allowance
                                      
                                      
                                      (8,347,000
                                      )
                                      
                                      (4,740,000
                                      )$
                                      -
                                      
                                      $
                                      -





F-31




Note 14
STOCKHOLDERS’ EQUITY




COMMON
STOCK




The
Company has 150,000,000 authorized shares, par value $0 .001 per
share.  As of September 30, 2008 and 2007, the Company had 134,756,213
and 107,117,101 shares of Common Stock issued, and 134,274,313 and 106,635,201
shares of Common Stock outstanding, respectively.




During
the fiscal year ended September 30, 2008, the Company entered into agreements to
issue 1,539,750 shares of Common Stock, valued between $0.21 and $0.22 per share
for legal services. The transaction was recorded at the fair market value. All
of these shares of Common Stock, with the exception of 600,139, were issued
during the 2008 fiscal year. The 600,139 shares of Common Stock, representing
$126,029, were issued on October 9, 2008, and included in shares to be issued as
of September 30, 2008. Additionally, the Company issued 17,149,359 shares of
common stock for $903,782 of converted debt and accrued interest, at conversion
prices between $0.01 and $0.19 per share. Lastly, the Company issued 8,950,003
shares of Common Stock, at prices of $0.03 and $0.10 per share for cash. Of the
shares of Common Stock issued for cash, 7,500,000 shares were issued between
March 2008 and May 2008 at $0.10 per share. The remaining 1,450,003 shares of
Common Stock having a value of $0.03 per share were issued to certain investors
pursuant to the terms of an offering undertaken by the Company in
2004.




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




The
Company has not issued 13,333 shares of Common Stock to certain investors
pursuant to the terms of an offering undertaken by the Company in 2004. 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




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




WeightedAverage
                              
                              
                              
                              
                              
                              AggregateExercise
                              
                              
                              Number
                              
                              
                              IntrinsicPrice
                              
                              
                              of Options
                              
                              
                              ValueOutstanding
      at October 1, 2006
                              
                              $
                              0.15
                              
                              
                              
                              7,034,140
                              
                              
                              $
                              -Granted
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              -Expired
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              -Forfeited
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              -Exercised
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              -Outstanding
      at September 30, 2007
                              
                              
                              0.15
                              
                              
                              
                              7,034,140
                              
                              
                              
                              -Granted
                              
                              
                              0.25
                              
                              
                              
                              10,539,312
                              
                              
                              
                              -Expired
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              -Forfeited
                              
                              
                              (0.25
                              )
                              
                              
                              (5,605,786
                              )
                              
                              
                              -Exercised
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              -Outstanding
      at September 30, 2008
                              
                              $
                              0.19
                              
                              
                              
                              11,967,666
                              
                              
                              $
                              -





F-32




Options
outstanding as of September 30, 2008:




Exercise
                        
                        
                        Options
                        
                        
                        Options
                        
                        
                        Weighted
                          Average
                          Remaining
                          Contractual
                        
                        
                        Weighted
      Average
                          ExercisePricePrice
                        
                        
                        Outstanding
                        
                        
                        Exercisable
                        
                        
                        Life
                        
                        
                        Outstanding
                        
                        
                        Exercisable$0.15
      - $0.25
                        
                        
                        
                        11,967,666
                        
                        
                        
                        11,967,666
                        
                        
                        
                        3.19
                        
                        
                        $
                        0.19
                        
                        
                        $
                        0.19




Outstanding
                
                
                Exercisable
                
                
                Weighted
                  Average
                  RemainingOption
      Holder
                
                Amount
                
                
                Exercise
                  Price
                
                
                Amount
                
                
                Exercise
                  Price
                
                
                Contractual
                  Life2001
      Executive Officers Stock Option Plan
                
                
                7,034,140
                
                
                $
                0.15
                
                
                
                7,034,140
                
                
                $
                0.15
                
                
                
                2.50Director
                
                
                1,000,000
                
                
                
                0.25
                
                
                
                1,000,000
                
                
                
                0.25
                
                
                
                4.17Former
      Chief Financial Officer
                
                
                1,000,000
                
                
                
                0.25
                
                
                
                1,000,000
                
                
                
                0.25
                
                
                
                4.17Former
      Chief Executive Officer
                
                
                2,933,526
                
                
                
                0.25
                
                
                
                2,933,526
                
                
                
                0.25
                
                
                
                4.17





STOCK
WARRANTS




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




Weighted
                          Average
                          Exercise
                          Price
                        
                        
                        Number
                          of Options
                        
                        
                        Aggregate
                          Intrinsic
                          ValueOutstanding
      at October 1, 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
                        
                        
                        
                        -Granted
                        
                        
                        0.20
                        
                        
                        
                        36,570,312
                        
                        
                        
                        600,000Expired
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -Forfeited
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -Exercised
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -Outstanding
      at September 30, 2008
                        
                        $
                        0.70
                        
                        
                        
                        39,365,766
                        
                        
                        $
                        600,000




F-33




Warrants
outstanding as of September 30, 2008:





Weighted
                    Average
                    Remaining
                  
                  
                  WeightedAverage
                    Exercise
      PriceExercise
                    Price
                  
                  
                  Warrants
                    Outstanding
                  
                  
                  Options
                    Exercisable
                  
                  
                  Contractual
                    Life
                  
                  
                  Outstanding
                  
                  
                  Exercisable$0.10
      - $0.40
                  
                  
                  
                  39,365,766
                  
                  
                  
                  39,365,766
                  
                  
                  
                  3.62
                  
                  
                  $
                  0.20
                  
                  
                  $
                  0.20




WeightedAverageOutstanding
                      
                      
                      Exercisable
                      
                      
                      RemainingWarrant
                      
                      
                      
                      
                      Exercise
                      
                      
                      
                      
                      
                      Exercise
                      
                      
                      ContractualHolder
                      
                      Amount
                      
                      
                      Price
                      
                      
                      Amount
                      
                      
                      Price
                      
                      
                      LifeConvertible
      Notes 3
                      
                      
                      2,795,454
                      
                      
                      $
                      0.30
                      
                      
                      
                      2,795,454
                      
                      
                      $
                      0.30
                      
                      
                      
                      3.70Advisory
      Board Members
                      
                      
                      8,640,000
                      
                      
                      
                      0.25
                      
                      
                      
                      8,640,000
                      
                      
                      
                      0.25
                      
                      
                      
                      4.17Consultant
                      
                      
                      8,539,312
                      
                      
                      
                      0.25
                      
                      
                      
                      8,539,312
                      
                      
                      
                      0.25
                      
                      
                      
                      4.1710%
      Subordinated Notes Payable
                      
                      
                      850,000
                      
                      
                      
                      0.40
                      
                      
                      
                      850,000
                      
                      
                      
                      0.40
                      
                      
                      
                      5.33Stockholders
                      
                      
                      15,000,000
                      
                      
                      
                      0.10
                      
                      
                      
                      15,000,000
                      
                      
                      
                      0.10
                      
                      
                      
                      2.52Richarson
      & Patel, LLC
                      
                      
                      400,000
                      
                      
                      
                      0.15
                      
                      
                      
                      400,000
                      
                      
                      
                      0.15
                      
                      
                      
                      5.67Director
                      
                      
                      500,000
                      
                      
                      
                      0.25
                      
                      
                      
                      500,000
                      
                      
                      
                      0.25
                      
                      
                      
                      4.75Director
                      
                      
                      500,000
                      
                      
                      
                      0.25
                      
                      
                      
                      500,000
                      
                      
                      
                      0.25
                      
                      
                      
                      4.75Richarson
      & Patel, LLC
                      
                      
                      641,000
                      
                      
                      
                      0.15
                      
                      
                      
                      641,000
                      
                      
                      
                      0.15
                      
                      
                      
                      5.75Advisory
      Board Member
                      
                      
                      1,500,000
                      
                      
                      
                      0.25
                      
                      
                      
                      1,500,000
                      
                      
                      
                      0.25
                      
                      
                      
                      4.92




Note 15
GOING CONCERN




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, 2008, the Company has incurred
cumulative losses of $21,893,656 including a loss for the year ended September
30, 2008 of $3,872,820. 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 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.




F-34




Management
expects an order for 14 additional water treatment systems from the customer who
purchased two water treatment systems. Additionally, management will continue to
identify new markets and demonstrate the water treatment unit to potential
customers. Management will closely monitor and evaluate expenses to identify
opportunities to reduce operating expenses.




Note 16
COMMITMENTS




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 the lease agreement are as follows.




For the Year Ended September 30,2009
                    
                    $
                    23,000





Total
rent expense under the operating lease was approximately $55,200 for the year
ended September 30, 2008.





As of
August 1, 2008, we entered into a 36 month lease for an industrial site
consisting of approximately 12,000 square feet of administrative offices and a
manufacturing facility.  Monthly lease payments for the period from
August 1, 2008 through July 31, 2009 are $8,650 plus common area maintenance
charges; monthly lease payments for the period from August 1, 2009 through July
31, 2010 are $8,995 plus common area maintenance charges and monthly lease
payments for the period from August 1, 2010 through July 31, 2011 are $9,355
plus common area maintenance charges.  The lease agreement includes an
option to extend the lease for an additional 36 months. If the option is
exercised, monthly payments over the three year term would be $9,730 plus common
are maintenance charges from August 1, 2011 through July 31, 2012, $10,118 plus
common area maintenance charges from August 1, 2012 through July 31, 2012, and
$10,523 plus common area maintenance charges from August 1, 2013 through July
31, 2014. The future aggregate minimum annual lease payments arising from this
lease agreement are as follows.




For the Year Ended September 30,2009
                      
                      $
                      104,4902010
                      
                      
                      108,6602011
                      
                      
                      93,550





Total
rent expense under the operating lease was approximately $18,470 for the year
ended September 30, 2008.





Note 17
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.




F-35




AsOriginally
                              
                              
                              AsCalculated
                              
                              
                              RecalculatedAuthorized
      shares per Articles of Incorportion
                              
                              
                              150,000,000
                              
                              
                              
                              150,000,000Outstanding
      shares
                              
                              
                              (106,635,201
                              )
                              
                              
                              (106,635,201
                              )Available
      shares
                              
                              
                              43,364,799
                              
                              
                              
                              43,364,799Securities
      convertible or exercisable into common stock shares:2001
      Executive Officers Stock Option Plan
                              
                              
                              7,343,032
                              
                              
                              
                              7,034,140Advisory
      Board Compensation
                              
                              
                              
                              
                              
                              
                              11,520,0002004
      Stock Purchase Agreement
                              
                              
                              
                              
                              
                              
                              1,463,336Warrants
      Related to 2004 Stock Purchase Agreement
                              
                              
                              
                              
                              
                              
                              1,463,336Warrants
      Issued for Services
                              
                              
                              
                              
                              
                              
                              1,010,000Beneficial
      Conversion Features
                              
                              
                              32,009,087
                              
                              
                              
                              36,606,318Warrants
      Related to $1,025,000 of Subordinated Convertible
    Debentures
                              
                              
                              2,159,088
                              
                              
                              
                              2,795,45441,511,207
                              
                              
                              
                              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 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.




F-36




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 beclassified 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.




F-37




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
133to 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 ofEITF 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 beclassified 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.




F-38




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. 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 modelwith 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.




F-39




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 modelwith 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 beclassified 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.




F-40




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.




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 modelwith 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.




F-41




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
modelwith 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 modelwith 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.




F-42




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 beclassified 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.




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.




F-43




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.




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.




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
                
                
                Reclassifications
                
                
                As
                  RestatedBalance
      SheetAccrued
      expenses
                
                $
                1,687,673
                
                
                
                
                
                $
                380,441
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                $
                2,068,114Convertible
      Notes, net
                
                
                920,337
                
                
                
                
                
                
                
                
                
                
                
                
                
                (73,114
                )
                
                
                (70,751
                )
                
                
                
                
                
                776,472Warrant
      liability
                
                
                
                
                
                
                1,926,914
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                499,932
                
                
                
                
                
                
                2,426,846Beneficial
      conversion feature liability
                
                
                
                
                
                
                
                
                
                
                576,000
                
                
                
                
                
                
                1,430,812
                
                
                
                
                
                
                
                
                
                
                2,006,812Additional
      paid-in capital
                
                
                14,712,527
                
                
                
                (2,271,879
                )
                
                
                (269,851
                )
                
                
                (45,663
                )
                
                
                (1,021,569
                )
                
                
                (340,583
                )
                
                
                
                
                
                10,762,982Deficit
      accumulatedduring
      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, 2007General
      and administrative
                
                $
                1,423,347
                
                
                
                
                
                
                $
                153,354
                
                
                
                
                
                
                
                
                
                
                $
                87,736
                
                
                $
                (618,712
                )
                
                $
                1,045,725Research
      and development
                
                
                -
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                526,466
                
                
                
                526,466Interest
      expense
                
                
                (550,935
                )
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                (336,129
                )
                
                
                (55,179
                )
                
                
                
                
                
                
                (942,243
                )Decrease
      in warrant liability
                
                
                -
                
                
                
                344,965
                
                
                
                
                
                
                
                70,029
                
                
                
                
                
                
                
                54,317
                
                
                
                
                
                
                
                469,311Increase
      in beneficial conversion feature
                
                
                
                
                
                
                
                
                
                
                (4,044
                )
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                (4,044
                )Legal
      settlement
                
                
                -
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                (89,654
                )
                
                
                (89,654
                )Income
      tax expense
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                2,592
                
                
                
                2,592Basic
      and diluted loss per share
                
                
                0.02
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                0.02Statement
      of Cash Flows for the year ended September 30, 2007Net
      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
                
                
                
                
                
                
                
                208,989Decrease
      in warrant liability
                
                
                -
                
                
                
                (344,965
                )
                
                
                
                
                
                
                (70,029
                )
                
                
                
                
                
                
                (54,317
                )
                
                
                
                
                
                
                (469,311
                )Increase
      in beneficial conversion feature liaiblity
                
                
                
                
                
                
                
                
                
                
                4,044
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                4,044Accrued
      expenses
                
                
                566,278
                
                
                
                
                
                
                
                895,044
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                (15,376
                )
                
                
                1,445,946Accrual
      of liquidating damages
                
                
                -
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                15,375
                
                
                
                15,375




Note 18
SUPPLEMENTAL CASH FLOW INFORMATION



















Note 19
SUBSEQUENT EVENTS




On
October 14, 2008, the Company entered into an agreement to purchase machinery
and equipment from RJ Metals Co. for $125,000. The Company issued a total of
833,334 shares of Common Stock to three employees at $0.15 per share as
consideration for the purchase.




On
November 11, 2008, the Company entered into a termination, separation, and
release agreement with Mr. Richard Papalian, who resigned as the Company’s Chief
Executive Officer on August 14, 2008. Under the terms of the separation
agreement Mr. Papalian retained a five year option granted on December 19, 2007
to purchase 2,933,536 shares of Common Stock at an exercise price of $0.25 per
share, and received a five year option to purchase up to 3,500,000 shares of
Common Stock at an exercise price of $0.15 per share.




F-44





ITEM
      9.
            CHANGES
      IN AND DISAGREEMENTS WITH ACCOUNTANTS ONACCOUNTING
      AND FINANCIAL DISCLOSURE.





Not
applicable.





ITEM
      9A(T).
            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 of the period covered by this
report.  Based on that evaluation, our Chief Executive Officer and
Chief Financial Officer have concluded that as of September 30, 2008, our
disclosure controls and procedures were not effective at the reasonable
assurance level due to the material weaknesses described below.





A
material weakness is a control deficiency (within the meaning of the Public
Company Accounting Oversight Board (PCAOB) Auditing Standard No. 2) or
combination of control deficiencies that result 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 in our disclosure controls and
procedures:





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.  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
do not have review and supervision procedures for financial reporting functions.
The review and supervision function of internal control relates to the accuracy
of financial information reported. The failure to review and supervise could
allow the reporting of inaccurate or incomplete financial information. Due to
our size and nature, review and supervision may not always be possible or
economically possible.  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.




23




Remediation
of Material Weaknesses





We have
retained the services of personnel with experience in financial reporting to
assist us with the process of implementing internal controls to remediate these
material weaknesses. Written documentation of the internal controls of financial
reporting will be prepared after our material weaknesses have been eliminated
and our disclosure controls and procedures are effective.





We
anticipate that our internal controls will be implemented, tested, deficiencies
remediated and documented by September 30, 2009.





Report
on Internal Control over Financial Reporting





Our
management is responsible for establishing and maintaining adequate internal
control over financial reporting.  Internal control over financial
reporting is defined in Rule 13a-15(f) or 15d-15(f) promulgated under the
Securities Exchange Act of 1934 as a process designed by, or under the
supervision of, a company's principal executive and principal financial officers
and effected by a company's board of directors, management and other personnel,
to provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with accounting principles generally accepted in the United States of America
and includes those policies and procedures that:





-  Pertain
to the maintenance of records that in reasonable detail accurately and
fairly reflect the transactions and dispositions of the assets of
the company;





-  Provide
reasonable assurance that transactions are recorded as necessary
to permit
preparation of financial statements in accordance with
accounting principles
generally accepted in the United States of America and that receipts
and expenditures of the Company are being made only in
accordance with
authorizations of management and directors of the Company; and





-  Provide
reasonable assurance regarding prevention or timely detection
of unauthorized
acquisition, use or disposition of the Company's assets that could
have a material effect on the financial statements.





Because
of its inherent limitations, internal control over financial reporting may not
prevent or detect misstatements.  Projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.  All internal control
systems, no matter how well designed, have inherent
limitations.  Therefore, even those systems determined to be effective
can provide only reasonable assurance with respect to financial statement
preparation and presentation.  Because of the inherent limitations of
internal control, there is a risk that material misstatements may not be
prevented or detected on a timely basis by internal control over financial
reporting. However, these inherent limitations are known features of the
financial reporting process.  Therefore, it is possible to design into
the process safeguards to reduce, though not eliminate, this risk.





As of
September 30, 2008 management assessed the effectiveness of our internal control
over financial reporting based on the criteria for effective internal control
over financial reporting established in Internal Control—Integrated Framework
issued by the Committee of Sponsoring Organizations of the Treadway Commission
("COSO") and SEC guidance on conducting such assessments.  Based on
that evaluation, they concluded that, during the period covered by this report,
such internal controls and procedures were not effective to detect the
inappropriate application of US GAAP rules as more fully described
below.  This was due to deficiencies that existed in the design or
operation of our internal controls over financial reporting that adversely
affected our internal controls and that may be considered to be material
weaknesses.




24




The
matters involving internal controls and procedures that our management
considered to be material weaknesses under the standards of the Public Company
Accounting Oversight Board were: (1) lack of written documentation of internal
control policies and procedures; (2) inadequate segregation of duties consistent
with control objectives; and (3) lack of review and supervision over period end
financial disclosure and reporting processes.  The aforementioned
material weaknesses were identified by our Chief Executive Officer in connection
with the review of our financial statements as of September 30,
2008.





Management
believes that the lack of documentation of internal controls did not have an
effect on our financial results.  However, management believes that
the lack of segregation of duties, and a lack of review and supervision of
reporting could result in a material misstatement in our financial statements in
future periods.





This
annual report does not include an attestation report of the Corporation's
registered public accounting firm regarding internal control over financial
reporting.  Management's report was not subject to attestation by the
Corporation's registered public accounting firm pursuant to temporary rules of
the SEC that permit the Corporation to provide only the management's report in
this annual report.





Changes
in Internal Control over Financial Reporting





During
the year ended September 30, 2008, the Company has retained a consultant and
hired personnel with financial reporting expertise to oversee and prepare the
Company’s financial reporting, The changes made by these individuals to our
internal control over financial reporting included the following:




·
            Timely
      filing of reporting information.


·
            Review
      of financial reporting information by personnel with sufficient
      experience.


·
            Proper
      application of generally accepted accounting
  principles.





ITEM
      9B.
            OTHER
      INFORMATION.





As of
August 1, 2008, the Company entered into a 36 month lease for an industrial site
consisting of administrative offices and a manufacturing
facility.  The address of the facility is 3880 East Eagle Drive,
Anaheim, California 92807 and our telephone number at that address is (714)
678-1000.  Monthly lease payments are $8,650 plus common area
maintenance charges from August 1, 2008 through July 31, 2009, $8,995 plus
common area maintenance charges from August 1, 2009 through July 31, 2010, and
$9,355 plus common area maintenance charges from August 1, 2010 through July 31,
2011.  The lease agreement includes an option to extend the lease for
an additional 36 months. If the option is exercised, monthly payments would be
$9,730 plus common area maintenance charges from August 1, 2011 through July 31,
2012, $10,118 plus common area maintenance charges from August 1, 2012 through
July 31, 2012, and $10,523 plus common area maintenance charges from August 1,
2013 through July 31, 2014.





PART
III





ITEM
      10.
            DIRECTORS,
      EXECUTIVE OFFICERS AND CORPORATE
GOVERNANCE.





Set forth
below is certain information regarding our directors, executive officers and key
personnel.  There are no family relationships among our executive
officers and directors.  A director holds office until the annual
shareholder meeting for the year in which his term expires and until his
successor is elected and qualified.




25




Name
              Age
              Position
              Director SinceJames
      J. Houtz
              69
              President
      Chief Executive Officer and Director
              1998Rodney
      Anderson
              81
              Interim
      Chief Financial Officer and Director
              2001Marcus
      Woods
              61
              Director
              2008John
      Pavia
              
              Director
              2007





James J. Houtz.Mr.
Houtz has been our president, chief operating officer and a director since March
1998 and on August 14, 2008 was appointed as our chief executive
officer.





Rodney
Anderson.From 1982 to 2007, Mr. Anderson was president and a
principal shareholder of RJ Metal Co., a manufacturer of hardware supplying the
U.S. defense industry and Sionix.  At RJ Metal Co., Mr. Anderson was
responsible for accounting and financial reporting functions, in addition to his
executive duties.  He has served on our Board of Directors since
2001and
he was appointed as our interim Chief Financial Officer on October 15,
2008.





Marcus Woods.Mr.
Woods served as a financial reporting consultant to us from January 2008 to
October 2008 and has served as one of our directors since May
2008.  Mr. Woods also serves as a senior advisor to Clarion
Consulting, a retail real estate consulting firm headquartered in Irvine,
California.  Mr. Woods began his career with Ernst & Young in
September 1970, leaving the firm after eight years to co-found his own public
accounting firm.  He specializes in re-organization and re-engineering
projects and has significant experience with financial modeling, analyzing
management information systems, computerizing manual systems, and many other
aspects of operations management.  Mr. Woods is the former president
and chief executive officer of D&L Airflow Solutions, a fabricator of sheet
metal products for the HVAC industry, where he served from 1999 to 2003, and the
former chief financial officer of Surterre Properties, Inc., where he served
from November 2005 to September 2007.  Mr. Woods earned a Bachelor of
Science degree in accounting from San Jose State University.





John Pavia.Mr.
Pavia joined our board in July 2008.  He is the founding partner and
Executive Managing Director of Siena Lane Partners, LLC, an advisory group that
assists small and medium sized companies with devising and implementing growth
strategies.  He has served in this role since October
2006.  Mr. Pavia also serves as general counsel to several companies
including IPT, LLC, a national facilities management company, BeenVerified, LLC
and OneWayLimo.com, Inc., and he sits on the board of directors of RedRoller
Holdings, Inc., a publicly traded company.  From 2002 to 2006, Mr.
Pavia served as vice president, deputy general counsel and assistant secretary
of RR Donnelley & Sons after joining the management team that took control
of Moore Corporation Ltd. in late 2000.  Mr. Pavia still serves as a
consultant to the chief executive officer of RR Donnelley & Sons providing
advice and assistance on federal government affairs.  Mr. Pavia
attended American University School of Law and later clerked for U.S. District
Judge Robert Zampano.  He served as an Assistant District Attorney in
Brooklyn from 1992 to 1995 and later became a partner at the law firm of Levy
& Droney, where he worked from 1995 to 1999.  Mr. Pavia has been
associated with Quinnipiac University School of Law since 1990 as an adjunct
professor.





None of
our directors or executive officers has, during the past five
years,





·
            had
      any bankruptcy petition filed by or against any business of which such
      person was a general partner or executive officer, either at the time of
      the bankruptcy or within two years prior to that
  time,




26




·
            been
      convicted in a criminal proceeding and none of our directors or executive
      officers is subject to a pending criminal
  proceeding,





·
            been
      subject to any order, judgment, or decree, not subsequently reversed,
      suspended or vacated, of any court of competent jurisdiction, permanently
      or temporarily enjoining, barring, suspending or otherwise limiting his
      involvement in any type of business, securities, futures, commodities or
      banking activities, or





·
            been
      found by a court of competent jurisdiction (in a civil action), the
      Securities and Exchange Commission or the Commodity Futures Trading
      Commission to have violated a federal or state securities or commodities
      law, and the judgment has not been reversed, suspended, or
      vacated.





Director
Compensation





The
following table sets forth certain information concerning compensation granted
to our directors during the 2008 fiscal year.  No options were
exercised by our directors during the last fiscal year.





Name
                
                Fees Earned
                  or Paid in
                  Cash
                
                
                Stock
                  Awards
                
                
                Warrant/
                  Option
                  Awards
                
                
                Non-Equity
                  Incentive Plan
                  Compensation
                
                
                Non-Qualified
                  Deferred
                  Compensation
                
                
                Other
                
                
                TotalJames
      J. Houtz
                
                $
                -
                
                
                $
                -
                
                
                $
                -
                
                
                $
                -
                
                
                $
                -
                
                
                $
                -
                
                
                $
                -Rodney
      Anderson
                
                
                -
                
                
                
                -
                
                
                
                171,520
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                171,520
                (1)Marcus
      Woods
                
                
                -
                
                
                
                -
                
                
                
                51,582
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                51,582
                (2)John
      Pavia
                
                
                -
                
                
                
                -
                
                
                
                51,582
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                51,582
                (3)





(1) The
value of this award was computed using the Black Scholes Option Pricing Model
using the following assumptions: risk free interest rate of 3.22%, expected
volatility of 99.86%, dividend yields of 0% and expected term of 5
years.


(2) The
value of this award was computed using the Black Scholes Option Pricing Model
using the following assumptions: risk free interest rate of 2.30%, expected
volatility of 71.69%, dividend yields of 0% and expected term of 5
years.


(3) The
value of this award was computed using the Black Scholes Option Pricing Model
using the following assumptions: risk free interest rate of 2.30%, expected
volatility of 71.69%, dividend yields of 0% and expected term of 5
years.




Section
16(a) Beneficial Ownership Reporting Compliance





Section
16(a) of the Securities Exchange Act of 1934, as amended, and the rules
thereunder require our officers and directors, and persons who own more than 10%
of our common stock, to file reports of ownership and changes in ownership with
the Securities and Exchange Commission and to furnish us with
copies.  To our knowledge, based solely upon review of the copies of
such reports received or written representations from the reporting persons, we
believe that during the 2008 fiscal year our directors, executive officers and
persons who own more than 10% of our common stock complied with all Section
16(a) filing requirementswith
the exception of the following:





Name
      and Title
                        
                        Form
                        
                        TransactionsJohn
      Pavia, director
                        
                        3/4
                        
                        Mr.
      Pavia was appointed to the board of directors on July 7,
      2008.  Mr. Pavia has not filed a form 3 disclosing his
      securities holdings on the date of his appointment.  Mr. Pavia
      also failed to file a form 4 disclosing the grant of an option to purchase
      500,000 shares of our common stock that was made on July 11,
      2008.
  27
  Rodney
      Anderson, Chief Financial Officer and director
                      
                      4
                      
                      Mr.
      Anderson failed to file a form 4 disclosing the grant of an option to
      purchase 1,000,000 shares of common stock that was made on December 13,
      2007.Marc
      Woods, director
                      
                      3/4
                      
                      Mr.
      Woods was appointed as a director on May 5, 2008.  Mr. Woods has
      not filed a form 3 disclosing his securities holdings on the date of his
      appointment. Mr. Woods also failed to file a form 4 to disclose the grant
      of an option to purchase 500,000  shares of common stock that
      was made on July 11, 2008.Dr.
      John H. Foster, former director
                      
                      4
                      
                      Dr.
      Foster failed to file a form 4 disclosing an option we granted to him on
      February 21, 2008 for the purchase of 2,880,000 shares of our common
      stock.Dr.
      Richard Laton, former director
                      
                      4
                      
                      Dr.
      Laton failed to file a form 4 disclosing an option we granted to him on
      February 21, 2008 for the purchase of 2,880,000 shares of our common
      stock.





Code
of Ethics





The
Company had not adopted a code of ethics as of September 30, 2008, however, a
draft code of ethics has been prepared and is being reviewed by
management.  The Company expects that a code of ethics will be adopted
during the 2009 fiscal year.





Corporate
Governance





Our board
of directors does not have an audit committee, a compensation committee or a
nominating committee.





We have
not adopted any procedures by which our security holders may recommend nominees
to our board of directors and that has not changed during this fiscal
year.





With the
exception of Marcus Woods, none of the members of our board of directors
qualifies as an “audit committee financial expert”, as defined by Item 407 of
Regulation S-K promulgated under the Securities Act of 1933 and the Securities
Exchange Act of 1934.





ITEM 11.
            EXECUTIVE
      COMPENSATION.





The
following table and discussion sets forth information with respect to all
compensation awarded to, earned by or paid to our chief executive officer and up
to four of our executive officers whose annual salary and bonus exceeded
$100,000 during our last two completed fiscal years (collectively referred to in
this discussion as the “named executive officers”).  Robert McCray
resigned as our chief financial officer on March 24, 2008, Richard Papalian
resigned as our Chief Executive Officer on August 14, 2008 and subsequent to the
2008 fiscal year, on October 15, 2008, Marcus Woods separated from service as
chief financial officer.




28




Principal
      Position
                                  
                                  Year
                                  
                                  Salary
                                  
                                  
                                  Bonus
                                  
                                  
                                  Stock
                                    Awards
                                  
                                  
                                  Option
                                    Awards
                                  
                                  
                                  Incentive Plan
                                    Compensation
                                  
                                  
                                  Deferred
                                    Compensation
                                  
                                  
                                  Other
                                  
                                  
                                  TotalJames
      J. Houtz
                                  
                                  2008
                                  
                                  $
                                  186,242
                                  
                                  
                                  $
                                  -
                                  
                                  
                                  $
                                  -
                                  
                                  
                                  $
                                  -
                                  
                                  
                                  $
                                  -
                                  
                                  
                                  $
                                  -
                                  
                                  
                                  $
                                  22,641
                                  
                                  
                                  $
                                  208,883Chief
      Executive Officer
                                  
                                  2007
                                  
                                  
                                  172,446
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  20,582
                                  
                                  
                                  
                                  193,028
                                  (1)(2)PresidentRobert
      McCray
                                  
                                  2008
                                  
                                  
                                  26,400
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  171,520
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  197,920
                                  (3)(4)former
      Chief Financial Officer
                                  
                                  2007
                                  
                                  
                                  151,200
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  151,200Richard
      Papalian
                                  
                                  2008
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  1,448,321
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  1,448,321
                                  (5)former
      Chief Executive Officer
                                  
                                  2007
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -Marcus
      Woods
                                  
                                  2008
                                  
                                  
                                  35,000
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  51,582
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  86,582
                                  (6)(7)former
      Chief Financial Officer
                                  
                                  2007
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -





(1) This
amount was accrued but has not been paid.


(2) Other
compensation is for automobile allowance.


(3) The
value of the option was computed using the Black Scholes Option Pricing Model
using the following assumptions: risk free interest rate of 3.22%; expected
volatility of 99.86%; dividend yields of 0%; and expected term of 5
years.


(4) Robert
McCray resigned as Chief Financial Officer on March 24, 2008. There were salary
payments subsequent to the resignation.


(5) The
value of the option was computed using the Black Scholes Option Pricing Model
using the following assumptions: risk free interest rate of 3.26%; expected
volatility of 98.01%; dividend yields of 0%; and expected term of 5 years. On
November 11, 2008 we entered into an agreement with Mr. Papalian as part of his
separation from service. Pursuant to the agreement, he agreed to forfeit
5,605,786 option shares.


(6) Marcus
Woods was Chief Financial Officer from August 2008 to October 2008.


(7) The
value of the option was computed using the Black Scholes Option Pricing Model
using the following assumptions: risk free interest rate of 2.30%; expected
volatility of 71.69%; dividend yields of 0%; and expected term of 5
years.





We have
not had the resources to pay cash salaries to our executive
officers.  On occasion, in lieu of cash, we have paid our executive
officers with awards of stock options.  For example, during the 2008
fiscal year we granted an option to purchase 8,539,312 shares of our common
stock to Richard Papalian in lieu of a cash salary.





When we
are able to do so, our plan is to implement a compensation program consisting of
base salary, bonuses and awards of stock options or, possibly, restricted
stock.  We believe that a combination of cash and common stock or
options will allow us to attract and retain the services of the individuals who
will help us achieve our business objectives, thereby increasing value for our
shareholders.  We grant options or restricted stock because we believe
that share ownership by our employees is an effective method to deliver superior
stockholder returns by increasing the alignment between the interests of our
employees and our shareholders. No employee is required to own common stock in
our company.





In
setting the compensation for our officers, we look primarily at the person’s
responsibilities, at salaries paid to others in businesses comparable to ours,
at the person’s experience and at our ability to replace the
individual.  We expect the salaries of our executive officers to
remain relatively constant unless the person’s responsibilities are materially
changed.  During the 2007 and 2008 fiscal years, we have accrued
salaries for our executive officers.  It is not likely that we will be
able to pay these salaries until we begin to generate cash from sales of our
products or we arrange financing that will permit us to pay some or all of the
amounts outstanding.




29




We also
expect that we may pay bonuses in the future to reward exceptional performance,
either by the individual or by the company.





The following table sets forth certain
information concerning stock option awards granted to our executive officers as
of September 30, 2008.  No options were exercised by our executive
officers during the last fiscal year.




OUTSTANDING
      EQUITY AWARDS AT FISCAL YEAR-END





OPTION
      AWARDS
                      
                      STOCKAWARDSNumber of securities
                        underlying unexercised
                        options
                      
                      
                      Equity
                        Incentive
                        Plan
                        Awards:
                        Number of
                        Securities
                        underlying
                        unexercised
                        unearned
                      
                      
                      Option
                        exercise
                      
                      Option
                        expiration
                      
                      Number of
                        shares or
                        units of
                        stock that
                        have not
                      
                      
                      Market
                        value of
                        shares or
                        units of
                        stock that
                        have not
                      
                      
                      Equity
                        incentive
                        plan awards:
                        number of
                        unearned
                        shares,units
                        or other
                        rights that
                        have not
                      
                      
                      Equity
                        incentive
                        plan awards:
                        Market or
                        payout
                        value of
                        unearned
                        shares, units
                        or other
                        rights that
                        have notName
                      
                      Exercisable
                      
                      
                      Unexercisable
                      
                      
                      options
                      
                      
                      price
                      
                      date
                      
                      vested
                      
                      
                      vested
                      
                      
                      vested
                      
                      
                      vestedJames
      Houtz
                      
                      
                      6,171,000
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      $
                      0.15
                      
                      04/19/11
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -Richard
      Papalian
                      
                      
                      2,933,526
                      
                      
                      
                      5,605,786
                      (1)
                      
                      
                      -
                      
                      
                      
                      0.25
                      
                      12/18/12
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -Robert
      McCray
                      
                      
                      1,000,000
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      0.25
                      
                      12/12/12
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -Marcus
      Woods
                      
                      
                      500,000
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      0.25
                      
                      07/10/13
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -


(1) On
November 11, 2008 we entered into an agreement with Mr. Papalian as part of his
separation from service. Pursuant to the agreement, he agreed to forfeit his
unexercisable option.




Employment
Agreements





On
September 30, 2003 we entered into an employment agreement with James J.
Houtz.  The term of the agreement began on October 1, 2003 and
continued until September 30, 2008.  Thereafter, the term continues on
a month-to-month basis.  Pursuant to the terms of the agreement, Mr.
Houtz provides services as our president and chief executive
officer.  For his services, Mr. Houtz was initially paid $11,407.78
per month until October 1, 2004, when his compensation was increased by 8% per
year.  Mr. Houtz initially received an automobile allowance of
$1,288.65 per month, which is increased by 10% each year.  We also
agreed to provide life insurance to Mr. Houtz in the face amount of $500,000 and
disability insurance that would provide disability benefits to Mr. Houtz in an
amount equal to one-half of his base salary until he reached 65 years of
age.  We may terminate the agreement immediately for cause, or upon 30
days written notice.  The agreement will terminate automatically upon
mutual agreement of the parties, at the election of either party upon the
bankruptcy or insolvency of either party, upon Mr. Houtz’s death or, at the
election of either party, upon Mr. Houtz’s disability, if such disability lasts
for a period of at least 6 months.





ITEM
      12.
            SECURITY
      OWNERSHIP OF CERTAIN BENEFICAL OWNERS ANDMANAGEMENT
      AND RELATED STOCKHOLDER MATTERS.





The
following table sets forth, as of January 7, 2009, information regarding the
beneficial ownership of our common stock with respect to each of our executive
officers, each of our directors, each person known by us to own beneficially
more than 5% of the common stock, and all of our directors and executive
officers as a group.  Beneficial ownership is determined under the
rules of the Securities and Exchange Commission and generally includes voting or
investment power over securities.  Each individual or entity named has
sole investment and voting power with respect to the shares of common stock
indicated as beneficially owned by them, subject to community property laws,
where applicable, except where otherwise noted.




30




Shares of
common stock subject to options or warrants that are currently exercisable or
exercisable within 60 days of January 7, 2009 are considered outstanding and
beneficially owned by the person holding the options or warrants for the purpose
of computing the percentage ownership of that person but are not treated as
outstanding for the purpose of computing the percentage ownership of any other
person.





Title
      of Class of
                      Security
                    
                    Name and Address(1)
                    
                    Number of
                      Shares of
                      Common
                      Stock
                      Beneficially
                      Owned
                    
                    
                    Percentage
                      of
                      Common
                      StockCommon
      Stock
                    
                    James
      J. Houtz, Chief Executive Officer, President, director
                    
                    
                    6,250,167
                    (2)
                    
                    
                    3.26
                    %Common
      Stock
                    
                    Rodney
      Anderson, Chief Financial Officer, director
                    
                    
                    1,300,000
                    (3)
                    
                    
                    0.68
                    %Common
      Stock
                    
                    John
      Pavia, director
                    
                    
                    500,000
                    (4)
                    
                    
                    0.26
                    %Common
      Stock
                    
                    Marcus
      Woods, director
                    
                    
                    500,000
                    (4)
                    
                    
                    0.26
                    %


(1) The
address for each of our officers and directors is 3880 East Eagle Drive,
Anaheim, California 92807


(2)
Includes 79,167 shares of common stock and an option granted on April 20, 2001,
to purchase 6,171,000 shares of common stock at $0.15 per share from the 2001
executive officers stock option plan, which expires on April 19,
2011.
 (3)
Includes 300,000 shares of common stock and an option granted on December 13,
2007, to purchase 1,000,000 shares of common stock at $0.25 per share, which
expires on December 12, 2012.
 (4)
Consists of an option granted on July 11, 2008, to purchase 300,000 shares of
common stock at $0.25 per share, which expires on July 10,
2012.




For information relating to securities
authorized for issuance under our equity compensation plans, please see Part II,
Item 5 of this report.





ITEM
      13.
            CERTAIN
      RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTORINDEPENDENCE.





Using the
definition of “independent” set forth in Section 803A of the Rules of NYSE
Alternext US, we have determined that 2 of our directors, John Pavia and Marcus
Woods, are independent





On
October 1, 2005 we entered into an employment agreement with Robert E.
McCray.  The term of the agreement began on October 1, 2005 and
continued until September 30, 2007.  Thereafter, the term continued on
a month-to-month basis.  Pursuant to the terms of the agreement, Mr.
McCray provided services as our chief financial officer.  For his
services, Mr. McCray was initially paid $144,000 annually, after which his
compensation was to be increased by 5% per year.  Mr. McCray also
received an automobile allowance of $600 per month.  We were entitled
to terminate the agreement immediately for cause, or upon 30 days written
notice.  The agreement was to terminate automatically upon mutual
agreement of the parties, at the election of either party upon the bankruptcy or
insolvency of either party, upon Mr. McCray’s death or, at the election of
either party, upon Mr. McCray’s disability, if such disability lasts for a
period of at least 6 months.  We could also terminate the agreement
without cause upon the payment of 3 months severance pay.  Mr. McCray
resigned from his position as chief financial officer on March 24,
2008.




31




On
November 7, 2007 we entered into a Stock Exchange Agreement with Rodney L.
Anderson, Joey M. Anderson and Robert A. Hasson, the sole shareholders of RJ
Metals, Inc. (collectively referred to in this discussion as the
“Shareholders”). Pursuant to the Stock Exchange Agreement, we were to acquire
from the Shareholders all of the issued and outstanding shares of RJ Metals,
Inc. in exchange for issuing to the Shareholders a total of 3,400,000 shares of
our common stock (the “Transaction”).  Mr. Rodney Anderson is a
significant shareholder of RJ Metals, Inc. and one of our
directors.  The Transaction was not consummated and on March 14, 2008
our board of directors approved, and we and the Shareholders entered into, a
Termination Agreement. Pursuant to the Termination Agreement, the Share Exchange
Agreement was terminated and the parties released each other and each of their
officers, employees, principals and agents from any and all claims or demands
incidental to the Share Exchange Agreement and the Transaction.





On
October 8, 2008 we issued a Notice of Grant of Stock Option and a Stock Option
Agreement to Mr. David Ross, a former director.  The stock option was
authorized by the board of directors on December 13, 2007.  The option
permits Mr. Ross to purchase 2,880,000 shares of our common stock at an exercise
price of $0.25 per shares.  The option was fully vested on the date of
grant and has a term of 5 years.  Pursuant to the stock option
agreement, Mr. Ross agreed not to sell any shares of common stock acquired upon
exercise of his option prior to December 13, 2008.  On December 13,
2007, the fair value of the option was $519,235 at the date of grant and was
calculated using the Black Sholes option valuation model with the following
assumptions: risk free interest rate of 3.22%, expected volatility of 99.86%,
dividend yields of 0% and expected term of 5 years.





On
October 14, 2008, we entered into an agreement with RJ Metal Co., a company
controlled by one of our directors, Rodney Anderson, to purchase equipment
valued at $125,000 in consideration of an aggregate of 833,334 shares of our
common stock.  Mr. Anderson received 300,000 of the shares
issued.  The market value of our common stock on October 14, 2008 was
$0.13 per share.





On
November 11, 2008, we entered into a Termination, Separation and Release
Agreement (the “Separation Agreement”) with Richard H. Papalian, our former
chief executive officer, pursuant to which we and Mr. Papalian mutually agreed
to terminate Mr. Papalian’s Employment Agreement dated December 19, 2007, and
agreed that such termination would be deemed neither a termination by us for
“Cause” nor a termination by Mr. Papalian for “Good Reason”, as those terms are
defined in the Employment Agreement, and agreed to a mutual general release of
any claims arising from Mr. Papalian’s service as an officer and
director.  Mr. Papalian agreed to forfeit all unvested stock options
granted to him pursuant to the Notice of Grant of Stock Option dated December
19, 2007, leaving him with a vested option to purchase 2,933,526 shares of our
common stock at an exercise price $0.25 per share, after giving effect to
anti-dilution adjustments to which Mr. Papalian was entitled pursuant to his
Stock Option Agreement dated December 19, 2007.  In addition, we
agreed to grant Mr. Papalian a fully vested 5-year option to purchase 3,500,000
shares of our common stock at an exercise price of $0.15 per share in
consideration of Mr. Papalian’s acceptance of the Separation Agreement. The fair
value of the option on November 11, 2008 was $238,244 at the date of grant and
was calculated using the Black Sholes option valuation model with the following
assumptions: risk free interest rate of 1.16%, expected volatility of 89.31%,
dividend yields of 0% and expected term of 5 years.





On
February 21, 2008, we entered into a one year Consulting Agreement with Dr. John
H. Foster, Ph.D., who was the chairman of our board of directors on that
date.  Pursuant to the Consulting Agreement, Dr. Foster will (i)
actively assist in the testing and demonstration of our water purification
product on site at the Villa Park Dam in Irvine, California; (ii) attend
technical meetings, demonstrations and trade shows in support of our business;
(iii) prepare grant applications and white papers as technological and
scientific results are confirmed; and (iv) act in our best interests and aid in
our day-to-day operations for a minimum of 5 days per month, after which we will
pay Dr. Foster an hourly rate of $250 per hour.  The term of the
Consulting Agreement is from January 1, 2008 until January 1, 2009 (the
“Term”).




32




As
compensation for the services, we will pay Dr. Foster:





(i) so
long as we raise at least $250,000 in gross proceeds from an equity financing or
series of equity financings occurring on or after December 31, 2007 and before
the end of the Term, for services performed from January 1 until June 1, 2008,
$10,000 per month payable on the first day of each month during such period;
and





(ii) so
long as we raise at least $500,000 in gross proceeds (including the $250,000
referred to above) from an equity financing or series of equity financings
occurring on or after December 31, 2007 and before the end of the Term: (i) a
one time payment of $30,000 for services performed from October 1, 2007 through
December 31, 2007, and (ii) for services performed from July 1 until December
31, 2008, $10,000 per month payable on the first day of each month during such
period.





In
addition, in consideration of Dr. Foster’s efforts in bringing about a
definitive licensing, manufacturing, distribution, purchase order or
substantially similar agreement between us and Primon, an Ireland based company
in the business of water purification, or any of its affiliates, during the Term
or within six months thereafter, Dr. Foster will receive, regardless of the
termination of the Consulting Agreement, 2.5% of the royalty payments or other
amounts received by us from Primon pursuant to the agreement, until Dr. Foster
has received $2,500,000 in such commissions, after which we will have no further
obligation to pay such commissions.





Pursuant
to the Consulting Agreement, we also agreed to carry forward the debt incurred
to Dr. Foster in the amount of $144,000 for services rendered during the time
Dr. Foster served as a member of our board of advisors, which will be payable at
the earlier of September 30, 2010 or the date on which we show on our balance
sheet as filed with the Securities and Exchange Commission at least $1.5 million
in working capital and the closing price of our common stock has been at least
$1.25 for at least 15 consecutive trading days.  This obligation will
survive the termination of the Consulting Agreement.





In
addition, on February 21, 2008, pursuant to a Notice of Grant of Stock Option
and a Stock Option Agreement (the “Option Agreement”), we granted to Dr. Foster
a 5-year fully vested option to purchase 2,880,000 shares of our common stock at
an exercise price of $0.25 per share.  The option may be exercised on
a cashless basis.  Pursuant to the Option Agreement, Dr. Foster agreed
not to sell any shares of common stock acquired upon exercise of his option
prior to December 13, 2008, which is the one year anniversary of the date the
option was authorized by our board of directors.  On December 13,
2007, the date of authorization by the board of directors, the fair value of the
option was $519,235 at the date of grant and was calculated using the Black
Sholes option valuation model with the following assumptions: risk free interest
rate of 3.22%, expected volatility of 99.86%, dividend yields of 0% and expected
term of 5 years.





Dr.
Foster resigned from our board of directors on October 15, 2008.





On
February 21, 2008, we entered into a one year Consulting Agreement with Dr. W.
Richard Laton who was, at the time, a member of our board of
directors.  Pursuant to the Consulting Agreement, Dr. Laton will (i)
actively assist in the testing and demonstration of our water purification
product on site at the Villa Park Dam in Irvine, California; (ii) attend
technical meetings, demonstrations and trade shows in support of the
Registrant’s business; (iii) prepare grant applications and white papers as
technological and scientific results are confirmed; and (iv) act in our best
interests and aid in our day-to-day operations for a minimum of 5 days per
month, after which we will pay Dr. Laton an hourly rate of $250 per
hour.  The term of the Consulting Agreement is from January 1, 2008
until January 1, 2009 (the “Term”).





As
compensation for the services, we agreed to pay Dr. Laton:





(i) so
long as we raise at least $250,000 in gross proceeds from an equity financing or
series of equity financings occurring on or after December 31, 2007 and before
the end of the Term, for services performed from January 1 until June 1, 2008,
$10,000 per month payable on the first day of each month during such period;
and




33




(ii) so
long as we raise at least $500,000 in gross proceeds (including the $250,000
referred to above) from an equity financing or series of equity financings
occurring on or after December 31, 2007 and before the end of the Term: (i) a
one time payment of $30,000 for services performed from October 1, 2007 through
December 31, 2007, and (ii) for services performed from July 1 until December
31, 2008, $10,000 per month payable on the first day of each month during such
period.





In
addition, in consideration of Dr. Laton’s efforts in bringing about the Primon
Agreement during the Term or within six months thereafter, Dr. Laton will
receive, regardless of the termination of the Consulting Agreement, 5% of the
royalty payments or other amounts received by us from Primon pursuant to the
agreement, until Dr. Laton has received $5,000,000 in such commissions, after
which we will have no further obligation to pay such commissions.





Pursuant
to the Consulting Agreement, we also agreed to carry forward the debt incurred
to Dr. Laton in the amount of $144,000 for services rendered during the time Dr.
Laton served as a member of our board of advisors, which will be payable at the
earlier of September 30, 2010 or the date on which we show on our balance sheet
as filed with the Securities and Exchange Commission at least $1.5 million in
working capital and the closing price of our common stock has been at least
$1.25 for at least 15 consecutive trading days.  This obligation will
survive the termination of the Consulting Agreement.





In
addition, on February 21, 2008, pursuant to a Notice of Grant of Stock Option
and a Stock Option Agreement (the “Option Agreement”), we granted to Dr. Laton a
5-year fully vested option to purchase 2,880,000 shares of our common stock at
an exercise price of $0.25 per share.  The option may be exercised on
a cashless basis.  Pursuant to the Option Agreement, Dr. Laton agreed
not to sell any shares of common stock acquired upon exercise of his option
prior to December 13, 2008, which is the one year anniversary of the date the
option was authorized by our board of directors.    On
December 13, 2007, the date of authorization by the board of directors, the fair
value of the option was $519,235 at the date of grant and was calculated using
the Black Sholes option valuation model with the following assumptions: risk
free interest rate of 3.22%, expected volatility of 99.86%, dividend yields of
0% and expected term of 5 years.





Dr. Laton
resigned from our board of directors on July 16, 2008.





On
December 19, 2007, we entered into a one year Employment Agreement with Richard
H. Papalian pursuant to which Mr. Papalian was appointed as our chief executive
officer and was elected to fill a vacancy on our board of
directors.  Mr. Papalian did 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, we granted Mr. Papalian a five year option to purchase up to 8,539,312
shares of our common stock at an exercise price of $0.25 per share, which
represented 5% of the outstanding shares of our common stock on a fully diluted
basis.  The option was subject to the following vesting conditions:
(i) 30% of the option vested upon the grant date; (ii) 20% of the option was to
vest when our market capitalization exceeded $50 million for fifteen consecutive
trading days; (iii) 30% of the option was to vest when our market capitalization
exceeded $75 million for fifteen consecutive trading days; and (iv) 20% of the
option was to vest when our market capitalization exceeded $100 million for
fifteen consecutive trading days.





We also
entered into an Indemnification Agreement with Mr. Papalian on December 19,
2007.  The Indemnification Agreement provides for indemnification of
Mr. Papalian to the extent he becomes a party or is threatened to be made a
party to any legal proceeding by reason of his status as our officer or
director, against any expenses incurred as a result of such proceeding, as and
when such expenses are incurred.  Before any claim for indemnification
is approved by us, we will determine by any of the methods set forth in the
Nevada Revised Statutes that Mr. Papalian has met the applicable standards of
conduct which make it permissible to indemnify him.




34




Mr.
Papalian resigned as our chief executive officer on August 14, 2008 and as a
member of our board of directors on November 11, 2008.





ITEM
      14.
            PRINCIPAL
      ACCOUNTING FEES AND SERVICES.




2008
                        
                        
                        2007Fee
      Category:Audit
      fees
                        
                        $
                        53,000
                        
                        
                        $
                        72,250Tax
      fees
                        
                        
                        -
                        
                        
                        
                        -All
      other fees
                        
                        
                        -
                        
                        
                        
                        -$
                        53,000
                        
                        
                        $
                        72,250





The
following is a summary of the fees billed to us by Kabani & Company, Inc.
for professional services rendered for the fiscal years ended September 30, 2008
and 2007:





Audit
Fees consists of fees billed for professional services rendered for the audit of
our financial statements and review of the interim financial statements included
in quarterly reports and services that are normally provided by Kabani &
Company, Inc. in connection with our 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 our financial
statements and are not reported under “Audit Fees”.





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.





We do not
have an audit committee.  Our board of directors pre-approves 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.  The board of
directors may also pre-approve particular services on a case-by-case
basis.





ITEM
      15.
            EXHIBITS.





The
following exhibits are filed herewith or incorporated by reference:





No.
              
              Description3.1
              
              Amended
      and Restated Articles of Incorporation (1)3.2
              
              Amended
      and Restated Bylaws (1)  35
  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
      registrant and certain investors (3)10.5
                    
                    Form
      of Convertible Debenture, dated as of June 18, 2007, issued by the
      registrant to certain investors. (3)10.6
                    
                    Form
      of Registration Rights Agreement, dated as of June 18, 2007, between the
      registrant and certain investors (3).10.7
                    
                    Form
      of Warrant, dated as of June 18, 2007, issued by the registrant to certain
      investors. (3)10.8
                    
                    Lease
      between the registrant and   Klein Investments Family
      Limited Partnership, dated August 30, 2007 (4)10.9
                    
                    Share
      Exchange Agreement, dated November 7, 2007, between the registrant and the
      shareholders of RJ Metals, Inc. (4)10.10
                    
                    Termination
      Agreement dated March 14, 2008 between the registrant and the shareholders
      of RJ Metals, Inc. (6)*10.11
                    
                    Employment
      Agreement, dated December 19, 2007 between the registrant and Richard H.
      Papalian (5)*10.12
                    
                    Notice
      of Grant of Stock Option to Richard H. Papalian (5)*10.13
                    
                    Stock
      Option Agreement between the registrant and Richard H. Papalian
      (5)*10.14
                    
                    Indemnification
      Agreement between the registration and Richard H. Papalian
      (5)*10.15
                    
                    Notice
      of Grant of Stock Option to David Ross (7)*10.16
                    
                    Stock
      Option Agreement between the registrant and David Ross
  (7)*10.17
                    
                    Notice
      of Grant of Stock Option to Rodney Anderson (7)*10.18
                    
                    Stock
      Option Agreement between the registrant and Rodney Anderson
      (7)*10.19
                    
                    Form
      of Securities Purchase Agreement for 12% Convertible Debentures
      (8)10.20
                    
                    Sionix
      Corporation 12% Convertible Debenture due July 29, 2009
  (8)10.21
                    
                    Form
      of Common Stock Purchase Warrant dated July 29, 2008
(8)10.23
                    
                    Form
      of Unit Offering Securities Purchase Agreement (9)10.24
                    
                    Form
      of Common Stock Purchase Warrant (9)10.25
                    
                    Amended
      and Restated Promissory Notes with Calico Capital Management LLC, BRAX
      Capital LLC and Gene Salkin (10)10.26
                    
                    Second
      Amended and Restated Convertible Promissory Notes dated March 17, 2008
      with Calico Capital Management LLC, BRAX Capital LLC and Gene Salkin
      (11)10.27
                    
                    Form
      of Securities Purchase Agreement for 10% Debentures
(12)10.28
                    
                    Form
      of Subordinated 10% Debenture (12)10.29
                    
                    Form
      of Common Stock Purchase Warrant (12)10.30
                    
                    Consulting
      Agreement dated February 21, 2008 between the registrant and John H.
      Foster, Ph.D. (13)*10.31
                    
                    Notice
      of Grant of Stock Option to John H. Foster (13)*10.32
                    
                    Stock
      Option Agreement between the registrant and Dr. John H. Foster
      (13)*10.33
                    
                    Consulting
      Agreement dated February 21, 2008 between the registrant and Dr. W.
      Richard Laton (13)*10.34
                    
                    Notice
      of Grant of Stock Option (13)10.35
                    
                    Stock
      Option Agreement between the registrant and Dr. W. Richard Laton
      (13)*10.36
                    
                    Letter
      Agreement dated October 14, 2008 between the registrant and RJ Metals Inc.
      (7)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 and Chief Financial Officer Pursuant to Section
      906 of the Sarbanes-Oxley Act of
2002.


* Denotes
a contract with management.


(1)
Incorporated by reference from registrant’s Current Report on Form 8-K, file no.
002-95626-D, 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, file
no. 002-95626-D, 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, file no.
002-95626-D , 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, file no.
002-95626-D, filed with the Commission on December 20, 2007, and incorporated
herein by reference.


(6)
Incorporated by reference from the registrant’s Current Report on Form 8-K, file
no. 002-95626-D, filed with the Commission on March 17, 2008, and incorporated
herein by reference.




36




(7)
Incorporated by reference from the registrant’s Current Report on Form 8-K, file
no. 002-95626-D, filed with the Commission on October 23, 2008, and incorporated
herein by reference.


(8)
Incorporated by reference from the registrant’s Current Report on Form 8-K, file
no. 002-95626-D, filed with the Commission on July 30, 2008, and incorporated
herein by reference.


(9)
Incorporated by reference from the registrant’s Current Report on Form 8-K, file
no. 002-95626-D, filed with the Commission on May 29, 2008, and incorporated
herein by reference.


(10)
Incorporated by reference from the registrant’s Current Report on Form 8-K, file
no. 002-95626-D, filed with the Commission on January 28, 2008, and incorporated
herein by reference.


(11)
Incorporated by reference from the registrant’s Current Report on Form 8-K, file
no. 002-95626-D, filed with the Commission on March 24, 2008, and incorporated
herein by reference.


(12)
Incorporated by reference from the registrant’s Current Report on Form 8-K, file
no. 002-95626-D, filed with the Commission on March 3, 2008, and incorporated
herein by reference.


(13)
Incorporated by reference from the registrant’s Current Report on Form 8-K, file
no. 002-95626-D, filed with the Commission on February 25, 2008, and
incorporated herein by reference.




37




SIGNATURES




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




Dated:  January
13, 2009




SIONIX,
      INC.By:
                  /s/
      James J. HoutzJames
      J. Houtz, Chief Executive OfficerBy:
                  /s/
      Rodney AndersonRodney
      Anderson, Chief Financial
Officer





Pursuant
to the requirements of the Securities Exchange Act of 1934, this report has been
signed below by the following persons on behalf of the Registrant and in the
capacities and on the dates indicated





Signature
                      
                      Title
                      
                      Date/s/
      James J. Houtz
                      
                      Chief
      Executive Officer,
                      
                      January
      13, 2009James
      J. Houtz
                      
                      President
      and director/s/
      Rodney Anderson
                      
                      Interim
      Chief Financial Officer
                      
                      January
      13, 2009Rodney
      Anderson
                      
                      and
      director/s/
      John Pavia
                      
                      Director
                      
                      January
      13, 2009John
      Pavia





38