UNITED STATES

SECURITIES AND EXCHANGE COMMISSION



Washington, D.C. 20549



Form 10-QSB/A

(Amendment Number 2)



Mark One



þ   Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the quarterly period ended December 31, 2007; or



 ̈   Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the transition period from ________________ to ________ ___________.



Commission File No. 002-95626-D



Sionix Corporation

(Exact name of registrant as specified in charter)



|                                |  |                                        
|------------------------------- |  | ---------------------------------------
|Nevada                          |  | 87-0428526                             
|(State or other jurisdiction of |  | (I.R.S. Employer Identification Number)
|incorporation or organization)  |  |                                        



3880 East Eagle Drive, Anaheim, California 92807

(Address of principal executive offices)



(847) 235-4566

(Registrants telephone number, including area code)

N/A

(Former name, former address and former fiscal year if changed since last report)



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

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

The number of shares of common stock outstanding at February 10, 2009 was 136,684,616 shares.

Transitional Small Business Format (Check one) Yes  ̈No þ













1



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EXPLANATORY NOTE

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

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

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

·

2001 Executive Officers Stock Option Plan

·

Advisory Board Compensation

·

Warrants Related to 2004 Stock Purchase Agreement

·

Convertible Notes 1

·

Convertible Notes 2

·

Subordinated Convertible Notes 3

·

Warrants related to Subordinated Convertible Notes 3

As a result of these transactions, we filed amendment number 2 (Amendment 2) to our Form 10-QSB/A (Amendment 1) that was filed with the Securities and Exchange Commission (the SEC) on February 18,2009, for the period ended December 31, 2007.

The primary purpose of the Amendment is to disclose the restatement of our financial statements for the three months ended December 31, 2007, and cumulative inception to date operations for December 31, 2007. A complete discussion of the restatement is included in the section of the Amendment 2 titled Managements Discussion and Analysis or Plan of Operation and in note 14 to our financial statements for the period ended December 31, 2007.

This Amendment 2 includes all of the information contained in the Amendment 1, and we have made no attempt in this Amendment 2 to modify or update the disclosures presented in the Amendment 1, except as identified.

The disclosures in this Amendment 2 continue to speak as of the date of the Amendment 1, and do not reflect events occurring after the filing of the Amendment 1. Accordingly, this Amendment 2 should be read in conjunction with our other filings made with the Securities and Exchange Commission subsequent to the filing of the Amendment 1, including any amendments to those filings. The filing of this Amendment 2 shall not be deemed to be an admission that the Amendment 1, when made, included any untrue statement of a material fact or omitted to state a material fact necessary to make a statement not misleading.

The following adjustments were made to our financial statements for the periods ended December 31, 2007:





2



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|                                                                       |  |                      |             |   |                               |   |             |                      |  |   |                               |   |  |   |             |  
|---------------------------------------------------------------------- |  | -------------------- | ----------- | - | ----------------------------- | - | ----------- | -------------------- |  | - | ----------------------------- | - |  | - | ----------- | -
|                                                                       |  | As Previously Stated |             |   | Benficial
Conversion
Features |   |             | Warrants and Options |  |   | As Restated
December 31,
2007 |  
|Balance Sheet                                                          |  |                      |             |   |                               |   |             |                      |  |   |                               |  
|Accrued expenses                                                       |  | $                    | 2,353,077   |   |                               | $ |           |                      |  | $ |                             |   |  | $ | 2,353,077   |  
|Warrant and option liability                                           |  |                      | 6,464,460   |   |                               |   |           |                      |  |   | 1,032,937                     |   |  |   | 7,497,397   |  
|Beneficial conversion liability                                        |  |                      | 1,222,663   |   |                               |   | 21,031,723  |                      |  |   |                             |   |  |   | 22,254,386  |  
|Additional paid-in capital                                             |  |                      | 10,762,982  |   |                               |   |           |                      |  |   | 334,746                       |   |  |   | 11,097,728  |  
|Deficit accumulated during developmental stage                         |  |                      | (22,488,813 | ) |                               |   | (21,031,723 | )                    |  |   | (1,367,683                    | ) |  |   | (44,888,219 | )
|                                                                       |  |                      |             |   |                               |   |             |                      |  |   |                               |   |  |   |             |  
|Statement of Operations (for the three months ended December 31, 2007) |  |                      |             |   |                               |   |             |                      |  |   |                               |   | 
|Gain on change in fair value of warrant and option liability           |  | $                    | 759,773     |   |                               | $ |           |                      |  | $ | 1,418,732                     |   |  | $ | 2,178,505   |  
|Gain on change in fair value of beneficail conversion liability        |  |                      | 208,149     |   |                               |   | 7,626,152   |                      |  |   |                             |   |  |   | 7,834,301   |  
|General and administrative expense                                     |  |                      | 5,064,569   |   |                               |   |           |                      |  |   |                             |   |  |   | 5,064,569   |  
|Interest expense and financing costs                                   |  |                      | (126,286    | ) |                               |   |           |                      |  |   |                             |   |  |   | (126,286    | )
|                                                                       |  |                      |             |   |                               |   |             |                      |  |   |                               |   |  |   |             |  
|Statement of Operations (since inception)                              |  |                      |             |   |                               |   |             |                      |  |   |                               |   |  |   |             |  
|Gain on change in fair value of warrant and option liability           |  | $                    | 848,644     |   |                               | $ |           |                      |  | $ | 1,658,334                     |   |  | $ | 2,506,978   |  
|Gain on change in fair value of beneficail conversion liability        |  |                      | 204,105     |   |                               |   | 11,544,227  |                      |  |   |                             |   |  |   | 11,748,332  |  
|General and administrative expense                                     |  |                      | 18,394,074  |   |                               |   | 3,787,032   |                      |  |   |                             |   |  |   | 22,181,106  |  
|Interest expense and financing costs                                   |  |                      | (922,775    | ) |                               |   | (30,536,702 | )                    |  |   | (1,278,233                    | ) |  |   | (32,737,710 | )
|                                                                       |  |                      |             |   |                               |   |             |                      |  |   |                               |   |  |   |             |  
|Statement of Cash Flows (for the three months ended December 31, 2007) |  |                      |             |   |                               |   |             |                      |  |   |                               |   | 
|Net income (loss)                                                      |  | $                    | (4,467,977  | ) |                               | $ | 7,626,152   |                      |  | $ | 1,418,732                     |   |  | $ | 4,576,907   |  
|Gain on change in fair value of warrant and option liability           |  |                      | (759,773    | ) |                               |   |           |                      |  |   | (1,418,732                    | ) |  |   | (2,178,505  | )
|Gain on change in fair value of beneficail conversion liability        |  |                      | (208,149    | ) |                               |   | (7,626,152  | )                    |  |   |                             |   |  |   | (7,834,301  | )
|Non-cash compensation expense                                          |  |                      | 1,791,360   |   |                               |   |           |                      |  |   |                             |   |  |   | 1,791,360   |  
|Non-cash financing costs                                               |  |                      |           |   |                               |   |           |                      |  |   |                             |   |  |   |           |  
|                                                                       |  |                      |             |   |                               |   |             |                      |  |   |                               |   |  |   |             |  
|Statement of Cash Flows (since inception)                              |  |                      |             |   |                               |   |             |                      |  |   |                               |   |  |   |             |  
|Net income (loss)                                                      |  | $                    | (22,488,813 | ) |                               | $ | (22,779,507 | )                    |  | $ | 380,101                       |   |  | $ | (44,888,219 | )
|Gain on change in fair value of warrant and option liability           |  |                      | (1,229,084  | ) |                               |   |           |                      |  |   | (1,658,334                    | ) |  |   | (2,887,418  | )
|Gain on change in fair value of beneficail conversion liability        |  |                      | (204,105    | ) |                               |   | (11,544,227 | )                    |  |   |                             |   |  |   | (11,748,332 | )
|Non-cash compensation expense                                          |  |                      | 3,627,317   |   |                               |   | 3,787,032   |                      |  |   |                             |   |  |   | 7,414,349   |  
|Non-cash financing costs                                               |  |                      | -           |   |                               |   | 30,536,702  |                      |  |   | 1,278,233                     |   |  |   | 31,814,935  |  
|                                                                       |  |                      |             |   |                               |   |             |                      |  |   |                               |   |  |   |             |  







3



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Sionix Corporation  Form 10-QSB

Table of Contents



|        |                       |                                                                                                                                                                              |    
|------- | --------------------- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ---
|Part I  | Financial Information |                                                                                                                                                                             
|        |                       |                                                                                                                                                                              |    
|        | Item 1                | Financial Statements                                                                                                                                                         |    
|        |                       |                                                                                                                                                                              |    
|        |                       | Balance Sheet as of December 31, 2007 (Unaudited) (Restated)                                                                                                                 | 5  
|        |                       |                                                                                                                                                                              |    
|        |                       | Statements of Operations (Unaudited) for the three month ended December 31, 2007 and December 31, 2006 and from inception (October 3, 1994) to December 31, 2007 (Restated)  | 6  
|        |                       |                                                                                                                                                                              |    
|        |                       | Statements of Stockholders Equity (Deficit) for the period from inception (October 3, 1994) to December 31, 2007 (Restated)                                                  | 7  
|        |                       |                                                                                                                                                                              |    
|        |                       | Statements of Cash Flows (unaudited) for the three months ended December 31, 2007 and December 31, 2006 and from inception (October 3, 1994) to December 31, 2007 (Restated) | 9  
|        |                       |                                                                                                                                                                              |    
|        |                       | Notes to unaudited condensed financial statements                                                                                                                            | 10 
|        |                       |                                                                                                                                                                              |    
|        |                       | Forward-Looking Statements                                                                                                                                                   | 301
|        |                       |                                                                                                                                                                              |    
|Part II | Other Information     |                                                                                                                                                                             
|        |                       |                                                                                                                                                                              |    
|        | Item 1                | Legal Proceedings                                                                                                                                                            | 68 
|        |                       |                                                                                                                                                                              |    
|        | Item 2                | Unregistered Sales of Equity Securities and Use of Proceeds                                                                                                                  | 68 
|        |                       |                                                                                                                                                                              |    
|        | Item 3                | Defaults upon Senior Securities                                                                                                                                              | 68 
|        |                       |                                                                                                                                                                              |    
|        | Item 4                | Submission of Matters to a Vote of Security Holders                                                                                                                          | 68 
|        |                       |                                                                                                                                                                              |    
|        | Item 5                | Other Information                                                                                                                                                            | 68 
|        |                       |                                                                                                                                                                              |    
|        | Item 6                | Exhibits                                                                                                                                                                     | 68 
|        |                       |                                                                                                                                                                              |    
|        | Signatures            |                                                                                                                                                                              | 70 





4



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SIONIX CORPORATION

(A DEVELOPMENT STAGE COMPANY)

BALANCE SHEET

AS OF DECEMBER 31, 2007(UNAUDITED)



|                                                                                                                                                            |  |             |             |  
|----------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ----------- | ----------- | -
|                                                                                                                                                            |  | As
Restated |            
|ASSETS                                                                                                                                                      |  |             |            
|CURRENT ASSETS                                                                                                                                              |  |             |            
|Cash and cash equivalents                                                                                                                                   |  | $           | 1,366       |  
|Other current assets                                                                                                                                        |  |             | 2,000       |  
|TOTAL CURRENT ASSETS                                                                                                                                        |  |             | 3,366       |  
|                                                                                                                                                            |  |             |             |  
|PROPERTY AND EQUIPMENT, net                                                                                                                                 |  |             | 59,343      |  
|DEPOSITS                                                                                                                                                    |  |             | 104,600     |  
|TOTAL ASSETS                                                                                                                                                |  | $           | 167,309     |  
|                                                                                                                                                            |  |             |             |  
|LIABILITIES AND STOCKHOLDERS' DEFICIT                                                                                                                       |  |             |             |  
|CURRENT LIABILITIES                                                                                                                                         |  |             |             |  
|Accounts payable                                                                                                                                            |  | $           | 344,854     |  
|Accrued expenses                                                                                                                                            |  |             | 2,353,077   |  
|Liquidated damages liability                                                                                                                                |  |             | 61,500      |  
|Notes payable  related parties                                                                                                                             |  |             | 124,000     |  
|Notes payable  officers                                                                                                                                    |  |             |           |  
|Convertible notes, net of debt discounts of $688,949                                                                                                        |  |             | 1,172,051   |  
|Equity line of credit                                                                                                                                       |  |             |           |  
|Warrant and option liability                                                                                                                                |  |             | 7,497,397   |  
|Beneficial conversion feature liability                                                                                                                     |  |             | 22,254,386  |  
|TOTAL CURRENT LIABILITIES                                                                                                                                   |  |             | 33,807,265  |  
|                                                                                                                                                            |  |             |             |  
|STOCKHOLDERS' DEFICIT                                                                                                                                       |  |             |             |  
|Common Stock (150,000,000 shares authorized; 107,117,101 shares issued and                             
106,635,201 shares outstanding at December 31, 2007 |  |             | 106,635     |  
|Shares to be issued                                                                                                                                         |  |             | 43,900      |  
|Additional paid-in capital                                                                                                                                  |  |             | 10,762,982  |  
|Deficit accumulated during development stage                                                                                                                |  |             | (44,888,219 | )
|TOTAL STOCKHOLDERS' DEFICIT                                                                                                                                 |  |             | (33,639,956 | )
|TOTAL LIABILITIES AND STOCKHOLDERS' DEFICIT                                                                                                                 |  | $           | 167,309     |  

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





5



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SIONIX CORPORATION

(A DEVELOPMENT STAGE COMPANY)

STATEMENT OF OPERATIONS

(UNAUDITED)



|                                                                |  |   |                     |   |   |                          |   |   |               |  
|--------------------------------------------------------------- |  | - | ------------------- | - | - | ------------------------ | - | - | ------------- | -
|                                                                |  |   |                     |   |   |                          |   |   | Cumulative    |  
|                                                                |  |   | For the Years       |   |   | from
October 3, 1994) to |  
|                                                                |  |   | Ended September 30, |   |   | September 30,            |  
|                                                                |  |   | 2007                |   |   | 2006                     |   |   | 2007          |  
|                                                                |  |   | (As Restated)       |   |   | (As Restated)            |   |   | (As Restated) |  
|Revenues                                                        |  | $ |                   |   | $ |                        |   | $ |             |  
|                                                                |  |   |                     |   |   |                          |   |   |               |  
|Operating expenses                                              |  |   |                     |   |   |                          |   |   |               |  
|General and administrative                                      |  |   | 5,064,569           |   |   | 275,242                  |   |   | 22,181,106    |  
|Research and development                                        |  |   | 236,904             |   |   |                        |   |   | 2,212,844     |  
|Depreciation and amortization                                   |  |   | 8,157               |   |   | 7,793                    |   |   | 540,262       |  
|Total operating expenses                                        |  |   | 5,309,630           |   |   | 283,035                  |   |   | 24,934,212    |  
|Loss from operations                                            |  |   | (5,309,630)         | ) |   | (283,035                 | ) |   | (24,934,212   | )
|                                                                |  |   |                     |   |   |                          |   |   |               |  
|Other income (expense)                                          |  |   |                     |   |   |                          |   |   |               |  
|Interest income                                                 |  |   | 917                 |   |   | 106                      |   |   | 59,460        |  
|Interest expense and financing costs                            |  |   | (126,286            | ) |   | (110,410                 | ) |   | (32,737,710   | )
|Gain on change in fair value of warrant and option liability    |  |   | 2,178,505           |   |   |                        |   |   | 2,506,978     |  
|Gain on change in fair value of beneficial conversion liability |  |   | 7,834,301           |   |   |                        |   |   | 11,748,332    |  
|Impairment of intangibles                                       |  |   |                   |   |   |                        |   |   | (1,267,278    | )
|Inventory obsolesence                                           |  |   |                   |   |   |                        |   |   | (365,078      | )
|Legal settlement                                                |  |   |                   |   |   |                        |   |   | 344,949       |  
|Loss on settlement of debt                                      |  |   |                   |   |   |                        |   |   | (230,268      | )
|Total other (income) expense                                    |  |   | 9,887,437           |   |   | (110,304                 | ) |   | (19,940,615   | )
|Loss before income taxes                                        |  |   | 4,577,807           |   |   | (393,339                 | ) |   | (44,874,827   | )
|Income taxes                                                    |  |   | 900                 |   |   | 900                      |   |   | 13,392        |  
|Net income (loss)                                               |  | $ | 4,576,907           |   | $ | (394,239                 | ) | $ | (44,888,219   | )
|                                                                |  |   |                     |   |   |                          |   |   |               |  
|Basic income (loss) per share                                   |  | $ | 0.04                |   | $ | (0.00                    | ) |   |               |  
|Dilutive income (loss) per share                                |  | $ | 0.04                |   | $ | (0.00                    | ) |   |               |  
|                                                                |  |   |                     |   |   |                          |   |   |               |  
|Basic weighted average number of                                |  |   |                     |   |   |                          |   |   |               |  
|shares of common stock outstanding                              |  |   | 106,635,201         |   |   | 105,459,175              |   |   |               |  
|Dilutive weighted average number of                             |  |   |                     |   |   |                          |   |   |               |  
|shares of common stock outstanding                              |  |   | 106,635,201         |   |   | 105,459,175              |   |   |               |  
|                                                                |  |   |                     |   |   |                          |   |   |               |  

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



6



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SIONIX CORPORATION

(A DEVELOPMENT STAGE COMPANY)

STATEMENTS OF STOCKHOLDERS EQUITY (DEFICIT)

FOR THE PERIOD FROM OCTOBER 3, 1994 (INCEPTION) TO DECEMBER 31, 2007

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





7



---





SIONIX CORPORATION

(A DEVELOPMENT STAGE COMPANY)

STATEMENTS OF STOCKHOLDERS EQUITY (DEFICIT)

FOR THE PERIOD FROM OCTOBER 3, 1994 (INCEPTION) TO DECEMBER 31, 2007 (Continued)

|                                                    |  |              |             |   |            |  |         |         |  |  |            |   |  |              |          |   |             |  |    |             |  |  |               |   |  |           |          |   |  |  |             |   |  |  |            |  
|--------------------------------------------------- |  | ------------ | ----------- | - | ---------- |  | ------- | ------- |  |  | ---------- | - |  | ------------ | -------- | - | ----------- |  | -- | ----------- |  |  | ------------- | - |  | --------- | -------- | - |  |  | ----------- | - |  |  | ---------- | -
|                                                    |  |              |             |   |            |  |         |         |  |  |            |   |  |              |          |   |             |  |    |             |  |  | Deficit       |   |  | Total     |         
|                                                    |  | Common Stock |             |   | Additional |  |         | Shares  |  |  | Stock      |   |  | Shares       |          |   | Unamortized |  |    | Accumulated |  |  | Stockholders' |  
|                                                    |  | Number       |             |   |            |  |         | Paid-in |  |  | to be      |   |  | Subscription |          |   | to be       |  |    | Consulting  |  |  | from          |   |  | Equity    |         
|                                                    |  | of 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 services                          |  |              | 2,517,376   |   |            |  | 2,517   |         |  |  | 530,368    |   |  |              |        |   |             |  |  |             |  |  |             |   |  |           | (141,318 | ) |  |  |           |   |  |  | 391,567    |  
|Shares issued for cash                              |  |              | 6,005,000   |   |            |  | 6,005   |         |  |  | 594,495    |   |  |              |        |   |             |  |  |             |  |  |             |   |  |           |        |   |  |  |           |   |  |  | 600,500    |  
|Shares to be issued for cash (100,000 shares)       |  |              |           |   |            |  |       |         |  |  |          |   |  |              | 10,000   |   |             |  |  |             |  |  |             |   |  |           |        |   |  |  |           |   |  |  | 10,000     |  
|Shares to be issued for debt (639,509 shares)       |  |              |           |   |            |  |       |         |  |  |          |   |  |              | 103,295  |   |             |  |  |             |  |  |             |   |  |           |        |   |  |  |           |   |  |  | 103,295    |  
|Net loss                                            |  |              |           |   |            |  |       |         |  |  |          |   |  |              |        |   |             |  |  |             |  |  |             |   |  |           |        |   |  |  | (1,353,429  | ) |  |  | (1,353,429 | )
|Balance at 
September 30, 2001                      |  |              | 62,688,698  |   |            |  | 62,688  |         |  |  | 9,229,213  |   |  |              | 113,295  |   |             |  |  |             |  |  |             |   |  |           | (141,318 | ) |  |  | (9,522,180  | ) |  |  | (258,302   | )
|Shares issued for services                          |  |              | 1,111,710   |   |            |  | 1,112   |         |  |  | 361,603    |   |  |              |        |   |             |  |  |             |  |  |             |   |  |           | 54,400   |   |  |  |           |   |  |  | 417,115    |  
|Shares issued as a contribution                     |  |              | 100,000     |   |            |  | 100     |         |  |  | 11,200     |   |  |              |        |   |             |  |  |             |  |  |             |   |  |           |        |   |  |  |           |   |  |  | 11,300     |  
|Shares issued for compensation                      |  |              | 18,838      |   |            |  | 19      |         |  |  | 2,897      |   |  |              |        |   |             |  |  |             |  |  |             |   |  |           |        |   |  |  |           |   |  |  | 2,916      |  
|Shares issued for cash                              |  |              | 16,815,357  |   |            |  | 16,815  |         |  |  | 1,560,782  |   |  |              | (10,000  | ) |             |  |  |             |  |  |             |   |  |           |        |   |  |  |           |   |  |  | 1,567,597  |  
|Shares issued for debt                              |  |              | 1,339,509   |   |            |  | 1,340   |         |  |  | 208,639    |   |  |              | (103,295 | ) |             |  |  |             |  |  |             |   |  |           |        |   |  |  |           |   |  |  | 106,684    |  
|Shares to be issued related to equity               |  |              |             |   |            |  |         |         |  |  |            |   |  |              |          |   |             |  |    |             |  |  |               |   |  |           |          |   |  |  |             |   |  |  |            |  
|financing (967,742 shares)                          |  |              |           |   |            |  |       |         |  |  | (300,000   | ) |  |              | 300,000  |   |             |  |  |             |  |  |             |   |  |           |        |   |  |  |           |   |  |  |          |  
|Cancellation of shares                              |  |              | (7,533,701  | ) |            |  | (7,534  | )       |  |  |          |   |  |              |        |   |             |  |  |             |  |  |             |   |  |           |        |   |  |  |           |   |  |  | (7,534     | )
|Net loss                                            |  |              |           |   |            |  |       |         |  |  |          |   |  |              |        |   |             |  |  |             |  |  |             |   |  |           |        |   |  |  | (1,243,309  | ) |  |  | (1,243,309 | )
|Balance at 
September 30, 2002                      |  |              | 74,540,411  |   |            |  | 74,540  |         |  |  | 11,074,334 |   |  |              | 300,000  |   |             |  |  |             |  |  |             |   |  |           | (86,918  | ) |  |  | (10,765,489 | ) |  |  | 596,467    |  
|Shares issued for services                          |  |              | 2,467,742   |   |            |  | 2,468   |         |  |  | 651,757    |   |  |              | (300,000 | ) |             |  |  |             |  |  |             |   |  |           |        |   |  |  |           |   |  |  | 354,225    |  
|Shares issued for capital equity line               |  |              | 8,154,317   |   |            |  | 8,154   |         |  |  | 891,846    |   |  |              |        |   |             |  |  |             |  |  |             |   |  |           |        |   |  |  |           |   |  |  | 900,000    |  
|Amortization of consulting fees                     |  |              |           |   |            |  |       |         |  |  |          |   |  |              |        |   |             |  |  |             |  |  |             |   |  |           | 86,918   |   |  |  |           |   |  |  | 86,918     |  
|Cancellation of shares                              |  |              | (50,000     | ) |            |  | (50     | )       |  |  | 50         |   |  |              |        |   |             |  |  |             |  |  |             |   |  |           |        |   |  |  |           |   |  |  |          |  
|Shares to be cancelled (7,349,204 shares)           |  |              |           |   |            |  |       |         |  |  | 7,349      |   |  |              |        |   |             |  |  |             |  |  | (7,349        | ) |  |           |        |   |  |  |           |   |  |  |          |  
|Net loss                                            |  |              |           |   |            |  |       |         |  |  |          |   |  |              |        |   |             |  |  |             |  |  |             |   |  |           |        |   |  |  | (1,721,991  | ) |  |  | (1,721,991 | )
|Balance at 
September 30, 2003                      |  |              | 85,112,470  |   |            |  | 85,112  |         |  |  | 12,625,336 |   |  |              |        |   |             |  |  |             |  |  | (7,349        | ) |  |           |        |   |  |  | (12,487,480 | ) |  |  | 215,619    |  
|Shares issued for capital equity line               |  |              | 19,179,016  |   |            |  | 19,179  |         |  |  | 447,706    |   |  |              |        |   |             |  |  |             |  |  |             |   |  |           |        |   |  |  |           |   |  |  | 466,885    |  
|Shares issued for services                          |  |              | 5,100,004   |   |            |  | 5,100   |         |  |  | 196,997    |   |  |              |        |   |             |  |  |             |  |  |             |   |  |           | (13,075  | ) |  |  |           |   |  |  | 189,022    |  
|Share to be issued for cash (963,336 shares)        |  |              |           |   |            |  |       |         |  |  |          |   |  |              | 28,900   |   |             |  |  |             |  |  |             |   |  |           |        |   |  |  |           |   |  |  | 28,900     |  
|Shares to be issued for debt (500,000 shares)       |  |              |           |   |            |  |       |         |  |  |          |   |  |              | 15,000   |   |             |  |  |             |  |  |             |   |  |           |        |   |  |  |           |   |  |  | 15,000     |  
|Cancellation of shares                              |  |              | (7,349,204  | ) |            |  | (7,349  | )       |  |  |          |   |  |              |        |   |             |  |  |             |  |  | 7,349         |   |  |           |        |   |  |  |           |   |  |  |          |  
|Issuance of warrants related to 2004 stock purchase |  |              |           |   |            |  |       |         |  |  | 24,366     |   |  |              |        |   |             |  |  |             |  |  |             |   |  |           |        |   |  |  |           |   |  |  | 24,366     |  
|Net loss                                            |  |              |           |   |            |  |       |         |  |  |          |   |  |              |        |   |             |  |  |             |  |  |             |   |  |           |        |   |  |  | (1,593,135  | ) |  |  | (1,593,135 | )
|Balance at 
September 30, 2004                      |  |              | 102,042,286 |   |            |  | 102,042 |         |  |  | 13,294,405 |   |  |              | 43,900   |   |             |  |  |             |  |  |             |   |  |           | (13,075  | ) |  |  | (14,080,615 | ) |  |  | (653,343   | )
|Amortization of consulting fees                     |  |              |           |   |            |  |       |         |  |  |          |   |  |              |        |   |             |  |  |             |  |  |             |   |  |           | 13,075   |   |  |  |           |   |  |  | 13,075     |  
|Net loss                                            |  |              |           |   |            |  |       |         |  |  |          |   |  |              |        |   |             |  |  |             |  |  |             |   |  |           |        |   |  |  | (722,676    | ) |  |  | (722,676   | )
|Balance at 
September 30, 2005                      |  |              | 102,042,286 |   |            |  | 102,042 |         |  |  | 13,294,405 |   |  |              | 43,900   |   |             |  |  |             |  |  |             |   |  |           |        |   |  |  | (14,803,291 | ) |  |  | (1,362,944 | )
|Net loss                                            |  |              |           |   |            |  |       |         |  |  |          |   |  |              |        |   |             |  |  |             |  |  |             |   |  |           |        |   |  |  | (1,049,319  | ) |  |  | (1,049,319 | )





8



---





SIONIX CORPORATION

(A DEVELOPMENT STAGE COMPANY)

STATEMENTS OF STOCKHOLDERS EQUITY (DEFICIT)

FOR THE PERIOD FROM OCTOBER 3, 1994 (INCEPTION) TO DECEMBER 31, 2007(Continued)

|                                                    |  |              |             |  |            |   |         |         |  |   |            |   |  |              |        |  |             |   |    |             |  |   |               |  |  |           |    |  |  |   |             |   |  |   |             |  
|--------------------------------------------------- |  | ------------ | ----------- |  | ---------- | - | ------- | ------- |  | - | ---------- | - |  | ------------ | ------ |  | ----------- | - | -- | ----------- |  | - | ------------- |  |  | --------- | -- |  |  | - | ----------- | - |  | - | ----------- | -
|                                                    |  |              |             |  |            |   |         |         |  |   |            |   |  |              |        |  |             |   |    |             |  |   | Deficit       |  |  | Total     |   
|                                                    |  | Common Stock |             |  | Additional |   |         | Shares  |  |   | Stock      |   |  | Shares       |        |  | Unamortized |   |    | Accumulated |  |   | Stockholders' | 
|                                                    |  | Number       |             |  |            |   |         | Paid-in |  |   | to be      |   |  | Subscription |        |  | to be       |   |    | Consulting  |  |   | from          |  |  | Equity    |   
|                                                    |  | of Shares    |             |  | Amount     |   |         | Capital |  |   | Issued     |   |  | Receivable   |        |  | Cancelled   |   |    | Fees        |  |   | Inception     |  |  | (Deficit) |   
|Balance at 
September 30, 2006                      |  |              | 102,042,286 |  |            |   | 102,042 |         |  |   | 13,294,405 |   |  |              | 43,900 |  |             |   |  |             |  |   |             |  |  |           |  |  |  |   | (15,852,610 | ) |  |   | (2,412,263  | )
|Stock issued for consulting                         |  |              | 4,592,915   |  |            |   | 4,593   |         |  |   | 80,336     |   |  |              |      |  |             |   |  |             |  |   |             |  |  |           |  |  |  |   |           |   |  |   | 84,929      |  
|Reclassification to warrant and option liability    |  |              |           |  |            |   |       |         |  |   | (2,277,013 | ) |  |              |      |  |             |   |  |             |  |   |             |  |  |           |  |  |  |   |           |   |  |   | (2,277,013  | )
|Net loss                                            |  |              |           |  |            |   |       |         |  |   |          |   |  |              |      |  |             |   |  |             |  |   |             |  |  |           |  |  |  |   | (33,612,516 | ) |  |   | (33,612,516 | )
|Balance at 
September 30, 2007                      |  |              | 106,635,201 |  |            |   | 106,635 |         |  |   | 11,097,728 |   |  |              | 43,900 |  |             |   |  |             |  |   |             |  |  |           |  |  |  |   | (49,465,126 | ) |  |   | (38,216,863 | )
|Net income                                          |  |              |           |  |            |   |       |         |  |   |          |   |  |              |      |  |             |   |  |             |  |   |             |  |  |           |  |  |  |   | 4,576,907   |   |  |   | 4,576,907   |  
|Balance at 
December 31, 2007 (unaudited), restated |  |              | 106,635,201 |  |            | $ | 106,635 |         |  | $ | 11,097,728 |   |  | $            | 43,900 |  |             | $ |  |             |  | $ |             |  |  | $         |  |  |  | $ | (44,888,219 | ) |  | $ | (33,639,956 | )



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



9



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SIONIX CORPORATION

(A DEVELOPMENT STAGE COMPANY)

STATEMENT OF CASH FLOWS

(UNAUDITED)



|                                                                             |  |                      |            |   |                                                |   |          |               |  |   |             |  
|---------------------------------------------------------------------------- |  | -------------------- | ---------- | - | ---------------------------------------------- | - | -------- | ------------- |  | - | ----------- | -
|                                                                             |  | For the Three Months |            |   | Cummulative
from
Inception
(October 3, 1994
to |  
|                                                                             |  | Ended December 31,   |            |   | December 31,                                   |  
|                                                                             |  | 2007                 |            |   | 2006                                           |   |          | 2007          | 
|                                                                             |  | (As Restated)        |            |   |                                                |   |          | (As Restated) | 
|OPERATING ACTIVITIES:                                                        |  |                      |            |   |                                                |   |          |               | 
|Net income (loss)                                                            |  | $                    | 4,576,907  |   |                                                | $ | (394,239 | )             |  | $ | (44,888,219 | )
|Adjustments to reconcile net loss to net cash used in operating activities:  |  |                      |            |   |                                                |   |          |               |  |   |             |  
|Depreciation                                                                 |  |                      | 8,157      |   |                                                |   | 7,793    |               |  |   | 627,180     |  
|Amortization of beneficial conversion features discount and warrant discount |  |                      | 405,651    |   |                                                |   | 91,528   |               |  |   | 1,288,669   |  
|Stock based compensation expense - employee                                  |  |                      | 1,791,360  |   |                                                |   |        |               |  |   | 7,414,349   |  
|Stock based compensation expense - consultant                                |  |                      | 3,006,027  |   |                                                |   | 32,929   |               |  |   | 5,970,896   |  
|Gain on change in fair value of warrant and option liability                 |  |                      | (2,178,505 | ) |                                                |   |        |               |  |   | (2,887,418  | )
|Gain on change in  fair value of beneficial conversion liability             |  |                      | (7,834,301 | ) |                                                |   |        |               |  |   | (11,748,332 | )
|Non-cash financing costs                                                     |  |                      |          |   |                                                |   |        |               |  |   | 31,814,935  |  
|Impairment of assets                                                         |  |                      |          |   |                                                |   |        |               |  |   | 514,755     |  
|Write-down of obsolete assets                                                |  |                      |          |   |                                                |   |        |               |  |   | 38,862      |  
|Impairment of intangible assets                                              |  |                      |          |   |                                                |   |        |               |  |   | 1,117,601   |  
|Loss on settlement of debt                                                   |  |                      |          |   |                                                |   |        |               |  |   | 130,268     |  
|Write-off of beneficial conversion features                                  |  |                      | (380,440   | ) |                                                |   |        |               |  |   | (380,440    | )
|Accrual of liquidated damages                                                |  |                      | 46,125     |   |                                                |   |        |               |  |   | 61,500      |  
|Other                                                                        |  |                      |          |   |                                                |   |        |               |  |   | (799,044    | )
|Increase in assets:                                                          |  |                      |            |   |                                                |   |          |               |  |   |             |  
|Other current assets                                                         |  |                      | (650       | ) |                                                |   |        |               |  |   | (2,000      | )
|Other assets                                                                 |  |                      |          |   |                                                |   |        |               |  |   | (104,600    | )
|Increase (decrease) in liabilities:                                          |  |                      |            |   |                                                |   |          |               |  |   |             |  
|Accounts payable                                                             |  |                      | 187,455    |   |                                                |   | (59,576  | )             |  |   | 344,854     |  
|Accrued expenses                                                             |  |                      | 79,331     |   |                                                |   | 159,389  |               |  |   | 2,086,143   |  
|Net cash used in operating activities                                        |  |                      | (292,883   | ) |                                                |   | (162,176 | )             |  |   | (9,400,041  | )
|INVESTING ACTIVITIES:                                                        |  |                      |            |   |                                                |   |          |               |  |   |             |  
|Acquisition of property and equipment                                        |  |                      | (26,666    | ) |                                                |   |        |               |  |   | (398,121    | )
|Acquisition of patents                                                       |  |                      |          |   |                                                |   |        |               |  |   | (154,061    | )
|Net cash used in investing activities                                        |  |                      | (26,666    | ) |                                                |   |        |               |  |   | (552,182    | )
|FINANACING ACTIVITIES:                                                       |  |                      |            |   |                                                |   |          |               |  |   |             |  
|Payment on notes payable to officer                                          |  |                      | (19,260    | ) |                                                |   | (18,800  | )             |  |   | (218,502    | )
|Proceeds from notes payable, related party                                   |  |                      |          |   |                                                |   |        |               |  |   | 457,433     |  
|Payments on notes payable to related party                                   |  |                      | (5,000     | ) |                                                |   |        |               |  |   | (5,000      | )
|Receipt from (payments to) equity line of credit                             |  |                      | (27,336    | ) |                                                |   | (75,000  | )             |  |   | 428,664     |  
|Proceeds from convertible notes payable                                      |  |                      |          |   |                                                |   | 622,500  |               |  |   | 1,861,000   |  
|Issuance of common stock                                                     |  |                      |          |   |                                                |   |        |               |  |   | 7,386,094   |  
|Receipt of cash for stock to be issued                                       |  |                      |          |   |                                                |   |        |               |  |   | 43,900      |  
|Net cash (used in) provided by financing activities                          |  |                      | (51,596    | ) |                                                |   | 528,700  |               |  |   | 9,953,589   |  
|Net increase (decrease) in cash and cash equivalents                         |  |                      | (371,145   | ) |                                                |   | 366,524  |               |  |   | 1,366       |  
|CASH AND CASH EQUIVALENTS, BEGINNING                                         |  |                      | 372,511    |   |                                                |   | 4,544    |               |  |   |           |  
|CASH AND CASH EQUIVALENTS, ENDING                                            |  | $                    | 1,366      |   |                                                | $ | 371,068  |               |  | $ | 1,366       |  
|SUPPLEMENTAL INFORMATION:                                                    |  |                      |            |   |                                                |   |          |               |  |   |             |  
|Cash and cash equivalents paid for interest                                  |  | $                    |          |   |                                                | $ |        |               |  | $ |           |  
|Cash and cash equivalents paid for taxes                                     |  | $                    |          |   |                                                | $ |        |               |  | $ |           |  

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



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Sionix Corporation

A Development Stage Company

December 31, 2007

Notes to Financial Statements (Unaudited)

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 reincorporated in Nevada effective July 1, 2003 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

Basis of Presentation

The unaudited financial statements have been prepared by the Company, pursuant to the rules and regulations of the Securities and Exchange Commission. The information furnished in these unaudited financial statements reflects all adjustments (consisting of normal recurring accruals and adjustments) which are, in the opinion of management, necessary to fairly present the operating results for the respective periods. Certain information and footnote disclosures normally present in annual financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been omitted pursuant to such rules and regulations. The results of the three month period ended December 31, 2007 are not necessarily indicative of the results to be expected for the full year ending September 30, 2008 and should be read in conjunction with the audited financial statements for the year ended September 30, 2007.

Revenue Recognition

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



11



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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 asset impairment in the fourth quarter of our fiscal year or sooner if indicators of impairment exist.

Accrued Derivative Liabilities

The Company applies a two-step model to determine whether a financial instrument or an embedded feature is indexed to an issuers own stock and thus able to qualify for equity treatment. However, liability accounting is triggered as there were insufficient shares to fulfill all potential conversions. The Company determines which instruments or embedded features require liability accounting and records the fair values as an accrued derivative liability. The changes in the values of the accrued derivative liabilities are shown in the accompanying statements of operations as gain on change in fair value of warrant and option liability and gain on change in fair value of beneficial conversion liability.

Legal Contingencies

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



12



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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.

Net Loss Per Share

Net loss per share is calculated in accordance with Statement of Financial Accounting Standards No. 128, Earnings Per Share, (SFAS 128). Basic net loss per share is computed by dividing the net loss available to common stock holders by  the weighted average number of common shares outstanding. Diluted net loss per share is based on the assumption that all dilutive convertible shares and stock options and warrants were converted or exercised. Dilution is computed by applying the treasury stock method. Under this method, options and warrants are assumed to be exercised at the beginning of the period (or at the time of issuance, if later), and as if funds obtained thereby were used to purchase common stock at the average market price during the period. During the three months ended December 31, 2007, the Company had net income; however, the net income was due to the change in the fair value of the warrant and option liability and in the change in the fair value of the beneficial conversion liability. If these securities had been converted at the beginning of the period, then the Company would have realized a loss for the three month period ended December 31, 2007. As such, these securities are determined to be anti-dilutive and the number of shares used to determine the basic and dilutive earnings per share is the same.

Estimates

The preparation of financial statements requires management to make 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 revenue and expenses during the reporting period. Actual results could differ from those estimates

Advertising

The cost of advertising is expensed as incurred. Total advertising costs were included in general and administrative expenses and were $2,474 and $1,410 for the three months ended December 31, 2007 and 2006, respectively.

Reclassification

For comparative purposes, the prior periods financial statements have been reclassified to conform to the current periods presentation.

Recently Issued Accounting Pronouncements

In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements. This statement clarifies the definition of fair value, establishes a framework for measuring fair value and expands the disclosures on fair value measurements. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007. Company management is currently evaluating the effect of this pronouncement on its financial statements.

In February 2007, FASB issued FASB Statement No. 159, The Fair Value Option for Financial Assets and Financial Liabilities. FAS 159 is effective for fiscal years beginning after November 15, 2007. Early adoption is permitted subject to specific requirements outlined in the new Statement. Therefore, calendar-year companies may be able to adopt FAS 159 for their first quarter 2007 financial statements. The new Statement allows entities to choose, at specified election dates, to measure eligible financial assets and liabilities at fair value that are not otherwise required to be measured at fair value. If a company elects the fair value option for an eligible item, changes in that item's fair value in subsequent reporting periods must be recognized in current earnings. FAS 159 also establishes presentation and disclosure requirements designed to draw comparison between entities that elect different measurement attributes for similar assets and liabilities. Management is currently evaluating the effect of this pronouncement on the Company's financial statements.



13



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In December 2007, the FASB issued SFAS No. 141 (Revised 2007), Business Combinations. The objective of this statement will significantly change the accounting for business combinations. Under Statement 141R, an acquiring entity will be required to recognize all the assets acquired and liabilities assumed in a transaction at the acquisition-date fair value with limited exceptions. Statement 141 applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. The Company does not expect the adoption of SFAS No. 141R to have a material impact on the Company's financial statements.

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

NOTE 3

PROPERTY AND EQUIPMENT

Property and equipment consisted of the following at December 31, 2007:

|                              |  |   |          |  
|----------------------------- |  | - | -------- | -
|Equipment and machinery       |  | $ | 213,166  |  
|Furniture and fixtures        |  |   | 24,594   |  
|Leasehold improvements        |  |   | 26,667   |  
|                              |  |   | 264,427  |  
|Less accumulated depreciation |  |   | (205,084 | )
|                              |  |   |          |  
|Net Property and Equipment    |  | $ | 59,343   |  



Depreciation expenses for the three month periods ended December 31, 2007 and 2006 were $8,157 and $7,793, respectively.

NOTE 4

ACCRUED EXPENSES (Restated)

Accrued expenses consisted of the following at December 31, 2007:

|                                                |  |   |           | 
|----------------------------------------------- |  | - | --------- | 
|Accrued salaries and amounts withheld therefrom |  | $ | 1,439,349 | 
|Advisory board compensation                     |  |   | 576,000   | 
|Interest payable                                |  |   | 196,936   | 
|Other accruals                                  |  |   | 140,792   | 
|                                                |  |   |           | 
|Total accrued expenses                          |  | $ | 2,353,077 | 

NOTE 5

NOTES PAYABLE TO 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 December 31, 2007, notes payable amounted to $124,000. The Company recorded $3,239 of interest expense on those notes during the three month period ended December 31, 2007.



14



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NOTE 6

CONVERTIBLE NOTES PAYABLE (Restated)

Convertible Notes 1

Between October 2006 and February 2007, the Company completed an offering of $750,000 in principal amount of convertible notes, which bear interest at 10% per annum and mature 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 be reduced below $0.04 per share. As of December 31, 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.

The fair value of the embedded beneficial conversion features was $750,000 at the date of issuance using the Black Sholes valuation 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, which is $41,667 per month, is amortized to interest expense over the term of the note.

As of December 31, 2007, the outstanding principal amount of the convertible notes was $750,000 and the unamortized embedded beneficial conversion feature discount was $165,556, for a net convertible debt of $584,444.

For the three months ended December 31, 2007, interest expense was $19,375, and amortization expense for the embedded beneficial conversion feature discount was $125,000, 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.



15



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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.

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

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

As of December 31, 2007, the outstanding principal amount of the convertible notes was $86,000 and the unamortized embedded beneficial conversion feature discount was $52,556, for a net convertible debt of $33,444.

For the three months ended December 31, 2007, interest expense was $2,191, and amortization expense for the embedded beneficial conversion feature discount was $14,333, 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 17, 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.



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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. As of and for the three months ended December 31, 2007, the Company recorded $61,500 and $46,125 as liquidated damages, respectively. No derivative liability is recorded as the amount of liquidated damage is fixed with a maximum ceiling.

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

The fair value of the warrants was $741,371 at the date of issuance calculated using the Black Sholes valuation 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 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 valuation 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 valuation model, using the following assumptions: risk free rate of return of 5.01%, volatility of 226.04%, dividend yield of 0% and expected term of five years.



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As of December 31, 2007, the outstanding principal amount of the convertible notes was $1,025,000, unamortized warrant discount was $197,681 and unamortized embedded beneficial conversion feature discount was $273,153, for a net convertible debt of $554,167, and the number of outstanding warrants was 2,329,546.

For the three months ended December 31, 2007, interest expense was $20,219, amortization expense for the warrant discount was $107,547, 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 $148,702, which was also included in interest expense in the other income (expense) section of the statement of operations.

NOTE 7

WARRANT LIABILITY (Restated)

2001 Executive Officers Stock Option Plan

In October 2000, the Company amended its employment agreements with its executive officers. In conjunction with the amendments the Company adopted the 2001 Executive Officers Stock Option Plan. The plan reserved 7,576,680 shares of Common Stock for awards and, as of December 31, 2007, had 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 valuation 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 December 31, 2007 by following the guidance of SFAS 133, paragraph 6 to ascertain if the options issued remained derivatives as of December 31, 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.

The fair value of the options was $1,223,588 as of December 31, 2007, calculated using the Black Sholes valuation model with the following assumptions: risk free rate of return of 3.34%; volatility of 98.01%; dividend yield of 0%; and an expected term of 3.25 years.

The decrease in the fair value of the options was recorded by decreasing warrant liability on the balance sheet by $703,326 for the three months ended December 31, 2007.

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.



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

The fair value of 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 valuation 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 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 December 31, 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 be classified as a liability.

The fair value of the warrants was determined to be $321,777 ($254,444 attributable to the holders of the Convertible Notes 3 and $67,333 attributable to the placement fee)as of December 31, 2007, which was calculated using the Black Sholes valuation model with the following assumptions: risk free rate of return of 3.34%; volatility of 98.01%; dividend yield of 0%; and an expected term of 4.42 to 4.50 years.

The decrease in the fair value of the warrants for the three months ended December 31, 2007 was recorded by decreasing warrant liabilities on the balance sheet by $178,155 ($125,228 attributable to the holders of the Convertible Notes 3 and $52,927 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 four 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 contracts that require net-cash settlement (including a requirement to net cash settle the contract if an event occurs and if that event is outside the control of the company) are liability instruments. In order to determine the value of the 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 $1,557,704 at the date of issuance and was calculated using the Black Sholes 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.



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The Company analyzed the warrants by applying FASB 133, paragraph 6 to ascertain if the warrants remained derivatives as of December 31, 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. 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 $1,533,300 as of December 31, 2007, using the Black Sholes valuation model with the following assumptions: risk free rate of return of 3.34%; volatility of 98.01%; dividend yield of 0%; and an expected term of 4.92 years.

The decrease in the fair value of the warrants was $24,404 for the three months ended December 31, 2007, 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.

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 contracts that require net-cash settlement (including a requirement to net cash settle the contract if an event occurs and if that event is outside the control of the company) are liability instruments. In order to determine the value of the 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 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 December 31, 2007. 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 $177,465 as of December 31, 2007, using the Black Sholes valuation model with the following assumptions: risk free rate of return of 3.34%; volatility of 98.01%; dividend yield of 0%; and an expected term of 4.92 years.

The increase in the fair value of the option was $5,945 for the three months ended December 31, 2007, and recorded by decreasing the warrant liability on the balance sheet.

Option Issued to 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 to purchase a total of 1,000,000 shares of the Companys common stock at an exercise price of $0.25 per share.



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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 contracts that require net-cash settlement (including a requirement to net cash settle the contract if an event occurs and if that event is outside the control of the company) are liability instruments. In order to determine the value of the 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 valuation model with the following assumptions: risk free interest rate of 3.22%, expected volatility of 99.86%, dividend yield 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 December 31, 2007. 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 $177,465 as of December 31, 2007 using the Black Sholes valuation model with the following assumptions: risk free rate of return of 3.34%; volatility of 98.01%; dividend yield of 0%; and an expected term of 4.92 years.

The increase in the fair value of the option was $5,945 for the three months ended December 31, 2007, and recorded by decreasing the warrant liability on the balance sheet.

Option Issued to 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 Notes 2 as discussed in Note 6 above) are eligible for conversion into shares of Common Stock. These options were not issued from the 2001 Executive Officers Stock Option Plan. 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 contracts that require net-cash settlement (including a requirement to net cash settle the contract if an event occurs and if that event is outside the control of the company) are liability instruments. In order to determine the value of the 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 valuation 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.



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The Company analyzed the option as of December 31, 2007 by applying FASB 133, paragraph 6 to ascertain if the option issued remained a derivative as of December 31, 2007. 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 $1,515,432 as of December 31, 2007, which was calculated using the Black Sholes valuation model with the following assumptions: risk free rate of return of 3.34%; volatility of 98.01%; dividend yield of 0%; and an expected term of 4.92 years.

The increase in the fair value of the option was $67,111 for the three months ended December 31, 2007, 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 was 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 Notes 2 as discussed in Note 6 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 contracts that require net-cash settlement (including a requirement to net cash settle the contract if an event occurs and if that event is outside the control of the company) are liability instruments. In order to determine the value of the 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 valuation model with the following assumptions: risk free interest rate of 3.26%, expected volatility of 98.01%, dividend yield 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, 2007. 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 option was $1,515,432 as of December 31, 2007, which was calculated using the Black Sholes valuation model with the following assumptions: risk free rate of return of 3.34%; volatility of 98.01%; dividend yield of 0%; and an expected term of 4.92 years.

The increase in the fair value of the option was $67,111 for the three months ended December 31, 2007, and was recorded by decreasing the warrant liability on the balance sheet.



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NOTE 8

BENEFICIAL CONVERSION FEATURES LIABILITY (Restated)

The Company issued convertible notes between October 17, 2006, and July 17, 2007 that 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.

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 valuation 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 December 31, 2007. All of the criteria in the original analysis were met, and the embedded beneficial conversion features 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 beneficial 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 $1,222,663 as of December 31, 2007, which was calculated using the Black Sholes valuation modelwith the following assumptions: risk free rate of return of 3.34%; volatility of 98.01%; dividend yield of 0% and an expected term of .33 to 1.00 years.

The decrease in the fair value of the embedded beneficial conversion features were recorded by decreasing beneficial conversion features liability on the balance sheet by $208,149.

NOTE 9

STOCKHOLDERS EQUITY (Restated)

Common Stock

The Company has 150,000,000 authorized shares with $0.001 par value. As of December 31, 2007, the Company had 107,117,101 shares issued and 106,635,201 shares outstanding.

The Company did not issue shares of common stock during the three months ended December 31, 2007.

Stock Options

In October 2000, the Company entered into amendments to the employment agreements of each of the executive officers eliminating the provisions of stock bonuses. In lieu of the bonus provision, the Company adopted the 2001 Executive Officers Stock Option Plan. The Company reserved 7,576,680 shares for issuance under the plan. The fair value of the options related to the 2001 Executive Stock Option Plan was $1,223,588 as of December 31, 2007,



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which was calculated using the Black-Sholes valuation model, using the following assumptions: risk free rate of return of 3.34%, volatility of 98.01%, dividend yield of 0% and expected term of 3.25 years. The decrease in the fair value of the options of $703,326 for the three month period ended December 31, 2007 was recorded in decrease in warrant liability in the other income (expense) section of the statement of operations.

On December 19, 2007, the Company entered into a one year Employment Agreement with Richard H. Papalian pursuant to which Mr. Papalian has been appointed as the Companys Chief Executive Officer. In terms of compensation, 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 agreements, initially the options shall not be exercisable as to 340,000 shares of common stock. These options were issued outside of the 2001 Executive Officers Stock Option Plan. The fair value of the options was $1,448,321 at the date of issuance, which was calculated using the Black Sholes 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 fair value of the options was $1,515,432 as of December 31, 2007, which was calculated using the Black-Sholes valuation model, using the following assumptions: risk free rate of return of 3.34%, volatility of 98.01%, dividend yield of 0% and expected term of 4.92 years. The increase in the fair value of the options of $67,111 for the three months ended December 31, 2007 was recorded in decrease in warrant liability in the other income (expense) section of the statement of operations.

On December 13, 2007, the Company issued 2,000,000 options to two employees to purchase shares of Common Stock at $0.25 per share. The options expire on December 13, 2012. The fair value of the options was $343,039 at the date of issuance and calculated using the Black Sholes 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 fair value of the options was $354,930 as of December 31, 2007, which was calculated using the Black-Sholes valuation model, using the following assumptions: risk free rate of return of 3.34%, volatility of 98.01%, dividend yield of 0% and expected term of 4.92 years. The increase in the fair value of the options of $11,890 for the three months ended December 31, 2007 was recorded in decrease in warrant liability in the other income (expense) section of the statement of operations.

During the three month period ended December 31, 2007 the Company recorded $1,791,360 as stock based compensation expense relating to the options granted.

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

|                                     |  |                                 |      |  |                               |  |            |                           |  |   |   | 
|------------------------------------ |  | ------------------------------- | ---- |  | ----------------------------- |  | ---------- | ------------------------- |  | - | - | 
|                                     |  | Weighted
Average
Exercise
Price |      |  | Number of
Outstanding
Options |  |            | Aggregate
Intrinsic
Value | 
|                                     |  |                                 |      |  |                               |  |            |                           |  |   |   | 
|Outstanding as of September 30, 2007 |  | $                               | 0.15 |  |                               |  | 7,034,140  |                           |  | $ | - | 
|Granted                              |  |                                 | 0.25 |  |                               |  | 10,539,312 |                           |  |   | - | 
|Forfeited                            |  |                                 | -    |  |                               |  | -          |                           |  |   | - | 
|Exercised                            |  |                                 | -    |  |                               |  | -          |                           |  |   | - | 
|Outstanding as of December 31, 2007  |  | $                               | 0.21 |  |                               |  | 17,573,452 |                           |  | $ | - | 



Outstanding Options:

|               |      |                           |            |           |                           |  |           |                                                      |  |  |                                                        |      |  |                                                        |      |      |  |  |      |      | 
|-------------- | ---- | ------------------------- | ---------- | --------- | ------------------------- |  | --------- | ---------------------------------------------------- |  |  | ------------------------------------------------------ | ---- |  | ------------------------------------------------------ | ---- | ---- |  |  | ---- | ---- | 
|Exercise
Price |      | Stock
Options
Outstanding |            |           | Stock
Options
Exercisable |  |           | Weighted
Average
Remaining
Contractual
Life
in Years |  |  | Weighted
Average
Exercise
Price of
Options
Outstanding |      |  | Weighted
Average
Exercise
Price of
Options
Exercisable |     
|               |      |                           |            |           |                           |  |           |                                                      |  |  |                                                        |      |  |                                                        |      |      |  |  |      |      | 
|$              | 0.15 |                           |            | 7,034,140 |                           |  |           | 7,034,140                                            |  |  |                                                        | 3.25 |  |                                                        | $    | 0.15 |  |  | $    | 0.15 | 
|0.25           |      |                           | 10,539,312 |           |                           |  | 4,134,828 |                                                      |  |  | 4.92                                                   |      |  |                                                        | 0.25 |      |  |  | 0.25 |     





24



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Stock Warrants

On July 17, 2007 the Company completed an offering of $1,025,000 of Convertible Bridge Notes 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 bridge notes, 465,908 shares of Common Stock as a placement fee) at an exercise price of $0.50 per share. The warrants expire five years from the date of issuance. The fair value of the warrants was $321,777 as of December 31, 2007, which was calculated using the Black-Sholes valuation model, using the following assumptions: risk free rate of return of 3.34%, volatility of 98.01%, dividend yield of 0% and expected term of 4.42 to 4.50 years. The decrease in the fair value of the options of $178,155 for the three month period ended December 31, 2007 was recorded in decrease in warrant liability in the other income (expense) section of the statement of operations.

On October 25, 2007, the Company entered into an agreement with its legal counsel, Richardson & Patel LLP, which included a five year warrant to purchase up to 150,000 shares of Common Stock at an exercise price of $0.25 per share for services.

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.

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 stock warrant agreements, initially the warrants shall not be exercisable as to 340,000 shares of common stock. These warrants were issued outside of the 2001 Executive Officers Stock Option Plan. The fair value of the warrant was $1,448,321 at the date of issuance and was calculated using the Black Sholes valuation model with the following assumptions: risk free interest rate of 3.26%, expected volatility of 98.01%, dividend yield of 0% and expected term of 5 years. The fair value of the warrants was $1,515,432 as of December 31, 2007, which was calculated using the Black-Sholes valuation model using the following assumptions: risk free rate of return of 3.34%, volatility of 98.01%, dividend yield of 0% and expected term of 4.92 years. The increase in the fair value of the warrants of $67,111 for the three months ended December 31, 2007 was recorded in decrease in warrant liability in the other income (expense) section of the statement of operations.

A summary of the Companys Outstanding Warrants is listed below:

|                                     |  |          |      |  |             |  |            |           |  |   |   | 
|------------------------------------ |  | -------- | ---- |  | ----------- |  | ---------- | --------- |  | - | - | 
|                                     |  | Weighted |      |  |             |  |            |           | 
|                                     |  | Average  |      |  | Number of   |  |            | Aggregate | 
|                                     |  | Exercise |      |  | Outstanding |  |            | Intrinsic | 
|                                     |  | Price    |      |  | Warrants    |  |            | Value     | 
|                                     |  |          |      |  |             |  |            |           |  |   |   | 
|Outstanding as of September 30, 2007 |  | $        | 0.50 |  |             |  | 2,795,454  |           |  | $ | - | 
|Granted                              |  |          | 0.25 |  |             |  | 17,329,312 |           |  |   | - | 
|Forfeited                            |  |          | -    |  |             |  | -          |           |  |   | - | 
|Exercised                            |  |          | -    |  |             |  | -          |           |  |   | - | 
|Outstanding as of December 31, 2007  |  | $        | 0.28 |  |             |  | 20,124,766 |           |  | $ | - | 

Warrants Outstanding



|         |  |             |            |  |             |  |            |             |  |  |             |  |  |             |      |  |  |   |      | 
|-------- |  | ----------- | ---------- |  | ----------- |  | ---------- | ----------- |  |  | ----------- |  |  | ----------- | ---- |  |  | - | ---- | 
|         |  |             |            |  |             |  |            | Weighted    |  |  | Weighted    |  |  | Weighted    |     
|         |  |             |            |  |             |  |            | Average     |  |  | Average     |  |  | Average     |     
|         |  |             |            |  |             |  |            | Remaining   |  |  | Exercise    |  |  | Exercise    |     
|         |  |             |            |  |             |  |            | Contractual |  |  | Price of    |  |  | Price of    |     
|Exercise |  | Warrants    |            |  | Warrants    |  |            | Life        |  |  | Options     |  |  | Options     |     
|Price    |  | Outstanding |            |  | Exercisable |  |            | in Years    |  |  | Outstanding |  |  | Exercisable |     
|         |  |             |            |  |             |  |            |             |  |  |             |  |  |             |     
|0.50     |  |             | 2,795,454  |  |             |  | 2,795,454  |             |  |  | 4.50        |  |  | $           | 0.50 |  |  | $ | 0.50 | 
|0.25     |  |             | 150,000    |  |             |  | 150,000    |             |  |  | 4.75        |  |  | $           | 0.25 |  |  | $ | 0.25 | 
|0.25     |  |             | 17,179,312 |  |             |  | 10,774,828 |             |  |  | 4.92        |  |  |             | 0.25 |  |  |   | 0.25 | 





25



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NOTE 10

GOING CONCERN (Restated)

The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. This basis of accounting contemplates the recovery of the Companys assets and the satisfaction of its liabilities in the normal course of business. Through December 31, 2007, the Company has incurred cumulative losses of $44,888,219 including net income for the three months ended December 31, 2007 of $4,576,907. As the Company has no cash flow from operations, its ability to transition from a development stage company to an operating company is entirely dependent upon obtaining adequate financing to 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 costs and expenses. In order for the Company to meet its basic financial obligations, including rent, salaries, debt service and other operating expenses, 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. Its 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. 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. 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 converted into equity. As a result, if it begins to generate revenues from operations, those revenues will need to be significant in order to cover current and anticipated expenses. These factors have raised substantial doubt about the Company's ability to continue as a going concern unless it is able to obtain substantial additional financing in the short term and generate revenues over the long term. If the Company is unable to obtain financing, it would likely discontinue operations.

Management expects an order for 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 11

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.

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, 2013, 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                             |  | $ | 104,490 | 
|2010                             |  |   | 108,660 | 
|2011                             |  |   | 93,550  | 



Total rent expense under the operating lease was approximately $18,470 for the year ended September 30, 2008. (See Note 12).



26



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NOTE 12

SUBSEQUENT EVENTS (Restated)

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

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

As part of the offering, the Company issued warrants to purchase 850,000 shares of Common Stock at $0.40 per share. The fair value of the warrants was $175,952 at the date of issuance and was calculated using the Black-Sholes valuation model using the following assumptions: risk free rate of return of 2.64% to 3.06%, expected volatility of 248%, dividend yield of 0% and expected term of 5 years.

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

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

As part of the offering, the Company issued warrants to purchase 15,000,000 shares of Common Stock at $0.10 per share. The grant date fair value of the warrants was $2,182,233 and was calculated using the Black-Sholes valuation model using the following assumptions: risk free rate of return of 1.80% to 2.05 expected volatility ranging from  242% to 245%, dividend yield of 0% and expected life of three years.

Termination of Lease

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

Conversion of Debt Into Shares of Common Stock

From January 2008 to September 2008, the Company issued 17,149,359 shares of Common Stock for the conversion of notes payable and related accrued interest of $903,782.

Warrant Issued to Legal Counsel

On June 24, 2008, the Company entered into an agreement with its legal counsel 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.

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.

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.

Warrant Issued to Legal Counsel

On July 22, 2008, the Company entered into an agreement with its legal counsel 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.

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.



27



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Lease of Administrative Offices and Manufacturing Facility

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. 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.

Purchase of Machinery and Equipment

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 of RJ Metals Co. at $0.15 per share as consideration for the purchase.

Termination, Separation and Release Agreement with Chief Executive Officer

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.

NOTE 13

RESTATEMENT

On December 11, 2007 the Company received a letter from the Securities & Exchange Commission relating to a registration statement on Form SB-2 filed by the Company on November 14, 2007. In responding to the 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, exceeded the number of shares of authorized Common Stock. The difference between the original calculation and the recalculation is illustrated below.

|                                                                      |  |            |              |   |              |  |              |  
|--------------------------------------------------------------------- |  | ---------- | ------------ | - | ------------ |  | ------------ | -
|                                                                      |  | As         |              |   |              | 
|                                                                      |  | Originally |              |   | As           | 
|                                                                      |  | Calculated |              |   | Recalculated | 
|Authorized shares per Articles of Incorportion                        |  |            | 150,000,000  |   |              |  | 150,000,000  |  
|Outstanding shares                                                    |  |            | (106,635,201 | ) |              |  | (106,635,201 | )
|Available shares                                                      |  |            | 43,364,799   |   |              |  | 43,364,799   |  
|                                                                      |  |            |              |   |              |  |              |  
|Securities convertible or exercisable into common stock shares:       |  |            |              |   |              |  |              |  
|2001 Executive Officers Stock Option Plan                             |  |            | 7,343,032    |   |              |  | 7,034,140    |  
|Advisory Board Compensation                                           |  |            |              |   |              |  | 11,520,000   |  
|2004 Stock Purchase Agreement                                         |  |            |              |   |              |  | 1,463,336    |  
|Warrants Related to 2004 Stock Purchase Agreement                     |  |            |              |   |              |  | 1,463,336    |  
|Warrants Issued for Services During the Year Ended September 30, 2007 |  |            |              |   |              |  | 1,010,000    |  
|Beneficial Conversion Features                                        |  |            | 32,009,087   |   |              |  | 36,606,318   |  
|Warrants Related to $1,025,000 of Subordinated Convertible Debentures |  |            | 2,159,088    |   |              |  | 2,795,454    |  
|                                                                      |  |            |              |   |              |  |              |  
|                                                                      |  |            | 41,511,207   |   |              |  | 61,892,584   |  



Adjustments to the original calculation included the following:

1.

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

2.

On October 1, 2004, the Company formed an advisory board consisting of four members. Each member



28



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was to receive $5,000 monthly from October 1, 2004, to February 22, 2007 (for a total of $576,000), convertible into Common Stock at $0.05 per share ($576,000/$.05 = 11,520,000 shares of Common Stock). The accrued expense related to converting the shares into 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.

On November 14, 2006, the Company entered into agreements for services pursuant to which it issued warrants to purchase a total of 1,010,000 shares of Common Stock. 850,000 shares may be purchased at an exercise price of $0.05 per share and 160,000 shares may be purchased at an exercise price of $0.25 per share. The warrants expire on November 13, 2011. The warrants were not included in the original calculation.

6.

As of September 30, 2007, the Company had Convertible Bridge 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 Bridge 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.

7.

On July 18, 2007 the Company completed an offering of $1,025,000 of Subordinated Convertible Debentures (the Subordinated 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.

Based on the result of the recalculation, the Company analyzed the effect on the balance sheet and the statements of operations and cash flows for the classification and valuation for all outstanding securities and contracts that were exercisable or convertible into shares of Common Stock as of September 30, 2007. The Company applied Emerging Issues Task Force (EITF) 00-19, Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Companys Own Stock, and Financial Accounting Standard Board (FASB) Statement No. 133, Accounting for Derivative Instruments and Hedging Activitiesand determined that the financial statements were required to be restated.

The Company performed an analysis on the classification and valuation of all outstanding securities and contracts that were exercisable or convertible into shares of Common Stock as of December 31, 2007, in accordance with EITF 00-19, paragraph 10 which states that the classification of all contracts should be reassessed at each balance sheet date.

The analysis and results were as follows:

2001 Executive Officers Stock Option Plan

In October 2000, the Company amended its employment agreements with each of the executive officers. A result of the amendments was that 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 to purchase 7,034,140 shares of Common Stock that expire 5 years from the date of issuance.

Balance Sheet

On the grant date, the Company applied FASB 133, paragraph 6 to determine if the options were within the scope and definition of a derivative. The options: had one or more underlings and one or more notional amounts, required no initial investment, and required or permitted net settlement. Therefore, the options were determined to be derivatives. Emerging Issue Task Force, paragraphs 7 and 8 were then applied to determine the classification. These



29



---





paragraphs state that contractsthat require settlement in shares are equity instruments. EITF 00-19, paragraph 9 was applied to determine the value of the options. This paragraph states that contracts that require the company 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 as of and for the year ended September 30, 2007 by applying FASB 133, paragraph 6 to ascertain if the options remained derivatives as of September 30, 2007. All of the criteria in the original analysis were met, and the options were determined to be within the scope and definition of a derivative. EITF 00-19, paragraph 19 was applied next, 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. EITF 00-19, paragraph 10 was then applied. Paragraph 10 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 $1,025,000 Convertible Bridge Notes 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. The value was calculated using the Black Sholes valuation 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.

EITF 00-19, paragraph 9 was then applied, 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 determined to be $1,926,914 as of September 30, 2007 and was calculated using the Black Sholes valuation 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 Company began the analysis for the restatement by applying FASB 133, paragraph 6 to ascertain if the options remained derivatives as of December 31, 2007. All of the criteria in the original analysis were met, and the options 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, which 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, was also applied.

The fair value of the options was determined to be $1,223,588 as of December 31, 2007 and was calculated using the Black Sholes valuation model with the following assumptions: risk free rate of return of 3.34%; volatility of 98.01%; dividend yield of 0%; and an expected term of 3.25 years.

The decrease in the fair value of the options was $703,326 for the three months ended December 31, 2007, and recorded by decreasing the warrant liability on the balance sheet.

Statement of Operations

EITF 00-19, paragraph 9 was applied 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 options for the three months ended December 31, 2007 was $703,326 and 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 change in the fair value of the options of $703,326.

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, convertible by the advisory board members into 11,520,000 shares of Common Stock at a rate of $0.05 per share. The Company



30



---





determined that: the accrued expense, embedded beneficial conversion feature, embedded beneficial conversion feature discount, and related amortization expense were not recorded at the date of issuance, or prior to the restatement of the financial statements as of September 30, 2007, no payments have been made to any advisory board members; and there has been no conversion by any Advisory Board members of the accrued liability into shares of Common Stock.

Balance Sheet

The Company began the analysis for the restatement by applying paragraph 6 of Financial Accounting Standard Board (FASB) Statement No. 133, Accounting for Derivative Instruments and Hedging Activities, to ascertain if the embedded beneficial conversion features were derivatives at the date of issuance. The embedded beneficial conversion features had one or more underlings and one or more notional amounts; required no initial investment; and required or permitted net settlement. Therefore, the embedded beneficial conversion features were determined to be within the scope and definition of a derivative at the date of issuance. Next, FASB 133, paragraph 12 was applied 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 features 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 FASB 133, paragraphs 6-11. Therefore, the embedded beneficial conversion features were separated from the accrued expense to determine the classification and valuation. EITF 00-19, paragraphs 7 and 8 were applied to determine the classification. Paragraph 7 states that contracts which require net-cash settlement are liabilities, and paragraph 8 states that contracts which give the counterparty (advisory board members) a choice of net-cash settlement or settlement in shares are liabilities. Therefore, the embedded conversion features were determined to be liabilities. EITF 00-19, paragraph 9 was applied to determine the value. Paragraph 9 of EITF 00-19 states 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 monthly embedded beneficial conversion features was calculated using the Black Sholes valuation 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, $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 as of September 30, 2006.

The fair value of the monthly embedded beneficial conversion features was determined to be $480,000 as of September 30, 2006, and was calculated using the Black Sholes valuation 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 renegotiated the compensation.



The Company began the analysis of the beneficial conversion features for the restatement as of and for the year ended September 30, 2007 by applying FASB 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 were determined to be within the scope and definition of a derivative. FASB 133, paragraph 12 was applied to determine if the embedded beneficial conversion features should be separated from the advisory board compensation. All of the criteria in the original analysis were met, and the embedded beneficial conversion features were separated from the advisory board compensation. EITF 00-19,



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paragraphs 7 and 8 were applied to determine the classification. Paragraph 7 states that contracts which require net-cash settlement are liabilities, and paragraph 8 states that contracts which give the counterparty (advisory board members) 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 rights of the holders of the convertible notes to convert the notes into shares of Common Stock. Therefore, share settlement is not controlled by the Company. EITF 00-19, paragraph 9 was applied to determine the value of the beneficial conversion features. Paragraph 9 of EITF 00-19 states that all contracts classified as liabilities must 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 calculated using the Black Sholes valuation model with the following assumptions: risk free rate of return of 4.94% to 5.09%; volatility of 268.59% to 277.2%; dividend yield of 0% and an expected term of 5 years. The sum of the embedded beneficial conversion features from October 1, 2006 to February 22, 2007 was $91,956 and was recorded to beneficial conversion features liability and netted against accrued expenses. 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) as of September 30, 2007, and recorded to accrued expenses.

The fair value of the monthly embedded beneficial conversion features was determined to be $576,000 as of September 30, 2007, and was calculated using the Black Sholes valuation 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 Company began the analysis for the restatement as of and for the three months ended December 31, 2007 by applying FASB 133, paragraph 6 to ascertain if the beneficial conversion features remained derivatives subsequent to the date of issuance. All of the criteria in the original analysis were met, and the beneficial conversion features were determined to be within the scope and definition of a derivative. Next, FASB 133, paragraph 12 was applied to determine if the embedded beneficial conversion features should be separated from the accrued expense. All of the criteria in the original analysis were met, and the beneficial conversion features were separated from the accrued liability. EITF 00-19, paragraphs 7 and 8 were applied to determine the classification. Paragraph 7 states that contracts which require net-cash settlement are liabilities, and paragraph 8 states that contracts which give the counterparty (the advisory board members) a choice of net-cash settlement or settlement in shares are liabilities. Therefore, the embedded conversion features were determined to be liabilities. EITF 00-19, paragraph 9 was applied to determine the value of the embedded beneficial conversion features. Paragraph 9 of EITF 00-19 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 monthly embedded beneficial conversion features was determined to be $576,000 as of December 31, 2007 and was calculated using the Black Sholes valuation model with the following assumptions: risk free rate of return of 3.34%; volatility of 98.01%; dividend yield of 0%; and an expected term of 1.92 to 4.25years.

The beneficial conversion features discount amortization was $15,104 for the three months ended December 31, 2007, which increased accrued expenses.

Statement of Operations

EITF 00-19, paragraph 9 was applied 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 increase in the fair value of the beneficial conversion features for the three months ended December 31, 2007.

The beneficial conversion feature discount amortization was determined to be $15,104 and has been included in general and administrative expenses in the operating expenses section of the statement of operations for the three months ended December 31, 2007.



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Statement of Cash Flows

Changes in the statement of cash flows were the result of the amortization of the beneficial conversion features discount of $15,104 on the statement of operations.

Warrants Related to 2004 Stock Purchase Agreement

Under the terms of a 2004 Stock Purchase Agreement, the Company issued warrants to purchase 1,463,336 shares of Common Stock at an exercise price of $0.03 which expire from February 9, 2007 to 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 began the analysis by applying 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. EITF 00-19, paragraphs 7 and 8 were then applied to determine classification. These paragraphs state that contractswhich require settlement in shares are equity instruments. EITF 00-19, paragraph 9 was applied to determine the value of the options. 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.

The fair value of the warrants was determined to be $24,367 at the date of issuance which was calculated using the Black Sholes valuation model with the following assumptions: risk free rate of return of 1.21% to 2.14%; volatility of 141.91% to 170.27%; dividend yield of 0% and an expected term of 5 years. The 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.

EITF 00-19, paragraph 19 was applied next. Paragraph 19 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. EITF 00-19, paragraph 10 was then applied. This paragraph 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 $1,025,000 Convertible Bridge Notes 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 was calculated using the Black Sholes valuation 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.

EITF 00-19, paragraph 9 was also applied in the analysis. Paragraph 9 states that all contracts classified as liabilities must 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 $0 as of September 30, 2007, due to their expiration.

The decrease in the fair value of the warrants was $70,029 for the year ended September 30, 2007, which was recorded to warrant liability and accumulated deficit during development stage as of September 30, 2007.

Statement of Operations

There was no change in the fair value of the warrants for the three months ended December 31, 2007, due to their expiration.

Statement of Cash Flows

There was no change in the statement of cash flows for the three months ended December 31, 2007.



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Beneficial Conversion Features

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

Balance Sheet

On the date of issuance, the Company applied FASB 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, FASB 133, paragraph 12 was applied to determine if the embedded beneficial conversion features should be separated from the convertible bridge notes. The Company determined that: the economic characteristics of the embedded beneficial conversion features are not clearly and closely related to the convertible bridge notes; the embedded beneficial conversion features and convertible bridge 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 FASB 133, paragraphs 6-11. Therefore, the embedded beneficial conversion features were separated from the convertible bridge notes to determine the classification and valuation. EITF 00-19, paragraphs 7 and 8 were then applied to determine the classification. Paragraphs 7 and 8 state that contractswhich require settlement in shares are equity instruments. EITF 00-19, paragraph 9 was applied to determine the value of the embedded beneficial conversion features. Paragraph 9 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 determined to be $1,021,570 at the date of issuance and was computed using the Black Sholes valuation model with the following assumptions: risk free rate of return of 6%; volatility of 122.67% to 195.97%; dividend yield of 0% and an expected term of 1 to 1.5 years. The embedded beneficial conversion features discount was $706,186 as of September 30, 2007, net of amortization of $315,383, prior to the restatement.

The Company began the analysis of the beneficial conversion features for the restatement as of and for the year ended September 30, 2007 by applying FASB 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. FASB 133, paragraph 12 was applied to determine if the embedded beneficial conversion features should be separated from the convertible bridge notes. All of the criteria in the original analysis were met, and the embedded beneficial conversion features were separated from the convertible bridge notes. EITF 00-19, paragraphs 7 and 8 were applied to determine the classification. 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 beneficial conversion features were determined to be liabilities. The change in the determination of the classification from equity to a liability was based on the rights of the holders of the convertible notes to convert the notes. Therefore, share settlement is not controlled by the Company. EITF 00-19, paragraph 9 was applied to determine the value. Paragraph 9 states that all contracts classified as liabilities must be measured at fair value at each balance sheet date, with changes in fair value reported in earnings and disclosed in the financial statements as long as the contracts remain classified as liabilities.

The fair value of the embedded beneficial conversion features was recalculated and was determined to be $1,430,811 at the date of issuance. The fair value was computed using the Black Sholes valuation model with the following assumptions: risk free rate of return of 2.02% to 5.09%; volatility of 108.5% to 274.86%; dividend yield of 0% and an expected term of 1 to 1.5 years. Based on the recalculation, the embedded beneficial conversion features discount was $491,264, net of accumulated amortization of $939,547 as of December 31, 2007.



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The fair value of the embedded beneficial conversion features was determined to be $1,430,811 as of September 30, 2007 and was calculated using the Black Sholes valuation 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 began the analysis for the restatement as of and for the three months ended December 31, 2007 by applying FASB 133, paragraph 6 to ascertain if the embedded beneficial conversion features remained derivatives subsequent to the date of issuance. 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. FASB 133, paragraph 12 was applied to determine if the embedded beneficial conversion features should be separated from the convertible bridge notes. All of the criteria in the original analysis were met, and the embedded beneficial conversion features were separated from the convertible bridge notes. EITF 00-19, paragraphs 7 and 8 were applied to determine the classification. 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 rights of the holders of the convertible notes to convert the notes into shares of Common Stock. Therefore, share settlement is not controlled by the Company. EITF 00-19, paragraph 9 was applied to determine the value of the embedded beneficial conversion features. Paragraph 9 states that all contracts classified as liabilities must 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 determined to be $1,222,663 as of December 31, 2007, which was calculated using the Black Sholes valuation model with the following assumptions: risk free rate of return of 3.34%; volatility of 98.01%; dividend yield of 0%; and an expected term of .33 to 1 year.

The decrease in the fair value of the beneficial conversion features was determined to be $208,149 for the three months ended December 31, 2007, and was recorded in beneficial conversion features liability on the balance sheet.

The amortization of the beneficial conversion features discount was $56,038 for the three months ended December 31, 2007, which increased convertible notes.

Statement of Operations

The beneficial conversion features were analyzed in accordance withEITF 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 decrease in the fair value of the beneficial conversion features was determined to be $208,149 for the three months ended December 31, 2007, and was recorded in increase (decrease) in beneficial conversion features liability, in the other income (expense) section of the statement of operations.

The amortization of the beneficial conversion features discount was $56,038 for the three months ended December 31, 2007, and was recorded in interest expense in the other income (expense) section of the statement of operations.

Statement of Cash Flows

Changes in the statement of cash flows were the result of the decrease in the fair value of the beneficial conversion features liability of $208,150 and the amortization of the beneficial conversion features discounts of $56,038 on the statement of operations.

Warrants related to $1,025,000 of Convertible Bridge Notes

On July 17, 2007 the Company completed an offering of $1,025,000 of Convertible Bridge Notes 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 bridge notes, 465,908 shares of Common Stock as a placement fee) at an exercise price of $0.50 per share.



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Balance Sheet

On the grant date, the Company applied FASB 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. EITF 00-19, paragraphs 7 and 8 were then applied to determine the classification. Paragraphs 7 and 8 state that contractswhich require settlement in shares are equity instruments. EITF 00-19, paragraph 9 was applied to determine the value of the warrants. Paragraph 9 states that contracts which require the company to deliver shares as part of a physical settlement or net-share settlement must be initially measured at fair value. In accordance with EITF 00-19, the warrants were recorded in additional paid-in capital at fair value on the date of issuance.

The fair value of the warrants was calculated as $340,585 ($304,259 related to the holders of the convertible bridge notes, and $36,326 related to the placement fee) at the date of issuance using the Black Sholes valuation 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 of the financial statements as of and for the year ended September 30, 2007 by applying FASB 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. EITF 00-19, paragraph 19 was applied next to determine classification. Paragraph 19 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. EITF 00-19, paragraph 9 was applied to determine the value of the warrants. Paragraph 9 states that all contracts classified as liabilities must 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, $340,585 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 related to the holders of the convertible bridge notes, and $124,060 related to the placement fee) at the date of issuance using the Black Sholes valuation 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 fair value of the warrants was determined to be $499,932 ($379,672 related to the holders of the convertible bridge notes, and $120,260 related to the placement fee) as of September 30, 2007. The fair value was calculated using the Black Sholes valuation 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 Company began the analysis for the restatement as of December 31, 2007 by applying FASB 133, paragraph 6 to ascertain if the warrants issued remained derivatives as of December 31, 2007. 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, which states that if share settlement is not controlled by the company the contract is required to be classified as a liability, was applied. Paragraph 9 of EITF 00-19, which 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, was also applied.

The fair value of the warrants was determined to be $321,778 as of December 31, 2007, and was calculated using the Black Sholes valuation model with the following assumptions: risk free rate of return of 3.34%; volatility of 98.01%; dividend yield of 0%; and an expected term of 4.5 years.

The decrease in the fair value of the warrants was determined to be $178,154 for the three months ended December 31, 2007, and recorded by decreasing warrant liabilities on the balance sheet by $178,154 ($125,228 related to the holders of the convertible bridge notes, and $52,926 related to the placement fee).

The amortization of the warrant discount was $30,065 for the three months ended December 31, 2007, which increased convertible notes.



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Statement of Operations

EITF 00-19, paragraph 9 was applied 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 decrease in the fair value of the warrants was determined to be $178,154 for the three months ended December 31, 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 $30,065 is included in interest expense in the other income (expense) section of the statement of operations.

Statement of Cash Flows

Changes in the statement of cash flows were the result of the decrease in the amount of $178,154 in thefair value of the warrants at the date of issuance on the statement of operations, and the increase in the amortization of the warrant discount of $30,065 on the balance sheet.

Table 1 shows the effect of each of the changes discussed above on the Companys balance sheet, statement of operation, statement of equity (deficit), and statement of cash flows for the three months ended December 31, 2007.

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 was 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 Notes 2 as discussed in Note 6 to our financial statements) 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 contracts that require net-cash settlement (including a requirement to net cash settle the contract if an event occurs and if that event is outside the control of the company) are liability instruments. In order to determine the value of the 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 determined to be $1,448,321 at the date of issuance and was calculated using the Black Sholes 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 December 31, 2007. 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 was also applied, which 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 $1,515,432 as of December 31, 2007, and was calculated using the Black Sholes valuation model with the following assumptions: risk free rate of return of 3.34%; volatility of 98.01%; dividend yield of 0%; and an expected term of 4.92 years.



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The increase in the fair value of the option was $67,111 for the three months ended December 31, 2007, and was recorded by decreasing the warrant liability on the balance sheet.

Option Issued to 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 to 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 Notes 2 as discussed in Note 6 to our financial statements) are eligible for conversion into shares of Common Stock. These options were not issued from the 2001 Executive Officers Stock Option Plan. 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 contracts that require net-cash settlement (including a requirement to net cash settle the contract if an event occurs and if that event is outside the control of the company) are liability instruments. In order to determine the value of the 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 determined to be $1,448,321 at the date of issuance, and was calculated using the Black Sholes valuation 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 December 31, 2007 by applying FASB 133, paragraph 6 to ascertain if the option remained a derivative as of December 31, 2007. All of the criteria in the original analysis were met, and the option 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, which 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, was also applied.

The fair value of the option was determined to be $1,515,432 as of December 31, 2007, and was calculated using the Black Sholes valuation model with the following assumptions: risk free rate of return of 3.34%; volatility of 98.01%; dividend yield of 0%; and an expected term of 4.92 years.

The increase in the fair value of the option was $67,111 for the three months ended December 31, 2007, and was 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 to a director of a five year option 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 contracts that require net-cash settlement (including a requirement to net cash settle the contract if an event occurs and if that event is outside the control of the company) are liability instruments. In order to determine the value of the 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.



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The fair value of the option was determined to be $171,520 at the date of issuance and was calculated using the Black Sholes valuation model with the following assumptions: risk free interest rate of 3.22%, expected volatility of 99.86%, dividend yield 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 December 31, 2007. All of the criteria in the original analysis were met, and the option 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, which 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, was also applied.

The fair value of the option was determined to be $177,465 as of December 31, 2007, using the Black Sholes valuation model with the following assumptions: risk free rate of return of 3.34%; volatility of 98.01%; dividend yield of 0%; and an expected term of 4.92 years.

The increase in the fair value of the option was $5,945 for the three months ended December 31, 2007, and recorded by decreasing the warrant liability on the balance sheet.

Option Issued to Chief Financial Officer

On December 13, 2007, the Companys Board of Directors approved the issuance to the Chief Financial Officer of a five year option 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 contracts that require net-cash settlement (including a requirement to net cash settle the contract if an event occurs and if that event is outside the control of the company) are liability instruments. In order to determine the value of the 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 determined to be $171,520 at the date of issuance and was calculated using the Black Sholes valuation model with the following assumptions: risk free interest rate of 3.22%, expected volatility of 99.86%, dividend yield 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 December 31, 2007. 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, which 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, was also applied.

The fair value of the option was determined to be $177,465 as of December 31, 2007, using the Black Sholes valuation model with the following assumptions: risk free rate of return of 3.34%; volatility of 98.01%; dividend yield of 0%; and an expected term of 4.92 years.



39



---





The increase in the fair value of the option was $5,945 for the three months ended December 31, 2007, and recorded by decreasing the warrant liability on the balance sheet.

Table 1 - 2007

|                                                                       |  |            |             |           |   |              |   |            |            |          |   |            |   |               |          |                |   |                    |         |                |          |                   |   |                   |           |          |            |         |           |          |           |   |          |   |   |           |   |             |            |  
|---------------------------------------------------------------------- |  | ---------- | ----------- | --------- | - | ------------ | - | ---------- | ---------- | -------- | - | ---------- | - | ------------- | -------- | -------------- | - | ------------------ | ------- | -------------- | -------- | ----------------- | - | ----------------- | --------- | -------- | ---------- | ------- | --------- | -------- | --------- | - | -------- | - | - | --------- | - | ----------- | ---------- | -
|                                                                       |  |            |             |           |   |              |   |            |            |          |   | Beneficial |   | Warrant       |          |                |   |                    |         |                |          |                   |   |                   |           |          |           
|                                                                       |  |            |             |           |   |              |   |            |            |          |   | Conversion |   | Related to    |          |                |   | Option Issued      |         |                |          |                   |   |                   |           |          |           
|                                                                       |  |            |             |           |   |              |   |            |            |          |   | Features   |   | $1,025,000 of |          | Warrant Issued |   | to Chief Executive |         |                |          |                   |   |                   |           |          |           
|                                                                       |  |            |             | 2001      |   |              |   | Warrants   |            |          |   | and        |   | Convertible   |          | to Consultant  |   | Officer for the    |         |                |          |                   |   |                   |           |          |           
|                                                                       |  |            |             | Executive |   |              |   | Related to |            | Warrant  |   | Beneficial |   | Bridge Notes  |          | for the Three  |   | Three Month        |         |                |          |                   |   |                   |           |          |           
|                                                                       |  | As         |             | Officers  |   | Advisory     |   | 2004 Stock |            | Issued   |   | Conversion |   | and           |          | Months Ended   |   | Period Ended       |         |                |          | Warrant Issued    |   |                   |           |          |           
|                                                                       |  | Previously |             | Option    |   | Board        |   | Purchase   |            | for      |   | Features   |   | Warrant       |          | December 31,   |   | December 31,       |         | Warrant Issued |          | to Chief          |   |                   |           | As       |           
|                                                                       |  | Stated     |             | Plan      |   | Compensation |   | Agreement  |            | Services |   | Discount   |   | Discount      |          | 2007           |   | 2007               |         | to Director    |          | Financial Officer |   | Reclassifications |           | Restated |           
|Balance Sheet                                                          |  |            |             |           |   |              |   |            |            |          |   |            |   |               |          |                |   |                    |         |                |          |                   |   |                   |           |          |           
|Accrued expenses                                                       |  | $          | 1,777,077   |           |   |              | $ | 576,000    |            |          |   |            |   |               |          |                |   |                    |         |                |          |                   |   |                   |           |          |            | $       | 2,353,077 |         
|Convertible Notes, net                                                 |  |            | 1,229,817   |           |   |              |   |            |            |          |   |            |   |               | (17,075  | )              |   | (40,691            | )       |                |          |                   |   |                   |           |          |            |         |           |          | 1,172,051 |  
|Warrant liability                                                      |  |            |           |           |   | 1,223,588    |   |            | 1,533,300  |          |   |            |   |               |          |                |   |                    | 321,778 |                |          | 1,515,432         |   |                   | 1,515,432 |          |            | 177,465 |           |          | 177,465   |   |          |   |   | 6,464,460 |  
|Beneficial conversion feature liability                                |  |            |           |           |   |              |   |            |            |          |   |            |   |               |          | 1,222,663      |   |                    |         |                |          |                   |   |                   |           |          |            |         |           |          |           |   |          |   |   | 1,222,663 |  
|Additional paid-in capital                                             |  |            | 15,643,156  |           |   | (2,271,879   | ) |            | (269,848   | )        |   | (45,663    | ) |               | (100,811 | )              |   | (1,021,570         | )       |                | (340,585 | )                 |   | (414,909          | )         |          | (414,909   | )       |           |          |           |   |          |   |   |           |   | 10,762,982  |           
|Deferred warrant expense                                               |  |            | (67,038     | )         |   |              |   |            |            |          |   |            |   |               | 67,038   |                |   |                    |         |                |          |                   |   |                   |           |          |            |         |           |          |           |   |          |   |   |           |   |           |           
|Deficit accumulated during development stage                           |  |            | (19,096,592 | )         |   | 1,048,291    |   |            | (1,839,452 | )        |   | 45,663     |   |               | 33,773   |                |   | (184,018           | )       |                | 59,498   |                   |   | (1,100,523        | )         |          | (1,100,523 | )       |           | (177,465 | )         |   | (177,465 | ) |   |           |   | (22,488,813 | )         
|                                                                       |  |            |             |           |   |              |   |            |            |          |   |            |   |               |          |                |   |                    |         |                |          |                   |   |                   |           |          |            |         |           |          |           |   |          |   |   |           |   |             |           
|Statement of Operations (for the three months ended December 31, 2007) |  |            |             |           |   |              |   |            |            |          |   |            |   |               |          |                |   |                    |         |                |          |                   |   |                   |           |          |            |         |           |          |           |   |          |   |   |           |   |             |           
|General and administrative                                             |  | $          | 1,367,677   |           |   |              |   | $          | 1,557,705  |          |   |            |   | $             | (33,773  | )              |   |                    |         |                |          |                   | $ | 1,033,412         |           | $        | 1,033,412  |         | $         | 171,520  |           | $ | 171,520  |   | $ | (236,904  | ) | $           | 5,064,569  |  
|Research and development                                               |  |            |           |           |   |              |   |            |            |          |   |            |   |               |          |                |   |                    |         |                |          |                   |   |                   |           |          |            |         |           |          |           |   |          |   |   | 236,904   |   |             | 236,904    |  
|Interest expense                                                       |  |            | (188,625    | )         |   |              |   |            | 380,440    |          |   |            |   |               |          |                |   | (288,036           | )       |                | (30,065  | )                 |   |                   |           |          |            |         |           |          |           |   |          |   |   |           |   |             | (126,286   | )
|Decrease (increase) in warrant liability                               |  |            |             |           |   | 703,326      |   |            | 24,405     |          |   |            |   |               |          |                |   |                    |         |                | 178,154  |                   |   | (67,111           | )         |          | (67,111    | )       |           | (5,945   | )         |   | (5,945   | ) |   |           |   |             | 759,773    |  
|Increase in beneficial conversion feature liability                    |  |            |             |           |   |              |   |            |            |          |   |            |   |               |          |                |   | 208,149            |         |                |          |                   |   |                   |           |          |            |         |           |          |           |   |          |   |   |           |   |             | 208,149    |  
|Beneficial conversion feature expense                                  |  |            | (231,998    | )         |   |              |   |            |            |          |   |            |   |               |          |                |   | 231,998            |         |                |          |                   |   |                   |           |          |            |         |           |          |           |   |          |   |   |           |   |             |          |  
|Basic and dilutive loss per s                                          |  |            | (0.02       | )         |   |              |   |            | (0.01      | )        |   |            |   |               |          |                |   |                    |         |                |          |                   |   | (0.01             | )         |          |            |         |           |          |           |   |          |   |   |           |   |             | (0.04      | )
|                                                                       |  |            |             |           |   |              |   |            |            |          |   |            |   |               |          |                |   |                    |         |                |          |                   |   |                   |           |          |            |         |           |          |           |   |          |   |   |           |   |             |            |  
|Statement of Operations (since inception)                              |  |            |             |           |   |              |   |            |            |          |   |            |   |               |          |                |   |                    |         |                |          |                   |   |                   |           |          |            |         |           |          |           |   |          |   |   |           |   |             |            |  
|General and administrative                                             |  | $          | 14,519,764  |           |   |              |   | $          | 2,215,848  |          | $ | 24,367     |   | $             | (33,773  | )              |   |                    |         | $              | 87,734   |                   | $ | 1,033,412         |           | $        | 1,033,412  |         | $         | 171,520  |           | $ | 171,520  |   | $ | (829,730  | ) | $           | 18,394,074 |  
|Research and development                                               |  |            | 1,449,474   |           |   |              |   |            |            |          |   |            |   |               |          |                |   |                    |         |                |          |                   |   |                   |           |          |            |         |           |          |           |   |          |   |   | 763,370   |   |             | 2,212,844  |  
|Interest expense                                                       |  |            | (658,869    | )         |   |              |   |            | 380,440    |          |   |            |   |               |          |                |   | (624,165           | )       |                | (85,239  | )                 |   |                   |           |          |            |         |           |          |           |   |          |   |   | (315,382  | ) |             | (1,303,215 | )
|Decrease in warrant liability                                          |  |            |             |           |   | 1,048,291    |   |            | 24,405     |          |   | 70,029     |   |               |        |                |   |                    |         |                | 232,471  |                   |   | (67,111           | )         |          | (67,111    | )       |           | (5,945   | )         |   | (5,945   | ) |   |           |   |             | 1,229,084  |  
|Increase in beneficial conversion feature liability                    |  |            |             |           |   |              |   |            | (4,044     | )        |   |            |   |               |          |                |   | 208,149            |         |                |          |                   |   |                   |           |          |            |         |           |          |           |   |          |   |   |           |   |             | 204,105    |  
|Beneficial conversion feature expense                                  |  |            | (548,858    | )         |   |              |   |            |            |          |   |            |   |               |          |                |   | 548,858            |         |                |          |                   |   |                   |           |          |            |         |           |          |           |   |          |   |   |           |   |             |          |  
|Legal settlement                                                       |  |            | 434,603     |           |   |              |   |            |            |          |   |            |   |               |          |                |   |                    |         |                |          |                   |   |                   |           |          |            |         |           |          |           |   |          |   |   | (89,654   | ) |             | 344,949    |  
|Income taxes                                                           |  |            | 10,800      |           |   |              |   |            |            |          |   |            |   |               |          |                |   |                    |         |                |          |                   |   |                   |           |          |            |         |           |          |           |   |          |   |   | 2,592     |   |             | 13,392     |  
|                                                                       |  |            |             |           |   |              |   |            |            |          |   |            |   |               |          |                |   |                    |         |                |          |                   |   |                   |           |          |            |         |           |          |           |   |          |   |   |           |   |             |            |  
|Statement of Cash Flows (for the three months ended December 31, 2007) |  |            |             |           |   |              |   |            |            |          |   |            |   |               |          |                |   |                    |         |                |          |                   |   |                   |           |          |            |         |           |          |           |   |          |   |   |           |   |             |            |  
|Net loss                                                               |  | $          | (1,796,440  | )         | $ | 703,326      |   | $          | (1,152,860 | )        |   |            |   | $             | 33,773   |                | $ | 152,111            |         | $              | 148,089  |                   | $ | (1,100,523        | )         | $        | (1,100,523 | )       | $         | (177,465 | )         | $ | (177,465 | ) |   |           |   | $           | (4,467,977 | )
|Amortization of beneficial conversion features discount and warr       |  |            | 231,998     |           |   |              |   |            |            |          |   |            |   |               |          |                |   | 56,038             |         |                | 30,065   |                   |   |                   |           |          |            |         |           |          |           |   |          |   |   | 87,550    |   |             | 405,651    |  
|Stock based compensation expense- employee                             |  |            | 414,909     |           |   |              |   |            |            |          |   |            |   |               |          |                |   |                    |         |                |          |                   |   |                   |           |          | 1,033,411  |         |           | 171,520  |           |   | 171,520  |   |   |           |   |             | 1,791,360  |  
|Stock based compensation expense- consultant                           |  |            | 414,909     |           |   |              |   |            | 1,557,706  |          |   |            |   |               |          |                |   |                    |         |                |          |                   |   | 1,033,412         |           |          |            |         |           |          |           |   |          |   |   |           |   |             | 3,006,027  |  
|(Decrease) increase in warrant liability                               |  |            |             |           |   | (703,326     | ) |            | (24,405    | )        |   |            |   |               |        |                |   |                    |         |                | (178,154 | )                 |   | 67,111            |           |          | 67,111     |         |           | 5,945    |           |   | 5,945    |   |   |           |   |             | (759,773   | )
|Increase in beneficial conversion feature liaiblity                    |  |            |             |           |   |              |   |            |            |          |   |            |   |               |          |                |   | (208,149           | )       |                |          |                   |   |                   |           |          |            |         |           |          |           |   |          |   |   |           |   |             | (208,149   | )
|Write-off of beneficial conversion feature                             |  |            |             |           |   |              |   |            | (380,440   | )        |   |            |   |               |          |                |   |                    |         |                |          |                   |   |                   |           |          |            |         |           |          |           |   |          |   |   |           |   |             | (380,440   | )
|Accrued expenses                                                       |  |            | 135,529     |           |   |              |   |            | 98,051     |          |   |            |   |               |          |                |   |                    |         |                |          |                   |   |                   |           |          |            |         |           |          |           |   |          |   |   | (46,125   | ) |             | 187,455    |  
|Accrual of liquidating damages                                         |  |            |             |           |   |              |   |            |            |          |   |            |   |               |          |                |   |                    |         |                |          |                   |   |                   |           |          |            |         |           |          |           |   |          |   |   | 46,125    |   |             | 46,125     |  
|Beneficial conversion feature                                          |  |            | 231,998     |           |   |              |   |            |            |          |   |            |   |               |          |                |   | (231,998           | )       |                |          |                   |   |                   |           |          |            |         |           |          |           |   |          |   |   |           |   |             |          |  
|Warrants issued for consulting                                         |  |            | 111,255     |           |   |              |   |            |            |          |   |            |   |               |          |                |   |                    |         |                |          |                   |   |                   |           |          |            |         |           |          |           |   |          |   |   | (111,255  | ) |             |            |  





40



---







|                                                                            |  |                      |             |                                     |   |                             |   |                                                   |            |                              |   |                                                                            |   |                                                                                 |        |                                                                            |   |                                                                                |   |                            |          |                                           |   |                   |   |             |            |   |   |          |   |   |          |   |   |            |   |   |             |  
|--------------------------------------------------------------------------- |  | -------------------- | ----------- | ----------------------------------- | - | --------------------------- | - | ------------------------------------------------- | ---------- | ---------------------------- | - | -------------------------------------------------------------------------- | - | ------------------------------------------------------------------------------- | ------ | -------------------------------------------------------------------------- | - | ------------------------------------------------------------------------------ | - | -------------------------- | -------- | ----------------------------------------- | - | ----------------- | - | ----------- | ---------- | - | - | -------- | - | - | -------- | - | - | ---------- | - | - | ----------- | -
|                                                                            |  | As
Previously
Stated |             | 2001
Executive
Officers
Option
Plan |   | Advisory
Board
Compensation |   | Warrants
Related to
2004 Stock
Purchase
Agreement |            | Warrants
Issued
for Services |   | Beneficial
Conversion
Features
and
Beneficial
Conversion
Features
Discount |   | Warrants
Related to
$1,025,000 of
Convertible
Bridge Notes
and
Warrant
Discount |        | Warrants
Issued
to Consultant
for the Three
Months Ended
December 31,
2007 |   | Options
Issued
to Employees
for the
Three Month
Period Ended
December 31,
2007 |   | Warrant Issued
to Direcotr |          | Warrant Issued
to Chief
Financial Officer |   | Reclassifications |   | As
Restated |           
|Statement of Cash Flows (since inception)                                   |  |                      |             |                                     |   |                             |   |                                                   |            |                              |   |                                                                            |   |                                                                                 |        |                                                                            |   |                                                                                |   |                            |          |                                           |   |                   |   |             |           
|Net loss                                                                    |  | $                    | (19,096,592 | )                                   | $ | 1,048,291                   |   | $                                                 | (1,839,452 | )                            | $ | 45,663                                                                     |   | $                                                                               | 33,773 |                                                                            | $ | 184,018                                                                        |   | $                          | 59,498   |                                           | $ | (1,100,523        | ) | $           | (1,100,523 | ) | $ | (177,465 | ) | $ | (177,465 | ) | $ | (353,114   | ) | $ | (22,473,891 | )
|Amoritzation of beneficial conversion feature discount and warrant discount |  |                      | 547,375     |                                     |   |                             |   |                                                   | 265,650    |                              |   |                                                                            |   |                                                                                 |        |                                                                            |   | 661,620                                                                        |   |                            | 85,244   |                                           |   |                   |   |             |            |   |   |          |   |   |          |   |   | (271,220   | ) |   | 1,288,669   |  
|Stock based compensation expense - employee                                 |  |                      | 414,909     |                                     |   |                             |   |                                                   |            |                              |   |                                                                            |   |                                                                                 |        |                                                                            |   |                                                                                |   |                            |          |                                           |   |                   |   |             | 1,033,412  |   |   | 171,520  |   |   | 171,520  |   |   | 1,835,956  |   |   | 3,627,317   |  
|Stock based compensation expense - consultant                               |  |                      | 414,909     |                                     |   |                             |   |                                                   | 1,557,705  |                              |   | 24,366                                                                     |   |                                                                                 |        |                                                                            |   |                                                                                |   |                            | 541,652  |                                           |   | 1,033,412         |   |             |            |   |   |          |   |   |          |   |   | 2,398,852  |   |   | 5,970,896   |  
|Warrants issued for consulting services                                     |  |                      | 217,366     |                                     |   |                             |   |                                                   |            |                              |   |                                                                            |   |                                                                                 |        |                                                                            |   |                                                                                |   |                            |          |                                           |   |                   |   |             |            |   |   |          |   |   |          |   |   | (217,366   | ) |   |             |  
|Issuance of Common Stock for compensation                                   |  |                      | 1,835,957   |                                     |   |                             |   |                                                   |            |                              |   |                                                                            |   |                                                                                 |        |                                                                            |   |                                                                                |   |                            |          |                                           |   |                   |   |             |            |   |   |          |   |   |          |   |   | (1,835,957 | ) |   |           |  
|Issuance of Common Stock for services                                       |  |                      | 2,181,486   |                                     |   |                             |   |                                                   |            |                              |   |                                                                            |   |                                                                                 |        |                                                                            |   |                                                                                |   |                            |          |                                           |   |                   |   |             |            |   |   |          |   |   |          |   |   | (2,181,486 | ) |   |           |  
|Decrease in warrant liability                                               |  |                      |             |                                     |   | (1,048,291                  | ) |                                                   | (24,405    | )                            |   | (70,029                                                                    | ) |                                                                                 |        |                                                                            |   |                                                                                |   |                            | (232,471 | )                                         |   | 67,111            |   |             | 67,111     |   |   | 5,945    |   |   | 5,945    |   |   |            |   |   | (1,229,084  | )
|Decrease in beneficial conversion feature liability                         |  |                      |             |                                     |   |                             |   |                                                   | 4,044      |                              |   |                                                                            |   |                                                                                 |        |                                                                            |   | (208,149                                                                       | ) |                            |          |                                           |   |                   |   |             |            |   |   |          |   |   |          |   |   |            |   |   | (204,105    | )
|Write-off of beneficial conversion feature                                  |  |                      |             |                                     |   |                             |   |                                                   | (576,000   | )                            |   |                                                                            |   |                                                                                 |        |                                                                            |   |                                                                                |   |                            |          |                                           |   |                   |   |             |            |   |   |          |   |   |          |   |   |            |   |   | (576,000    | )
|Increase in advances to employees                                           |  |                      | (512,727    | )                                   |   |                             |   |                                                   |            |                              |   |                                                                            |   |                                                                                 |        |                                                                            |   |                                                                                |   |                            |          |                                           |   |                   |   |             |            |   |   |          |   |   |          |   |   | 512,727    |   |   |           |  
|Decrease in other receivables                                               |  |                      | 3,000       |                                     |   |                             |   |                                                   |            |                              |   |                                                                            |   |                                                                                 |        |                                                                            |   |                                                                                |   |                            |          |                                           |   |                   |   |             |            |   |   |          |   |   |          |   |   | (3,000     | ) |   |           |  
|Increase in deposits                                                        |  |                      | (104,600    | )                                   |   |                             |   |                                                   |            |                              |   |                                                                            |   |                                                                                 |        |                                                                            |   |                                                                                |   |                            |          |                                           |   |                   |   |             |            |   |   |          |   |   |          |   |   | 104,600    |   |   |           |  
|                                                                            |  |                      |             |                                     |   |                             |   |                                                   |            |                              |   |                                                                            |   |                                                                                 |        |                                                                            |   |                                                                                |   |                            |          |                                           |   |                   |   |             |            |   |   |          |   |   |          |   |   |            |   |   |             |  
|Other current assets                                                        |  |                      |             |                                     |   |                             |   |                                                   |            |                              |   |                                                                            |   |                                                                                 |        |                                                                            |   |                                                                                |   |                            |          |                                           |   |                   |   |             |            |   |   |          |   |   |          |   |   | (2,000     | ) |   | (2,000      | )
|Other assets                                                                |  |                      |             |                                     |   |                             |   |                                                   |            |                              |   |                                                                            |   |                                                                                 |        |                                                                            |   |                                                                                |   |                            |          |                                           |   |                   |   |             |            |   |   |          |   |   |          |   |   | (104,600   | ) |   | (104,600    | )
|Accounts payable                                                            |  |                      | 414,853     |                                     |   |                             |   |                                                   |            |                              |   |                                                                            |   |                                                                                 |        |                                                                            |   |                                                                                |   |                            |          |                                           |   |                   |   |             |            |   |   |          |   |   |          |   |   | (69,999    | ) |   | 344,854     |  
|Accrued expenses                                                            |  |                      | 1,838,402   |                                     |   |                             |   |                                                   | 576,465    |                              |   |                                                                            |   |                                                                                 |        |                                                                            |   |                                                                                |   |                            |          |                                           |   |                   |   |             |            |   |   |          |   |   |          |   |   | (133,164   | ) |   | 2,281,703   |  
|Accrual of liquidating damages                                              |  |                      |             |                                     |   |                             |   |                                                   |            |                              |   |                                                                            |   |                                                                                 |        |                                                                            |   |                                                                                |   |                            |          |                                           |   |                   |   |             |            |   |   |          |   |   |          |   |   | 61,500     |   |   | 61,500      |  
|Proceeds from issuance of notes                                             |  |                      | 2,313,433   |                                     |   |                             |   |                                                   |            |                              |   |                                                                            |   |                                                                                 |        |                                                                            |   |                                                                                |   |                            |          |                                           |   |                   |   |             |            |   |   |          |   |   |          |   |   | (2,313,433 | ) |   |           |  
|Proceeds from convertible notes payable                                     |  |                      |             |                                     |   |                             |   |                                                   |            |                              |   |                                                                            |   |                                                                                 |        |                                                                            |   |                                                                                |   |                            |          |                                           |   |                   |   |             |            |   |   |          |   |   |          |   |   | 1,861,000  |   |   | 1,861,000   |  
|Proceeds from notes payable to related party                                |  |                      |             |                                     |   |                             |   |                                                   |            |                              |   |                                                                            |   |                                                                                 |        |                                                                            |   |                                                                                |   |                            |          |                                           |   |                   |   |             |            |   |   |          |   |   |          |   |   | 457,433    |   |   | 457,433     |  
|Payments on notes payable to related party                                  |  |                      |             |                                     |   |                             |   |                                                   |            |                              |   |                                                                            |   |                                                                                 |        |                                                                            |   |                                                                                |   |                            |          |                                           |   |                   |   |             |            |   |   |          |   |   |          |   |   | (5,000     | ) |   | (5,000      | )
|Issuance of common stock for cash                                           |  |                      | 7,376,094   |                                     |   |                             |   |                                                   |            |                              |   |                                                                            |   |                                                                                 |        |                                                                            |   |                                                                                |   |                            |          |                                           |   |                   |   |             |            |   |   |          |   |   |          |   |   | 10,000     |   |   | 7,386,094   |  
|Receipt of cash for stock to be issued                                      |  |                      | 53,900      |                                     |   |                             |   |                                                   |            |                              |   |                                                                            |   |                                                                                 |        |                                                                            |   |                                                                                |   |                            |          |                                           |   |                   |   |             |            |   |   |          |   |   |          |   |   | (10,000    | ) |   | 43,900      |  
|                                                                            |  |                      |             |                                     |   |                             |   |                                                   |            |                              |   |                                                                            |   |                                                                                 |        |                                                                            |   |                                                                                |   |                            |          |                                           |   |                   |   |             |            |   |   |          |   |   |          |   |   |            |   |   |           |  



Table 2 - 2006



|                                                                             |  |            |          |           |  |              |   |            |   |          |  |            |  |               |         |                |  |                    |  |                |  |                   |  |                   |  |          |  |        |         |   |          |  
|---------------------------------------------------------------------------- |  | ---------- | -------- | --------- |  | ------------ | - | ---------- | - | -------- |  | ---------- |  | ------------- | ------- | -------------- |  | ------------------ |  | -------------- |  | ----------------- |  | ----------------- |  | -------- |  | ------ | ------- | - | -------- | -
|                                                                             |  |            |          |           |  |              |   |            |   |          |  | Beneficial |  | Warrant       |         |                |  |                    |  |                |  |                   |  |                   |  |          | 
|                                                                             |  |            |          |           |  |              |   |            |   |          |  | Conversion |  | Related to    |         |                |  | Option Issued      |  |                |  |                   |  |                   |  |          | 
|                                                                             |  |            |          |           |  |              |   |            |   |          |  | Features   |  | $1,025,000 of |         | Warrant Issued |  | to Chief Executive |  |                |  |                   |  |                   |  |          | 
|                                                                             |  |            |          | 2001      |  |              |   | Warrants   |   |          |  | and        |  | Convertible   |         | to Consultant  |  | Officer for the    |  |                |  |                   |  |                   |  |          | 
|                                                                             |  |            |          | Executive |  |              |   | Related to |   | Warrant  |  | Beneficial |  | Bridge Notes  |         | for the Three  |  | Three Month        |  |                |  |                   |  |                   |  |          | 
|                                                                             |  | As         |          | Officers  |  | Advisory     |   | 2004 Stock |   | Issued   |  | Conversion |  | and           |         | Months Ended   |  | Period Ended       |  |                |  | Warrant Issued    |  |                   |  |          | 
|                                                                             |  | Previously |          | Option    |  | Board        |   | Purchase   |   | for      |  | Features   |  | Warrant       |         | December 31,   |  | December 31,       |  | Warrant Issued |  | to Chief          |  |                   |  | As       | 
|                                                                             |  | Stated     |          | Plan      |  | Compensation |   | Agreement  |   | Services |  | Discount   |  | Discount      |         | 2007           |  | 2007               |  | to Direcotr    |  | Financial Officer |  | Reclassifications |  | Restated | 
|Statement of Operations (for the three months ended December 31, 2006)       |  |            |          |           |  |              |   |            |   |          |  |            |  |               |         |                |  |                    |  |                |  |                   |  |                   |  |          | 
|General and administrative                                                   |  | $          | 202,938  |           |  |              | $ | 72,304     |   |          |  |            |  |               |         |                |  |                    |  |                |  |                   |  |                   |  |          |  | $      | 275,242 |  
|Interest expense                                                             |  |            | (19,242  | )         |  |              |   |            |   |          |  |            |  | $             | (89,686 | )              |  |                    |  |                |  |                   |  |                   |  |          |  | (1,482 | )       |   | (110,410 | )
|Beneficial conversion feature                                                |  |            | (1,482   | )         |  |              |   |            |   |          |  |            |  |               |         |                |  |                    |  |                |  |                   |  |                   |  |          |  | 1,482  |         |   |        |  
|                                                                             |  |            |          |           |  |              |   |            |   |          |  |            |  |               |         |                |  |                    |  |                |  |                   |  |                   |  |          |  |        |         |   |          |  
|Statement of Cash Flows (for the three months ended December 31, 2006)       |  |            |          |           |  |              |   |            |   |          |  |            |  |               |         |                |  |                    |  |                |  |                   |  |                   |  |          |  |        |         |   |          |  
|Net loss                                                                     |  | $          | (232,249 | )         |  |              | $ | (72,304    | ) |          |  |            |  | $             | (89,686 | )              |  |                    |  |                |  |                   |  |                   |  |          |  |        |         | $ | (394,239 | )
|Amortization of beneficial conversion features discount and warrant discount |  |            | 1,842    |           |  |              |   |            |   |          |  |            |  |               | 89,686  |                |  |                    |  |                |  |                   |  |                   |  |          |  |        |         |   | 91,528   |  
|Accrued expenses                                                             |  |            | 87,085   |           |  |              |   | 72,304     |   |          |  |            |  |               |         |                |  |                    |  |                |  |                   |  |                   |  |          |  |        |         |   | 159,389  |  





41



---





NOTE 14

SUBSEQUENT RESTATEMENT TO PREVIOUS RESTATEMENT

As discussed in NOTE 13 RESTATEMENT above, the Company restated its December 31, 2007 financial statements due to a comment letter received from the Securities and Exchange Commission. However, the restatement did not properly account for the certain derivative transactions as discussed below.

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

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

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

·

Warrants and Options

·

Beneficial Conversion Feature

The Company analyzed the effect of the recalculation on the balance sheet and the statements of operations and cash flows as of December 31, 2007. The analysis and results were as follows:

Warrants and Options Liability

As of December 31 2007, the Company had 19,784,766 warrants outstanding and 11,595,934 options outstanding.

Balance Sheet

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

At December 31, 2007, the Company determined the fair value of all warrants and options to be $4,731,442 and $2,765,955, respectively, using the Black Sholes model with the following assumptions:

·

risk free rate of return between 3.07% and 3.45%;

·

volatility between 264% and 280%;

·

dividend yield of 0%; and

·

expected term between 3.30 years and 4.97 years.

Statement of Operations

At December 31, 2007, the Company recorded $1,418,732 as a gain on change in fair value of warrant and option liability.

Statement of Cash Flows

Changes in the statement of cash flows were the result of the decrease in fair value of the warrant and option liability of $1,418,732.

Beneficial Conversion Feature





42



---





As of December 31, 2007, the Company had $2,005,000 in convertible notes that could be converted into 100,154,621 shares.



Balance Sheet

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

At December 31, 2007, the Company determined the fair value of the embedded conversion options to be $22,254,386 using the Black Sholes model with the following assumptions:

·

risk free rate of return between 3.34% and 3.49%;

·

volatility between 101% and 160%;

·

dividend yield of 0%; and

·

expected term of 0.30 years to 1.0 years.

Statement of Operations

At December 31, 2007, the Company  recorded $7,626,152 as a gain on change in fair value of beneficial conversion liability.

Statement of Cash Flows

Changes in the statement of cash flows were the result of the $7,626,152 change in fair value of the beneficial conversion liability.

The following table shows the effect of each of the changed discusses above on the Companys balance sheet, statement of operation, and statement of cash flows for the three months ended December 31, 2007.





43



---







|                                                                       |  |                      |             |   |                                 |   |             |                      |  |   |                                |   |  |   |             |  
|---------------------------------------------------------------------- |  | -------------------- | ----------- | - | ------------------------------- | - | ----------- | -------------------- |  | - | ------------------------------ | - |  | - | ----------- | -
|                                                                       |  | As Previously Stated |             |   | Benficial
 Conversion
 Features |   |             | Warrants and Options |  |   | As Restated
 December 31,
2007 |  
|Balance Sheet                                                          |  |                      |             |   |                                 |   |             |                      |  |   |                                |  
|Accrued expenses                                                       |  | $                    | 2,353,077   |   |                                 | $ |           |                      |  | $ |                              |   |  | $ | 2,353,077   |  
|Warrant and option liability                                           |  |                      | 6,464,460   |   |                                 |   |           |                      |  |   | 1,032,937                      |   |  |   | 7,497,397   |  
|Beneficial conversion liability                                        |  |                      | 1,222,663   |   |                                 |   | 21,031,723  |                      |  |   |                              |   |  |   | 22,254,386  |  
|Additional paid-in capital                                             |  |                      | 10,762,982  |   |                                 |   |           |                      |  |   | 334,746                        |   |  |   | 11,097,728  |  
|Deficit accumulated during developmental stage                         |  |                      | (22,488,813 | ) |                                 |   | (21,031,723 | )                    |  |   | (1,367,683                     | ) |  |   | (44,888,219 | )
|                                                                       |  |                      |             |   |                                 |   |             |                      |  |   |                                |   |  |   |             |  
|Statement of Operations (for the three months ended December 31, 2007) |  |                      |             |   |                                 |   |             |                      |  |   |                                |   | 
|Gain on change in fair value of warrant and option liability           |  | $                    | 759,773     |   |                                 | $ |           |                      |  | $ | 1,418,732                      |   |  | $ | 2,178,505   |  
|Gain on change in fair value of beneficail conversion liability        |  |                      | 208,149     |   |                                 |   | 7,626,152   |                      |  |   |                              |   |  |   | 7,834,301   |  
|General and administrative expense                                     |  |                      | 5,064,569   |   |                                 |   |           |                      |  |   |                              |   |  |   | 5,064,569   |  
|Interest expense and financing costs                                   |  |                      | (126,286    | ) |                                 |   |           |                      |  |   |                              |   |  |   | (126,286    | )
|                                                                       |  |                      |             |   |                                 |   |             |                      |  |   |                                |   |  |   |             |  
|Statement of Operations (since inception)                              |  |                      |             |   |                                 |   |             |                      |  |   |                                |   |  |   |             |  
|Gain on change in fair value of warrant and option liability           |  | $                    | 848,644     |   |                                 | $ |           |                      |  | $ | 1,658,334                      |   |  | $ | 2,506,978   |  
|Gain on change in fair value of beneficail conversion liability        |  |                      | 204,105     |   |                                 |   | 11,544,227  |                      |  |   |                              |   |  |   | 11,748,332  |  
|General and administrative expense                                     |  |                      | 18,394,074  |   |                                 |   | 3,787,032   |                      |  |   |                              |   |  |   | 22,181,106  |  
|Interest expense and financing costs                                   |  |                      | (922,775    | ) |                                 |   | (30,536,702 | )                    |  |   | (1,278,233                     | ) |  |   | (32,737,710 | )
|                                                                       |  |                      |             |   |                                 |   |             |                      |  |   |                                |   |  |   |             |  
|Statement of Cash Flows (for the three months ended December 31, 2007) |  |                      |             |   |                                 |   |             |                      |  |   |                                |   | 
|Net income (loss)                                                      |  | $                    | (4,467,977  | ) |                                 | $ | 7,626,152   |                      |  | $ | 1,418,732                      |   |  | $ | 4,576,907   |  
|Gain on change in fair value of warrant and option liability           |  |                      | (759,773    | ) |                                 |   |           |                      |  |   | (1,418,732                     | ) |  |   | (2,178,505  | )
|Gain on change in fair value of beneficail conversion liability        |  |                      | (208,149    | ) |                                 |   | (7,626,152  | )                    |  |   |                              |   |  |   | (7,834,301  | )
|Non-cash compensation expense                                          |  |                      | 1,791,360   |   |                                 |   |           |                      |  |   |                              |   |  |   | 1,791,360   |  
|Non-cash financing costs                                               |  |                      |           |   |                                 |   |           |                      |  |   |                              |   |  |   |           |  
|                                                                       |  |                      |             |   |                                 |   |             |                      |  |   |                                |   |  |   |             |  
|Statement of Cash Flows (since inception)                              |  |                      |             |   |                                 |   |             |                      |  |   |                                |   |  |   |             |  
|Net income (loss)                                                      |  | $                    | (22,488,813 | ) |                                 | $ | (22,779,507 | )                    |  | $ | 380,101                        |   |  | $ | (44,888,219 | )
|Gain on change in fair value of warrant and option liability           |  |                      | (1,229,084  | ) |                                 |   |           |                      |  |   | (1,658,334                     | ) |  |   | (2,887,418  | )
|Gain on change in fair value of beneficail conversion liability        |  |                      | (204,105    | ) |                                 |   | (11,544,227 | )                    |  |   |                              |   |  |   | (11,748,332 | )
|Non-cash compensation expense                                          |  |                      | 3,627,317   |   |                                 |   | 3,787,032   |                      |  |   |                              |   |  |   | 7,414,349   |  
|Non-cash financing costs                                               |  |                      | -           |   |                                 |   | 30,536,702  |                      |  |   | 1,278,233                      |   |  |   | 31,814,935  |  
|                                                                       |  |                      |             |   |                                 |   |             |                      |  |   |                                |   |  |   |             |  







44



---





FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-QSB/A filed by Sionix Corporation contains forward-looking statements. These are statements regarding financial and operating performance and results and other statements that are not historical facts. The words expect, project, estimate, believe, anticipate, intend, plan, forecast, and similar expressions are intended to identify forward-looking statements. These statements, and any other statements that are not historical facts, are forward looking statements. Certain important risks could cause results to differ materially from those anticipated by some of the forward-looking statements. Some, but not all, of these risks include, among other things:

Ø

whether we will be able to find financing to continue our operations;

Ø

whether there are changes in regulatory requirements that adversely affect our business;

Ø

the ability of management to execute its plans to meet its goals;

Ø

general economic conditions, whether nationally or in the regional and local markets in which we operate, which may be less favorable than expected;

Ø

the ability to retain key members of management and key employees; and

Ø

other uncertainties, all of which are difficult to predict and many of which are beyond our control.

We do not intend to update forward-looking statements. You should refer to and carefully review the information in the documents we file with the Securities and Exchange Commission.





45



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ITEM 2

MANAGEMENTS DISCUSSION AND ANALYSIS OR PLAN OF OPERATIONS

DEVELOPMENT STAGE COMPANY. Sionix Corporation (referred to as the Company, we, us or our) 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 designs and develops turn-key stand-alone water treatment systems for municipalities (both potable and wastewater), industry (both make-up water and wastewater), emergency response, military and small residential communities. To date, the Companys efforts have been principally devoted to research and development, organizational activities, and raising capital. Development of our ELIXIR water treatment system was completed in 2002. We are currently engaged in testing the product, as discussed below. We have earned no revenues from sales of our product and we do not expect our product to be available for sale during the next few months. Because we earn no revenues, our operations are, and have been in the past, dependent on our ability to borrow money or to raise capital by selling our equity or debt securities.

Our lack of operating capital has slowed the pace of the development and testing of our product. However, during the 2007 fiscal year we began raising working capital through sales of debt securities, which has allowed us to complete installation of the ELIXIR water treatment system at the Villa Park Dam, Villa Park, California.

Our plan for the next 12 months is to continue to raise capital, interview and hire an independent consulting firm to verify equipment production standards and test data, and continue the introduction of the ELIXIR water treatment system to the market place which we anticipate will result in initial sales in the near future. There is no guarantee, however, that we will be able to accomplish these goals or that the introduction of our water treatment system will produce revenues for us. If our production standards and test data are confirmed by the independent consultants and if we are able to raise sufficient capital then the Company plans to hire competent production support and administrative staff to effectively run the Company.

If we are not able to raise funds as and when we need them, we may be required to severely curtail, or even to cease, our operations.

MANAGEMENT. On December 19, 2007, the Company entered into a one year Employment Agreement with Richard H. Papalian and a one year Consulting Agreement with Mark Maron pursuant to which Mr. Papalian was appointed as the Companys Chief Executive Officer and Mr. Maron was appointed as Special Adviser to the Company. As compensation for these services, the Company granted each person 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 which represented 5% of the outstanding shares of the Companys Common Stock on a fully diluted basis on the date the options were issued.

PLAN OF OPERATION. As stated above, during the next twelve months we plan to continue to raise capital, interview and hire an independent consulting firm to verify equipment production standards and test data and continue the introduction of the ELIXIR water treatment system to the market place. If our production standards and test data are confirmed by the independent consultants and if we are able to raise sufficient capital, then we intend to hire competent production support and administrative staff. We plan to engage in substantial promotional activities in connection with the installation and 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 will receive orders for additional units.

NEW CORPORATE FACILITIES. Effective November 1, 2007, the Company leased a 60,000 square foot research and development, production, engineering and administrative office facility in Garden Grove, California. As soon as we obtain additional funding we will be adding a substantial number of additional employees. We anticipate that all of our capital needs will need to be funded by equity or debt financing. ENGAGEMENT OF THIRD PARTY TECHNICAL CONSULTANTS. The Company is in the process of interviewing third party consulting firms to assist in verifying operational efficiencies of the system and to establish testing protocols.

RESTATEMENT OF FINANCIAL STATEMENTS.On December 11, 2007 the Company received a comment letter from the Securities & Exchange Commission relating to a registration statement on Form SB-2 filed by the Company on November 14, 2007. 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, exceeded the number of shares of authorized Common Stock. The difference between the original calculation and the recalculation is illustrated below.





46



---







|                                                                      |  |            |              |   |              |  |              |  
|--------------------------------------------------------------------- |  | ---------- | ------------ | - | ------------ |  | ------------ | -
|                                                                      |  | As         |              |   |              | 
|                                                                      |  | Originally |              |   | As           | 
|                                                                      |  | Calculated |              |   | Recalculated | 
|                                                                      |  |            |              |   |              |  |              |  
|Authorized shares per Articles of Incorportion                        |  |            | 150,000,000  |   |              |  | 150,000,000  |  
|Outstanding shares                                                    |  |            | (106,635,201 | ) |              |  | (106,635,201 | )
|Available shares                                                      |  |            | 43,364,799   |   |              |  | 43,364,799   |  
|                                                                      |  |            |              |   |              |  |              |  
|Securities convertible or exercisable into common stock shares:       |  |            |              |   |              |  |              |  
|2001 Executive Officers Stock Option Plan                             |  |            | 7,343,032    |   |              |  | 7,034,140    |  
|Advisory Board Compensation                                           |  |            |              |   |              |  | 11,520,000   |  
|2004 Stock Purchase Agreement                                         |  |            |              |   |              |  | 1,463,336    |  
|Warrants Related to 2004 Stock Purchase Agreement                     |  |            |              |   |              |  | 1,463,336    |  
|Warrants Issued for Services During the Year Ended September 30, 2007 |  |            |              |   |              |  | 1,010,000    |  
|Beneficial Conversion Features                                        |  |            | 32,009,087   |   |              |  | 36,606,318   |  
|Warrants Related to $1,025,000 of Subordinated Convertible Debentures |  |            | 2,159,088    |   |              |  | 2,795,454    |  
|                                                                      |  |            | 41,511,207   |   |              |  | 61,892,584   |  



Adjustments to the original calculation included the following:

1.

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

2.

On October 1, 2004, the Company formed an Advisory Board consisting of four members. Each member was to receive $5,000 monthly from October 1, 2004, to February 22, 2007 (for a total of $576,000), convertible into Common Stock at $0.05 per share ($576,000/$.05 = 11,520,000 shares of Common Stock). The accrued expense related to converting the shares into 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.

On November 14, 2006, the Company entered into agreements for services pursuant to which it issued warrants to purchase a total of 1,010,000 shares of Common Stock. 850,000 shares may be purchased at an exercise price of $0.05 per share and 160,000 shares may be purchased at an exercise price of $0.25 per share. The warrants expire on November 13, 2011. The warrants were not included in the original calculation.

6.

As of September 30, 2007, the Company had Convertible Bridge 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 Bridge 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.

7.

On July 18, 2007 the Company completed an offering of $1,025,000 of Subordinated Convertible Debentures (the Subordinated 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.





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Based on the result of the recalculation, the Company analyzed the effect on the balance sheet and the statements of operations and cash flows for the classification and valuation for all outstanding securities and contracts that were exercisable or convertible into shares of Common Stock as of September 30, 2007. The Company applied Emerging Issues Task Force (EITF) 00-19, Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Companys Own Stock, and Financial Accounting Standard Board (FASB) Statement No. 133, Accounting for Derivative Instruments and Hedging Activitiesand determined that the financial statements were required to be restated.

The Company performed an analysis on the classification and valuation of all outstanding securities and contracts that were exercisable or convertible into shares of Common Stock as of December 31, 2007, in accordance with EITF 00-19, paragraph 10 which states that the classification of all contracts should be reassessed at each balance sheet date.

The analysis and results were as follows:

2001 Executive Officers Stock Option Plan

In October 2000, the Company amended its employment agreements with each of the executive officers. A result of the amendments was that 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 to purchase 7,034,140 shares of Common Stock that expire 5 years from the date of issuance.

Balance Sheet

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

The Company began the analysis for the restatement as of and for the year ended September 30, 2007 by applying FASB 133, paragraph 6 to ascertain if the options remained derivatives as of September 30, 2007. All of the criteria in the original analysis were met, and the options were determined to be within the scope and definition of a derivative. EITF 00-19, paragraph 19 was applied next 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. EITF 00-19, paragraph 10 was then applied. Paragraph 10 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 $1,025,000 Convertible Bridge Notes 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 which was calculated using the Black Sholes valuation 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.

EITF 00-19, paragraph 9 was applied 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 determined to be $1,926,914 as of September 30, 2007 and was calculated using the Black Sholes valuation 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 Company began the analysis for the restatement by applying FASB 133, paragraph 6 to ascertain if the options remained derivatives as of December 31, 2007. All of the criteria in the original analysis were met, and the options 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.





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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 options was determined to be $1,223,588 as of December 31, 2007 and was calculated using the Black Sholes valuation model with the following assumptions: risk free rate of return of 3.34%; volatility of 98.01%; dividend yield of 0%; and an expected term of 3.25 years.

The decrease in the fair value of the options was $703,326 for the three months ended December 31, 2007, and recorded by decreasing the warrant liability on the balance sheet.

Statement of Operations

EITF 00-19, paragraph 9 was applied 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 options for the three months ended December 31, 2007 was $703,326 and 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 change in the fair value of the options of $703,326.

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, convertible by the Advisory Board members into 11,520,000 shares of Common Stock at a rate of $0.05 per share. The Company determined that: the accrued expense, embedded beneficial conversion feature, embedded beneficial conversion feature discount, and related amortization expense were not recorded at the date of issuance, or prior to the restatement of the financial statements as of September 30, 2007, as of December 31, 2007 no payments have been made to any Advisory Board members; and as of December 31, 2007 there has been no conversion by any Advisory Board members of the accrued liability into shares of Common Stock.

Balance Sheet

The Company began the analysis for the restatement by applying paragraph 6 of Financial Accounting Standards Board (FASB) Statement No. 133, Accounting for Derivative Instruments and Hedging Activities, to ascertain if the embedded beneficial conversion features were derivatives at the date of issuance. The embedded beneficial conversion features had one or more underlings, and one or more notional amounts; required no initial investment; and required or permitted net settlement. Therefore, the embedded beneficial conversion features were determined to be within the scope and definition of a derivative at the date of issuance. Next, FASB 133, paragraph 12 was applied 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 features 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 FASB 133, paragraphs 6-11. Therefore, the embedded beneficial conversion features were separated from the accrued expense to determine the classification and valuation. EITF 00-19, paragraphs 7 and 8 were applied to determine the classification. Paragraph 7 states that contracts which require net-cash settlement are liabilities, and paragraph 8 states that contracts which give the counterparty (Advisory Board members) a choice of net-cash settlement or settlement in shares are liabilities. Therefore, the embedded conversion features were determined to be liabilities. EITF 00-19, paragraph 9 was applied to determine the value. Paragraph 9 of EITF 00-19 states 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 monthly embedded beneficial conversion features was calculated using the Black Sholes valuation 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,





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respectively, and considered earned prior to October 1, 2006. Therefore, $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, as of September 30, 2006.

The fair value of the monthly embedded beneficial conversion features was determined to be $480,000 as of September 30, 2006, and was calculated using the Black Sholes valuation 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 renegotiated the compensation.

The Company began the analysis of the beneficial conversion features for the restatement as of and for the year ended September 30, 2007 by applying FASB 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 were determined to be within the scope and definition of a derivative. FASB 133, paragraph 12 was applied to determine if the embedded beneficial conversion features should be separated from the convertible bridge notes. All of the criteria in the original analysis were met, and the embedded beneficial conversion features were separated from the convertible bridge notes. EITF 00-19, paragraphs 7 and 8 were applied to determine the classification. Paragraph 7 states that contracts which require net-cash settlement are liabilities, and paragraph 8 states that contracts which give the counterparty (advisory board members) 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 rights of the advisory board members to convert the compensation into Common Stock. Therefore, share settlement is not controlled by the Company. EITF 00-19, paragraph 9 was applied to determine the value of the beneficial conversion features. Paragraph 9 of EITF 00-19 states that all contracts classified as liabilities must 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 calculated using the Black Sholes valuation model with the following assumptions: risk free rate of return of 4.94% to 5.09%; volatility of 268.59% to 277.2%; dividend yield of 0% and an expected term of 5 years. The sum of the embedded beneficial conversion features from October 1, 2006 to February 22, 2007 was $91,956 and was recorded to beneficial conversion features liability and netted against accrued expenses. 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) as of September 30, 2007, and recorded to accrued expenses.

The fair value of the monthly embedded beneficial conversion features was determined to be $576,000 as of September 30, 2007, using the Black Sholes valuation 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 Company began the analysis for the restatement as of and for the three months ended December 31, 2007 by applying FASB 133, paragraph 6 to ascertain if the beneficial conversion features remained derivatives subsequent to the date of issuance. All of the criteria in the original analysis were met, and the beneficial conversion features were determined to be within the scope and definition of a derivative. Next, FASB 133, paragraph 12 was applied to determine if the embedded beneficial conversion features should be separated from the accrued expense. All of the criteria in the original analysis were met, and the beneficial conversion features were separated from the accrued liability. EITF 00-19, paragraphs 7 and 8 were applied to determine the classification. Paragraph 7 states that contracts which require net-cash settlement are liabilities, and paragraph 8 states that contracts which give the counterparty (the Advisory Board members) a choice of net-cash settlement or settlement in shares are liabilities. Therefore, the embedded conversion features were determined to be liabilities. EITF 00-19, paragraph 9 was applied to determine the value of the embedded beneficial conversion features. Paragraph 9 of EITF 00-19 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





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liabilities.

The fair value of the monthly embedded beneficial conversion features was determined to be $576,000 as of December 31, 2007, using the Black Sholes valuation model with the following assumptions: risk free rate of return of 3.34%; volatility of 98.01%; dividend yield of 0%; and an expected term of 1.92 to 4.25years.

The beneficial conversion features discount amortization was $15,104 for the three months ended December 31, 2007, which increased accrued expenses.

Statement of Operations

EITF 00-19, paragraph 9 was applied 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 increase in the fair value of the beneficial conversion features for the three months ended December 31, 2007.

The beneficial conversion feature discount amortization was determined to be $15,104 and has been included in general and administrative expenses in the operating expenses section of the statement of operations, for the three months ended December 31, 2007.

Statement of Cash Flows

Changes in the statement of cash flows were the result of the amortization of the beneficial conversion features discount of $15,104 on the statement of operations.

Warrants Related to 2004 Stock Purchase Agreement

Under the terms of a 2004 Stock Purchase Agreement, the Company issued warrants to purchase 1,463,336 shares of Common Stock at an exercise price of $0.03 which expire from February 9, 2007 to 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 began the analysis by applying 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. EITF 00-19, paragraphs 7 and 8 were then applied to determine classification. These paragraphs state that contractswhich require settlement in shares are equity instruments. EITF 00-19, paragraph 9 was applied to determine the value of the options. 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.

The fair value of the warrants was determined to be $24,367 at the date of issuance which was calculated using the Black Sholes valuation model with the following assumptions: risk free rate of return of 1.21% to 2.14%; volatility of 141.91% to 170.27%; dividend yield of 0% and an expected term of 5 years. The 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.

EITF 00-19, paragraph 19 was applied next. Paragraph 19 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. EITF 00-19, paragraph 10 was then applied. This paragraph 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 $1,025,000 Convertible Bridge Notes 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 was calculated using the Black Sholes valuation 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.





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EITF 00-19, paragraph 9 was applied. Paragraph 9 states that all contracts classified as liabilities must 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 $0 as of September 30, 2007, due to their expiration.

The decrease in the fair value of the warrants was $70,029 for the year ended September 30, 2007, which was recorded to warrant liability and accumulated deficit during development stage as of September 30, 2007.

Statement of Operations

There was no change in the fair value of the warrants for the three months ended December 31, 2007, due to their expiration.

Statement of Cash Flows

There was no change in the statement of cash flows for the three months ended December 31, 2007.

Beneficial Conversion Features

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

Balance Sheet

On the date of issuance, the Company applied FASB 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, FASB 133, paragraph 12 was applied to determine if the embedded beneficial conversion features should be separated from the convertible bridge notes. The Company determined that: the economic characteristics of the embedded beneficial conversion features are not clearly and closely related to the convertible bridge notes; the embedded beneficial conversion features and convertible bridge 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 FASB 133, paragraphs 6-11. Therefore, the embedded beneficial conversion features were separated from the convertible bridge notes to determine the classification and valuation. EITF 00-19, paragraphs 7 and 8 were then applied to determine the classification. Paragraphs 7 and 8 state that contractswhich require settlement in shares are equity instruments. EITF 00-19, paragraph 9 was applied to determine the value of the embedded beneficial conversion features. Paragraph 9 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 were determined to be $1,021,5670 at the date of issuance and was computed using the Black Sholes valuation model with the following assumptions: risk free rate of return of 6%; volatility of 122.67% to 195.97%; dividend yield of 0% and an expected term of 1 to 1.5 years. The embedded beneficial conversion features discount was $706,186 as of September 30, 2007, net of amortization of $315,383, prior to the restatement.

The Company began the analysis of the beneficial conversion features for the restatement as of and for the year ended September 30, 2007 by applying FASB 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. FASB 133, paragraph 12 was applied to determine if the embedded beneficial conversion features should be separated from the convertible bridge notes. All of the criteria in the original analysis were met, and the embedded beneficial conversion features were separated from the convertible bridge notes. EITF 00-19, paragraphs





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7 and 8 were applied to determine the classification. 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 beneficial conversion features were determined to be liabilities. The change in the determination of the classification from equity to a liability was based on the rights of the holders of the convertible notes to convert the note. Therefore, share settlement is not controlled by the Company. EITF 00-19, paragraph 9 was applied to determine the value. Paragraph 9 states that all contracts classified as liabilities must be measured at fair value at each balance sheet date, with changes in fair value reported in earnings and disclosed in the financial statements as long as the contracts remain classified as liabilities.

The fair value of the embedded beneficial conversion features was recalculated and was determined to be $1,430,811 at the date of issuance and was computed using the Black Sholes valuation model with the following assumptions: risk free rate of return of 2.02% to 5.09%; volatility of 108.5% to 274.86%; dividend yield of 0% and an expected term of 1 to 1.5 years. Based on the recalculation, the embedded beneficial conversion features discount was $491,264, net of accumulated amortization of $939,547 as of December 31, 2007.

The fair value of the embedded beneficial conversion features was $1,430,811 as of September 30, 2007, using the Black Sholes valuation 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 began the analysis for the restatement as of and for the three months ended December 31, 2007 by applying FASB 133, paragraph 6 to ascertain if the embedded beneficial conversion features remained derivatives subsequent to the date of issuance. 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. FASB 133, paragraph 12 was applied to determine if the embedded beneficial conversion features should be separated from the convertible bridge notes. All of the criteria in the original analysis were met, and the embedded beneficial conversion features were separated from the convertible bridge notes. EITF 00-19, paragraphs 7 and 8 were applied to determine the classification. 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 rights of the holders of the convertible notes to convert the note. Therefore, share settlement is not controlled by the Company. EITF 00-19, paragraph 9 was applied to determine the value of the embedded beneficial conversion features. Paragraph 9 states that all contracts classified as liabilities must 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 determined to be $1,222,663 as of December 31, 2007, which was calculated using the Black Sholes valuation model with the following assumptions: risk free rate of return of 3.34%; volatility of 98.01%; dividend yield of 0%; and an expected term of .33 to 1 year.

The decrease in the fair value of the beneficial conversion features was determined to be $208,149 for the three months ended December 31, 2007, and was recorded in beneficial conversion features liability on the balance sheet.

The amortization of the beneficial conversion features discount was $56,038 for the three months ended December 31, 2007, which increased convertible notes.

Statement of Operations

The beneficial conversion features were analyzed in accordance withEITF 00-19, paragraph 9 was applied 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 decrease in the fair value of the beneficial conversion features was determined to be $208,149 for the three months ended December 31, 2007, and was recorded in increase (decrease) in beneficial conversion features liability, in the other income (expense) section of the statement of operations.

The amortization of the beneficial conversion features discount was $56,038 for the three months ended December 31, 2007, and was recorded in interest expense in the other income (expense) section of the statement of operations.





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Statement of Cash Flows

Changes in the statement of cash flows were the result of the decrease in the fair value of the beneficial conversion features liability of $208,150 and the amortization of the beneficial conversion features discounts of $56,038 on the statement of operations.

Warrants related to $1,025,000 of Convertible Bridge Notes

On July 17, 2007 the Company completed an offering of $1,025,000 of Convertible Bridge Notes 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 bridge notes, 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 FASB 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. EITF 00-19, paragraphs 7 and 8 were then applied to determine the classification. Paragraphs 7 and 8 state that contractswhich require settlement in shares are equity instruments. EITF 00-19, paragraph 9 was applied to determine the value of the warrants. Paragraph 9 states that contracts which require the company to deliver shares as part of a physical settlement or net-share settlement must be initially measured at fair value. In accordance with EITF 00-19, the warrants were recorded in additional paid-in capital at fair value on the date of issuance.

The fair value of the warrants was calculated as $340,585 ($304,259 related to the holders of the convertible bridge notes, and $36,326 related to the placement fee) at the date of issuance using the Black Sholes valuation 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 of the financial statements as of and for the year ended September 30, 2007, by applying FASB 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. EITF 00-19, paragraph 19 was applied next to determine classification. Paragraph 19 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. EITF 00-19, paragraph 9 was applied to determine the value of the warrants. Paragraph 9 states that all contracts classified as liabilities must 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, $340,585 was reclassified from additional paid-in capital to warrant liabilities.

The fair value of the warrants was recalculated and were determined to be $554,249 ($430,189 related to the holders of the convertible bridge notes, and $124,060 related to the placement fee) at the date of issuance using the Black Sholes valuation 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 fair value of the warrants was determined to be $499,932 ($379,672 related to the holders of the convertible bridge notes, and $120,260 related to the placement fee) as of September 30, 2007. The fair value was calculated using the Black Sholes valuation 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 Company began the analysis for the restatement as of December 31, 2007 by applying FASB 133, paragraph 6 to ascertain if the warrants issued remained derivatives as of December 31, 2007. 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, which states that if share settlement is not controlled by the company the contract is required to be classified as a liability was applied. Paragraph 9 of EITF 00-19, which 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 was also applied.





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The fair value of the warrants was determined to be $321,778 as of December 31, 2007, and was calculated using the Black Sholes model with the following assumptions: risk free rate of return of 3.34%; volatility of 98.01%; dividend yield of 0%; and an expected term of 4.5 years.

The decrease in the fair value of the warrants was determined to be $178,154 for the three months ended December 31, 2007, and recorded by decreasing warrant liabilities on the balance sheet by $178,154 ($125,228 related to the holders of the convertible bridge notes, and $52,926 related to the placement fee).

The amortization of the warrant discount was $30,065 for the three months ended December 31, 2007, which increased convertible notes.

Statement of Operations

EITF 00-19, paragraph 9 was applied 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 decrease in the fair value of the warrants was $178,154 for the three months ended December 31, 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 $30,065 is included in interest expense in the other income (expense) section of the statement of operations.

Statement of Cash Flows

Changes in the statement of cash flows were the result of the decrease in the amount of $178,154 in thefair value of the warrants at the date of issuance on the statement of operations, and the increase in the amortization of the warrant discount of $30,065 on the balance sheet.

Table 1 shows the effect of each of the changes discussed above on the Companys balance sheet, statement of operation, statement of equity (deficit), and statement of cash flows for the three months ended December 31, 2007.

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 was 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 6 to our financial statements) 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 contracts that require net-cash settlement (including a requirement to net cash settle the contract if an event occurs and if that event is outside the control of the company) are liability instruments. In order to determine the value of the 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 determined to be $1,448,321 at the date of issuance and was calculated using the Black Sholes valuation model with the following assumptions: risk free interest rate of 3.26%, expected volatility of 98.01%, dividend yield 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 December 31, 2007. All of the criteria in the original analysis were met, and the warrant issued was





55



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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 was also applied which 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 $1,515,432 as of December 31, 2007, and was calculated using the Black Sholes valuation model with the following assumptions: risk free rate of return of 3.34%; volatility of 98.01%; dividend yield of 0%; and an expected term of 4.92 years.

The increase in the fair value of the option was $67,111 for the three months ended December 31, 2007, and was recorded by decreasing the warrant liability on the balance sheet.

Option Issued to 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 to 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 6 to our financial statements) are eligible for conversion into shares of Common Stock. These options were not issued from the 2001 Executive Officers Stock Option Plan. 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 contracts that require net-cash settlement (including a requirement to net cash settle the contract if an event occurs and if that event is outside the control of the company) are liability instruments. In order to determine the value of the 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 determined to be $1,448,321 at the date of issuance, and was calculated using the Black Sholes valuation 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 December 31, 2007 by applying FASB 133, paragraph 6 to ascertain if the option remained a derivative as of December 31, 2007. All of the criteria in the original analysis were met, and the option 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, which 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 was also applied.

The fair value of the option was determined to be $1,515,432 as of December 31, 2007, and was calculated using the Black Sholes valuation model with the following assumptions: risk free rate of return of 3.34%; volatility of 98.01%; dividend yield of 0%; and an expected term of 4.92 years.

The increase in the fair value of the option was $67,111 for the three months ended December 31, 2007, and was 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 to a director of a five year option to purchase a total of 1,000,000 shares of the Companys common stock at an exercise price of $0.25 per share.





56



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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 contracts that require net-cash settlement (including a requirement to net cash settle the contract if an event occurs and if that event is outside the control of the company) are liability instruments. In order to determine the value of the 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 determined to be $171,520 at the date of issuance and was calculated using the Black Sholes valuation model with the following assumptions: risk free interest rate of 3.22%, expected volatility of 99.86%, dividend yield 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 December 31, 2007. All of the criteria in the original analysis were met, and the option 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, which 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 was also applied.

The fair value of the option was determined to be $177,465 as of December 31, 2007, using the Black Sholes valuation model with the following assumptions: risk free rate of return of 3.34%; volatility of 98.01%; dividend yield of 0%; and an expected term of 4.92 years.

The increase in the fair value of the option was $5,945 for the three months ended December 31, 2007, and recorded by decreasing the warrant liability on the balance sheet.

Option Issued to Chief Financial Officer

On December 13, 2007, the Companys Board of Directors approved the issuance to the Chief Financial Officer of a five year option 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 contracts that require net-cash settlement (including a requirement to net cash settle the contract if an event occurs and if that event is outside the control of the company) are liability instruments. In order to determine the value of the 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 determined to be $171,520 at the date of issuance and was calculated using the Black Sholes valuation model with the following assumptions: risk free interest rate of 3.22%, expected volatility of 99.86%, dividend yield 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 December 31, 2007. 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





57



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that if share settlement is not controlled by the company, the contract is required to be classified as a liability. Paragraph 9, which 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 was also applied.

The fair value of the option was determined to be $177,465 as of December 31, 2007, using the Black Sholes valuation model with the following assumptions: risk free rate of return of 3.34%; volatility of 98.01%; dividend yield of 0%; and an expected term of 4.92 years.

The increase in the fair value of the option was $5,945 for the three months ended December 31, 2007, and recorded by decreasing the warrant liability on the balance sheet.

Table 1 - 2007

|                                                                       |  |            |             |           |   |              |   |            |            |          |   |            |   |               |          |                |   |                    |         |                |          |                   |   |                   |           |          |            |         |           |          |           |   |          |   |   |           |   |             |            |  
|---------------------------------------------------------------------- |  | ---------- | ----------- | --------- | - | ------------ | - | ---------- | ---------- | -------- | - | ---------- | - | ------------- | -------- | -------------- | - | ------------------ | ------- | -------------- | -------- | ----------------- | - | ----------------- | --------- | -------- | ---------- | ------- | --------- | -------- | --------- | - | -------- | - | - | --------- | - | ----------- | ---------- | -
|                                                                       |  |            |             |           |   |              |   |            |            |          |   | Beneficial |   | Warrant       |          |                |   |                    |         |                |          |                   |   |                   |           |          |           
|                                                                       |  |            |             |           |   |              |   |            |            |          |   | Conversion |   | Related to    |          |                |   | Option Issued      |         |                |          |                   |   |                   |           |          |           
|                                                                       |  |            |             |           |   |              |   |            |            |          |   | Features   |   | $1,025,000 of |          | Warrant Issued |   | to Chief Executive |         |                |          |                   |   |                   |           |          |           
|                                                                       |  |            |             | 2001      |   |              |   | Warrants   |            |          |   | and        |   | Convertible   |          | to Consultant  |   | Officer for the    |         |                |          |                   |   |                   |           |          |           
|                                                                       |  |            |             | Executive |   |              |   | Related to |            | Warrant  |   | Beneficial |   | Bridge Notes  |          | for the Three  |   | Three Month        |         |                |          |                   |   |                   |           |          |           
|                                                                       |  | As         |             | Officers  |   | Advisory     |   | 2004 Stock |            | Issued   |   | Conversion |   | and           |          | Months Ended   |   | Period Ended       |         |                |          | Warrant Issued    |   |                   |           |          |           
|                                                                       |  | Previously |             | Option    |   | Board        |   | Purchase   |            | for      |   | Features   |   | Warrant       |          | December 31,   |   | December 31,       |         | Warrant Issued |          | to Chief          |   |                   |           | As       |           
|                                                                       |  | Stated     |             | Plan      |   | Compensation |   | Agreement  |            | Services |   | Discount   |   | Discount      |          | 2007           |   | 2007               |         | to Director    |          | Financial Officer |   | Reclassifications |           | Restated |           
|Balance Sheet                                                          |  |            |             |           |   |              |   |            |            |          |   |            |   |               |          |                |   |                    |         |                |          |                   |   |                   |           |          |           
|Accrued expenses                                                       |  | $          | 1,777,077   |           |   |              | $ | 576,000    |            |          |   |            |   |               |          |                |   |                    |         |                |          |                   |   |                   |           |          |            | $       | 2,353,077 |         
|Convertible Notes, net                                                 |  |            | 1,229,817   |           |   |              |   |            |            |          |   |            |   |               | (17,075  | )              |   | (40,691            | )       |                |          |                   |   |                   |           |          |            |         |           |          | 1,172,051 |  
|Warrant liability                                                      |  |            |           |           |   | 1,223,588    |   |            | 1,533,300  |          |   |            |   |               |          |                |   |                    | 321,778 |                |          | 1,515,432         |   |                   | 1,515,432 |          |            | 177,465 |           |          | 177,465   |   |          |   |   | 6,464,460 |  
|Beneficial conversion feature liability                                |  |            |           |           |   |              |   |            |            |          |   |            |   |               |          | 1,222,663      |   |                    |         |                |          |                   |   |                   |           |          |            |         |           |          |           |   |          |   |   | 1,222,663 |  
|Additional paid-in capital                                             |  |            | 15,643,156  |           |   | (2,271,879   | ) |            | (269,848   | )        |   | (45,663    | ) |               | (100,811 | )              |   | (1,021,570         | )       |                | (340,585 | )                 |   | (414,909          | )         |          | (414,909   | )       |           |          |           |   |          |   |   |           |   | 10,762,982  |           
|Deferred warrant expense                                               |  |            | (67,038     | )         |   |              |   |            |            |          |   |            |   |               | 67,038   |                |   |                    |         |                |          |                   |   |                   |           |          |            |         |           |          |           |   |          |   |   |           |   |           |           
|Deficit accumulated during development stage                           |  |            | (19,096,592 | )         |   | 1,048,291    |   |            | (1,839,452 | )        |   | 45,663     |   |               | 33,773   |                |   | (184,018           | )       |                | 59,498   |                   |   | (1,100,523        | )         |          | (1,100,523 | )       |           | (177,465 | )         |   | (177,465 | ) |   |           |   | (22,488,813 | )         
|                                                                       |  |            |             |           |   |              |   |            |            |          |   |            |   |               |          |                |   |                    |         |                |          |                   |   |                   |           |          |            |         |           |          |           |   |          |   |   |           |   |             |           
|Statement of Operations (for the three months ended December 31, 2007) |  |            |             |           |   |              |   |            |            |          |   |            |   |               |          |                |   |                    |         |                |          |                   |   |                   |           |          |            |         |           |          |           |   |          |   |   |           |   |             |           
|General and administrative                                             |  | $          | 1,367,677   |           |   |              |   | $          | 1,557,705  |          |   |            |   | $             | (33,773  | )              |   |                    |         |                |          |                   | $ | 1,033,412         |           | $        | 1,033,412  |         | $         | 171,520  |           | $ | 171,520  |   | $ | (236,904  | ) | $           | 5,064,569  |  
|Research and development                                               |  |            |           |           |   |              |   |            |            |          |   |            |   |               |          |                |   |                    |         |                |          |                   |   |                   |           |          |            |         |           |          |           |   |          |   |   | 236,904   |   |             | 236,904    |  
|Interest expense                                                       |  |            | (188,625    | )         |   |              |   |            | 380,440    |          |   |            |   |               |          |                |   | (288,036           | )       |                | (30,065  | )                 |   |                   |           |          |            |         |           |          |           |   |          |   |   |           |   |             | (126,286   | )
|Decrease (increase) in warrant liability                               |  |            |             |           |   | 703,326      |   |            | 24,405     |          |   |            |   |               |          |                |   |                    |         |                | 178,154  |                   |   | (67,111           | )         |          | (67,111    | )       |           | (5,945   | )         |   | (5,945   | ) |   |           |   |             | 759,773    |  
|Increase in beneficial conversion feature liability                    |  |            |             |           |   |              |   |            |            |          |   |            |   |               |          |                |   | 208,149            |         |                |          |                   |   |                   |           |          |            |         |           |          |           |   |          |   |   |           |   |             | 208,149    |  
|Beneficial conversion feature expense                                  |  |            | (231,998    | )         |   |              |   |            |            |          |   |            |   |               |          |                |   | 231,998            |         |                |          |                   |   |                   |           |          |            |         |           |          |           |   |          |   |   |           |   |             |          |  
|Basic and dilutive loss per s                                          |  |            | (0.02       | )         |   |              |   |            | (0.01      | )        |   |            |   |               |          |                |   |                    |         |                |          |                   |   | (0.01             | )         |          |            |         |           |          |           |   |          |   |   |           |   |             | (0.04      | )
|                                                                       |  |            |             |           |   |              |   |            |            |          |   |            |   |               |          |                |   |                    |         |                |          |                   |   |                   |           |          |            |         |           |          |           |   |          |   |   |           |   |             |            |  
|Statement of Operations (since inception)                              |  |            |             |           |   |              |   |            |            |          |   |            |   |               |          |                |   |                    |         |                |          |                   |   |                   |           |          |            |         |           |          |           |   |          |   |   |           |   |             |            |  
|General and administrative                                             |  | $          | 14,519,764  |           |   |              |   | $          | 2,215,848  |          | $ | 24,367     |   | $             | (33,773  | )              |   |                    |         | $              | 87,734   |                   | $ | 1,033,412         |           | $        | 1,033,412  |         | $         | 171,520  |           | $ | 171,520  |   | $ | (829,730  | ) | $           | 18,394,074 |  
|Research and development                                               |  |            | 1,449,474   |           |   |              |   |            |            |          |   |            |   |               |          |                |   |                    |         |                |          |                   |   |                   |           |          |            |         |           |          |           |   |          |   |   | 763,370   |   |             | 2,212,844  |  
|Interest expense                                                       |  |            | (658,869    | )         |   |              |   |            | 380,440    |          |   |            |   |               |          |                |   | (624,165           | )       |                | (85,239  | )                 |   |                   |           |          |            |         |           |          |           |   |          |   |   | (315,382  | ) |             | (1,303,215 | )
|Decrease in warrant liability                                          |  |            |             |           |   | 1,048,291    |   |            | 24,405     |          |   | 70,029     |   |               |        |                |   |                    |         |                | 232,471  |                   |   | (67,111           | )         |          | (67,111    | )       |           | (5,945   | )         |   | (5,945   | ) |   |           |   |             | 1,229,084  |  
|Increase in beneficial conversion feature liability                    |  |            |             |           |   |              |   |            | (4,044     | )        |   |            |   |               |          |                |   | 208,149            |         |                |          |                   |   |                   |           |          |            |         |           |          |           |   |          |   |   |           |   |             | 204,105    |  
|Beneficial conversion feature expense                                  |  |            | (548,858    | )         |   |              |   |            |            |          |   |            |   |               |          |                |   | 548,858            |         |                |          |                   |   |                   |           |          |            |         |           |          |           |   |          |   |   |           |   |             |          |  
|Legal settlement                                                       |  |            | 434,603     |           |   |              |   |            |            |          |   |            |   |               |          |                |   |                    |         |                |          |                   |   |                   |           |          |            |         |           |          |           |   |          |   |   | (89,654   | ) |             | 344,949    |  
|Income taxes                                                           |  |            | 10,800      |           |   |              |   |            |            |          |   |            |   |               |          |                |   |                    |         |                |          |                   |   |                   |           |          |            |         |           |          |           |   |          |   |   | 2,592     |   |             | 13,392     |  
|                                                                       |  |            |             |           |   |              |   |            |            |          |   |            |   |               |          |                |   |                    |         |                |          |                   |   |                   |           |          |            |         |           |          |           |   |          |   |   |           |   |             |            |  
|Statement of Cash Flows (for the three months ended December 31, 2007) |  |            |             |           |   |              |   |            |            |          |   |            |   |               |          |                |   |                    |         |                |          |                   |   |                   |           |          |            |         |           |          |           |   |          |   |   |           |   |             |            |  
|Net loss                                                               |  | $          | (1,796,440  | )         | $ | 703,326      |   | $          | (1,152,860 | )        |   |            |   | $             | 33,773   |                | $ | 152,111            |         | $              | 148,089  |                   | $ | (1,100,523        | )         | $        | (1,100,523 | )       | $         | (177,465 | )         | $ | (177,465 | ) |   |           |   | $           | (4,467,977 | )
|Amortization of beneficial conversion features discount and warr       |  |            | 231,998     |           |   |              |   |            |            |          |   |            |   |               |          |                |   | 56,038             |         |                | 30,065   |                   |   |                   |           |          |            |         |           |          |           |   |          |   |   | 87,550    |   |             | 405,651    |  
|Stock based compensation expense- employee                             |  |            | 414,909     |           |   |              |   |            |            |          |   |            |   |               |          |                |   |                    |         |                |          |                   |   |                   |           |          | 1,033,411  |         |           | 171,520  |           |   | 171,520  |   |   |           |   |             | 1,791,360  |  
|Stock based compensation expense- consultant                           |  |            | 414,909     |           |   |              |   |            | 1,557,706  |          |   |            |   |               |          |                |   |                    |         |                |          |                   |   | 1,033,412         |           |          |            |         |           |          |           |   |          |   |   |           |   |             | 3,006,027  |  
|(Decrease) increase in warrant liability                               |  |            |             |           |   | (703,326     | ) |            | (24,405    | )        |   |            |   |               |        |                |   |                    |         |                | (178,154 | )                 |   | 67,111            |           |          | 67,111     |         |           | 5,945    |           |   | 5,945    |   |   |           |   |             | (759,773   | )
|Increase in beneficial conversion feature liaiblity                    |  |            |             |           |   |              |   |            |            |          |   |            |   |               |          |                |   | (208,149           | )       |                |          |                   |   |                   |           |          |            |         |           |          |           |   |          |   |   |           |   |             | (208,149   | )
|Write-off of beneficial conversion feature                             |  |            |             |           |   |              |   |            | (380,440   | )        |   |            |   |               |          |                |   |                    |         |                |          |                   |   |                   |           |          |            |         |           |          |           |   |          |   |   |           |   |             | (380,440   | )
|Accrued expenses                                                       |  |            | 135,529     |           |   |              |   |            | 98,051     |          |   |            |   |               |          |                |   |                    |         |                |          |                   |   |                   |           |          |            |         |           |          |           |   |          |   |   | (46,125   | ) |             | 187,455    |  
|Accrual of liquidating damages                                         |  |            |             |           |   |              |   |            |            |          |   |            |   |               |          |                |   |                    |         |                |          |                   |   |                   |           |          |            |         |           |          |           |   |          |   |   | 46,125    |   |             | 46,125     |  
|Beneficial conversion feature                                          |  |            | 231,998     |           |   |              |   |            |            |          |   |            |   |               |          |                |   | (231,998           | )       |                |          |                   |   |                   |           |          |            |         |           |          |           |   |          |   |   |           |   |             |          |  
|Warrants issued for consulting                                         |  |            | 111,255     |           |   |              |   |            |            |          |   |            |   |               |          |                |   |                    |         |                |          |                   |   |                   |           |          |            |         |           |          |           |   |          |   |   | (111,255  | ) |             |            |  







58



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|                                                                            |  |                      |             |                                     |   |                             |   |                                                   |            |                              |   |                                                                            |   |                                                                                 |        |                                                                            |   |                                                                                |   |                            |          |                                           |   |                   |   |             |            |   |   |          |   |   |          |   |   |            |   |   |             |  
|--------------------------------------------------------------------------- |  | -------------------- | ----------- | ----------------------------------- | - | --------------------------- | - | ------------------------------------------------- | ---------- | ---------------------------- | - | -------------------------------------------------------------------------- | - | ------------------------------------------------------------------------------- | ------ | -------------------------------------------------------------------------- | - | ------------------------------------------------------------------------------ | - | -------------------------- | -------- | ----------------------------------------- | - | ----------------- | - | ----------- | ---------- | - | - | -------- | - | - | -------- | - | - | ---------- | - | - | ----------- | -
|                                                                            |  | As
Previously
Stated |             | 2001
Executive
Officers
Option
Plan |   | Advisory
Board
Compensation |   | Warrants
Related to
2004 Stock
Purchase
Agreement |            | Warrants
Issued
for Services |   | Beneficial
Conversion
Features
and
Beneficial
Conversion
Features
Discount |   | Warrants
Related to
$1,025,000 of
Convertible
Bridge Notes
and
Warrant
Discount |        | Warrants
Issued
to Consultant
for the Three
Months Ended
December 31,
2007 |   | Options
Issued
to Employees
for the
Three Month
Period Ended
December 31,
2007 |   | Warrant Issued
to Direcotr |          | Warrant Issued
to Chief
Financial Officer |   | Reclassifications |   | As
Restated |           
|Statement of Cash Flows (since inception)                                   |  |                      |             |                                     |   |                             |   |                                                   |            |                              |   |                                                                            |   |                                                                                 |        |                                                                            |   |                                                                                |   |                            |          |                                           |   |                   |   |             |           
|Net loss                                                                    |  | $                    | (19,096,592 | )                                   | $ | 1,048,291                   |   | $                                                 | (1,839,452 | )                            | $ | 45,663                                                                     |   | $                                                                               | 33,773 |                                                                            | $ | 184,018                                                                        |   | $                          | 59,498   |                                           | $ | (1,100,523        | ) | $           | (1,100,523 | ) | $ | (177,465 | ) | $ | (177,465 | ) | $ | (353,114   | ) | $ | (22,473,891 | )
|Amoritzation of beneficial conversion feature discount and warrant discount |  |                      | 547,375     |                                     |   |                             |   |                                                   | 265,650    |                              |   |                                                                            |   |                                                                                 |        |                                                                            |   | 661,620                                                                        |   |                            | 85,244   |                                           |   |                   |   |             |            |   |   |          |   |   |          |   |   | (271,220   | ) |   | 1,288,669   |  
|Stock based compensation expense - employee                                 |  |                      | 414,909     |                                     |   |                             |   |                                                   |            |                              |   |                                                                            |   |                                                                                 |        |                                                                            |   |                                                                                |   |                            |          |                                           |   |                   |   |             | 1,033,412  |   |   | 171,520  |   |   | 171,520  |   |   | 1,835,956  |   |   | 3,627,317   |  
|Stock based compensation expense - consultant                               |  |                      | 414,909     |                                     |   |                             |   |                                                   | 1,557,705  |                              |   | 24,366                                                                     |   |                                                                                 |        |                                                                            |   |                                                                                |   |                            | 541,652  |                                           |   | 1,033,412         |   |             |            |   |   |          |   |   |          |   |   | 2,398,852  |   |   | 5,970,896   |  
|Warrants issued for consulting services                                     |  |                      | 217,366     |                                     |   |                             |   |                                                   |            |                              |   |                                                                            |   |                                                                                 |        |                                                                            |   |                                                                                |   |                            |          |                                           |   |                   |   |             |            |   |   |          |   |   |          |   |   | (217,366   | ) |   |             |  
|Issuance of Common Stock for compensation                                   |  |                      | 1,835,957   |                                     |   |                             |   |                                                   |            |                              |   |                                                                            |   |                                                                                 |        |                                                                            |   |                                                                                |   |                            |          |                                           |   |                   |   |             |            |   |   |          |   |   |          |   |   | (1,835,957 | ) |   |           |  
|Issuance of Common Stock for services                                       |  |                      | 2,181,486   |                                     |   |                             |   |                                                   |            |                              |   |                                                                            |   |                                                                                 |        |                                                                            |   |                                                                                |   |                            |          |                                           |   |                   |   |             |            |   |   |          |   |   |          |   |   | (2,181,486 | ) |   |           |  
|Decrease in warrant liability                                               |  |                      |             |                                     |   | (1,048,291                  | ) |                                                   | (24,405    | )                            |   | (70,029                                                                    | ) |                                                                                 |        |                                                                            |   |                                                                                |   |                            | (232,471 | )                                         |   | 67,111            |   |             | 67,111     |   |   | 5,945    |   |   | 5,945    |   |   |            |   |   | (1,229,084  | )
|Decrease in beneficial conversion feature liability                         |  |                      |             |                                     |   |                             |   |                                                   | 4,044      |                              |   |                                                                            |   |                                                                                 |        |                                                                            |   | (208,149                                                                       | ) |                            |          |                                           |   |                   |   |             |            |   |   |          |   |   |          |   |   |            |   |   | (204,105    | )
|Write-off of beneficial conversion feature                                  |  |                      |             |                                     |   |                             |   |                                                   | (576,000   | )                            |   |                                                                            |   |                                                                                 |        |                                                                            |   |                                                                                |   |                            |          |                                           |   |                   |   |             |            |   |   |          |   |   |          |   |   |            |   |   | (576,000    | )
|Increase in advances to employees                                           |  |                      | (512,727    | )                                   |   |                             |   |                                                   |            |                              |   |                                                                            |   |                                                                                 |        |                                                                            |   |                                                                                |   |                            |          |                                           |   |                   |   |             |            |   |   |          |   |   |          |   |   | 512,727    |   |   |           |  
|Decrease in other receivables                                               |  |                      | 3,000       |                                     |   |                             |   |                                                   |            |                              |   |                                                                            |   |                                                                                 |        |                                                                            |   |                                                                                |   |                            |          |                                           |   |                   |   |             |            |   |   |          |   |   |          |   |   | (3,000     | ) |   |           |  
|Increase in deposits                                                        |  |                      | (104,600    | )                                   |   |                             |   |                                                   |            |                              |   |                                                                            |   |                                                                                 |        |                                                                            |   |                                                                                |   |                            |          |                                           |   |                   |   |             |            |   |   |          |   |   |          |   |   | 104,600    |   |   |           |  
|                                                                            |  |                      |             |                                     |   |                             |   |                                                   |            |                              |   |                                                                            |   |                                                                                 |        |                                                                            |   |                                                                                |   |                            |          |                                           |   |                   |   |             |            |   |   |          |   |   |          |   |   |            |   |   |             |  
|Other current assets                                                        |  |                      |             |                                     |   |                             |   |                                                   |            |                              |   |                                                                            |   |                                                                                 |        |                                                                            |   |                                                                                |   |                            |          |                                           |   |                   |   |             |            |   |   |          |   |   |          |   |   | (2,000     | ) |   | (2,000      | )
|Other assets                                                                |  |                      |             |                                     |   |                             |   |                                                   |            |                              |   |                                                                            |   |                                                                                 |        |                                                                            |   |                                                                                |   |                            |          |                                           |   |                   |   |             |            |   |   |          |   |   |          |   |   | (104,600   | ) |   | (104,600    | )
|Accounts payable                                                            |  |                      | 414,853     |                                     |   |                             |   |                                                   |            |                              |   |                                                                            |   |                                                                                 |        |                                                                            |   |                                                                                |   |                            |          |                                           |   |                   |   |             |            |   |   |          |   |   |          |   |   | (69,999    | ) |   | 344,854     |  
|Accrued expenses                                                            |  |                      | 1,838,402   |                                     |   |                             |   |                                                   | 576,465    |                              |   |                                                                            |   |                                                                                 |        |                                                                            |   |                                                                                |   |                            |          |                                           |   |                   |   |             |            |   |   |          |   |   |          |   |   | (133,164   | ) |   | 2,281,703   |  
|Accrual of liquidating damages                                              |  |                      |             |                                     |   |                             |   |                                                   |            |                              |   |                                                                            |   |                                                                                 |        |                                                                            |   |                                                                                |   |                            |          |                                           |   |                   |   |             |            |   |   |          |   |   |          |   |   | 61,500     |   |   | 61,500      |  
|Proceeds from issuance of notes                                             |  |                      | 2,313,433   |                                     |   |                             |   |                                                   |            |                              |   |                                                                            |   |                                                                                 |        |                                                                            |   |                                                                                |   |                            |          |                                           |   |                   |   |             |            |   |   |          |   |   |          |   |   | (2,313,433 | ) |   |           |  
|Proceeds from convertible notes payable                                     |  |                      |             |                                     |   |                             |   |                                                   |            |                              |   |                                                                            |   |                                                                                 |        |                                                                            |   |                                                                                |   |                            |          |                                           |   |                   |   |             |            |   |   |          |   |   |          |   |   | 1,861,000  |   |   | 1,861,000   |  
|Proceeds from notes payable to related party                                |  |                      |             |                                     |   |                             |   |                                                   |            |                              |   |                                                                            |   |                                                                                 |        |                                                                            |   |                                                                                |   |                            |          |                                           |   |                   |   |             |            |   |   |          |   |   |          |   |   | 457,433    |   |   | 457,433     |  
|Payments on notes payable to related party                                  |  |                      |             |                                     |   |                             |   |                                                   |            |                              |   |                                                                            |   |                                                                                 |        |                                                                            |   |                                                                                |   |                            |          |                                           |   |                   |   |             |            |   |   |          |   |   |          |   |   | (5,000     | ) |   | (5,000      | )
|Issuance of common stock for cash                                           |  |                      | 7,376,094   |                                     |   |                             |   |                                                   |            |                              |   |                                                                            |   |                                                                                 |        |                                                                            |   |                                                                                |   |                            |          |                                           |   |                   |   |             |            |   |   |          |   |   |          |   |   | 10,000     |   |   | 7,386,094   |  
|Receipt of cash for stock to be issued                                      |  |                      | 53,900      |                                     |   |                             |   |                                                   |            |                              |   |                                                                            |   |                                                                                 |        |                                                                            |   |                                                                                |   |                            |          |                                           |   |                   |   |             |            |   |   |          |   |   |          |   |   | (10,000    | ) |   | 43,900      |  
|                                                                            |  |                      |             |                                     |   |                             |   |                                                   |            |                              |   |                                                                            |   |                                                                                 |        |                                                                            |   |                                                                                |   |                            |          |                                           |   |                   |   |             |            |   |   |          |   |   |          |   |   |            |   |   |           |  



Table 2 - 2006



|                                                                             |  |            |          |           |  |              |   |            |   |          |  |            |  |               |         |                |  |                    |  |                |  |                   |  |                   |  |          |  |        |         |   |          |  
|---------------------------------------------------------------------------- |  | ---------- | -------- | --------- |  | ------------ | - | ---------- | - | -------- |  | ---------- |  | ------------- | ------- | -------------- |  | ------------------ |  | -------------- |  | ----------------- |  | ----------------- |  | -------- |  | ------ | ------- | - | -------- | -
|                                                                             |  |            |          |           |  |              |   |            |   |          |  | Beneficial |  | Warrant       |         |                |  |                    |  |                |  |                   |  |                   |  |          | 
|                                                                             |  |            |          |           |  |              |   |            |   |          |  | Conversion |  | Related to    |         |                |  | Option Issued      |  |                |  |                   |  |                   |  |          | 
|                                                                             |  |            |          |           |  |              |   |            |   |          |  | Features   |  | $1,025,000 of |         | Warrant Issued |  | to Chief Executive |  |                |  |                   |  |                   |  |          | 
|                                                                             |  |            |          | 2001      |  |              |   | Warrants   |   |          |  | and        |  | Convertible   |         | to Consultant  |  | Officer for the    |  |                |  |                   |  |                   |  |          | 
|                                                                             |  |            |          | Executive |  |              |   | Related to |   | Warrant  |  | Beneficial |  | Bridge Notes  |         | for the Three  |  | Three Month        |  |                |  |                   |  |                   |  |          | 
|                                                                             |  | As         |          | Officers  |  | Advisory     |   | 2004 Stock |   | Issued   |  | Conversion |  | and           |         | Months Ended   |  | Period Ended       |  |                |  | Warrant Issued    |  |                   |  |          | 
|                                                                             |  | Previously |          | Option    |  | Board        |   | Purchase   |   | for      |  | Features   |  | Warrant       |         | December 31,   |  | December 31,       |  | Warrant Issued |  | to Chief          |  |                   |  | As       | 
|                                                                             |  | Stated     |          | Plan      |  | Compensation |   | Agreement  |   | Services |  | Discount   |  | Discount      |         | 2007           |  | 2007               |  | to Direcotr    |  | Financial Officer |  | Reclassifications |  | Restated | 
|Statement of Operations (for the three months ended December 31, 2006)       |  |            |          |           |  |              |   |            |   |          |  |            |  |               |         |                |  |                    |  |                |  |                   |  |                   |  |          | 
|General and administrative                                                   |  | $          | 202,938  |           |  |              | $ | 72,304     |   |          |  |            |  |               |         |                |  |                    |  |                |  |                   |  |                   |  |          |  | $      | 275,242 |  
|Interest expense                                                             |  |            | (19,242  | )         |  |              |   |            |   |          |  |            |  | $             | (89,686 | )              |  |                    |  |                |  |                   |  |                   |  |          |  | (1,482 | )       |   | (110,410 | )
|Beneficial conversion feature                                                |  |            | (1,482   | )         |  |              |   |            |   |          |  |            |  |               |         |                |  |                    |  |                |  |                   |  |                   |  |          |  | 1,482  |         |   |        |  
|                                                                             |  |            |          |           |  |              |   |            |   |          |  |            |  |               |         |                |  |                    |  |                |  |                   |  |                   |  |          |  |        |         |   |          |  
|Statement of Cash Flows (for the three months ended December 31, 2006)       |  |            |          |           |  |              |   |            |   |          |  |            |  |               |         |                |  |                    |  |                |  |                   |  |                   |  |          |  |        |         |   |          |  
|Net loss                                                                     |  | $          | (232,249 | )         |  |              | $ | (72,304    | ) |          |  |            |  | $             | (89,686 | )              |  |                    |  |                |  |                   |  |                   |  |          |  |        |         | $ | (394,239 | )
|Amortization of beneficial conversion features discount and warrant discount |  |            | 1,842    |           |  |              |   |            |   |          |  |            |  |               | 89,686  |                |  |                    |  |                |  |                   |  |                   |  |          |  |        |         |   | 91,528   |  
|Accrued expenses                                                             |  |            | 87,085   |           |  |              |   | 72,304     |   |          |  |            |  |               |         |                |  |                    |  |                |  |                   |  |                   |  |          |  |        |         |   | 159,389  |  







59



---





RESTATEMENT TO RESTATED FINANCIAL STATEMENTS. As discussed above, the Company restated its December 31, 2007 financial statements due to a comment letter from the Securities and Exchange Commission. However, the restatement did not properly account for the certain derivative transactions as discussed below.

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

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

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

·

Warrants and Options

·

Beneficial Conversion Feature

The Company analyzed the effect of the recalculation on the balance sheet and the statements of operations and cash flows as of December 31, 2007. The analysis and results were as follows:

Warrants and Options Liability

As of December 31 2007, the Company had 19,784,766 warrants outstanding and 11,595,934 options outstanding.

Balance Sheet

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

At December 31, 2007, the Company determined the fair value of all warrants and options to be $4,731,442 and $2,765,955, respectively using the Black Sholes model with the following assumptions:

·

risk free rate of return between 3.07% and 3.45%;

·

volatility between 264% and 280%;

·

dividend yield of 0%; and

·

expected term between 3.30 years and 4.97 years.

Statement of Operations

At December 31, 2007, the Company recorded $1,418,732 as a gain on change in fair value of warrant and option liability.

Statement of Cash Flows

Changes in the statement of cash flows were the result of the decrease in fair value of the warrant and option liability of $1,418,732.





60



---





Beneficial Conversion Feature

As of December 31, 2007, the Company had $2,005,000 in convertible notes that could be converted into 100,154,621 shares.

Balance Sheet

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

At December 31, 2007, the Company determined the fair value of the embedded conversion options to be $22,254,386 using the Black Sholes model with the following assumptions:

·

risk free rate of return between 3.34% and 3.49%;

·

volatility between 101% and 160%;

·

dividend yield of 0%; and

·

expected term of 0.30 years to 1.0 years.

Statement of Operations

At December 31, 2007, the Company recorded $7,626,152 as a gain on change in fair value of beneficial conversion liability.

Statement of Cash Flows

Changes in the statement of cash flows were the result of the $7,626,152 change in fair value of the beneficial conversion liability.

The following table shows the effect of each of the changed discusses above on the Companys balance sheet, statement of operation, and statement of cash flows for the three months December 31, 2007.





61



---







|                                                                       |  |                      |             |   |                                 |   |             |                      |  |   |                                |   |  |   |             |  
|---------------------------------------------------------------------- |  | -------------------- | ----------- | - | ------------------------------- | - | ----------- | -------------------- |  | - | ------------------------------ | - |  | - | ----------- | -
|                                                                       |  | As Previously Stated |             |   | Benficial
 Conversion
 Features |   |             | Warrants and Options |  |   | As Restated
 December 31,
2007 |  
|Balance Sheet                                                          |  |                      |             |   |                                 |   |             |                      |  |   |                                |  
|Accrued expenses                                                       |  | $                    | 2,353,077   |   |                                 | $ |           |                      |  | $ |                              |   |  | $ | 2,353,077   |  
|Warrant and option liability                                           |  |                      | 6,464,460   |   |                                 |   |           |                      |  |   | 1,032,937                      |   |  |   | 7,497,397   |  
|Beneficial conversion liability                                        |  |                      | 1,222,663   |   |                                 |   | 21,031,723  |                      |  |   |                              |   |  |   | 22,254,386  |  
|Additional paid-in capital                                             |  |                      | 10,762,982  |   |                                 |   |           |                      |  |   | 334,746                        |   |  |   | 11,097,728  |  
|Deficit accumulated during developmental stage                         |  |                      | (22,488,813 | ) |                                 |   | (21,031,723 | )                    |  |   | (1,367,683                     | ) |  |   | (44,888,219 | )
|                                                                       |  |                      |             |   |                                 |   |             |                      |  |   |                                |   |  |   |             |  
|Statement of Operations (for the three months ended December 31, 2007) |  |                      |             |   |                                 |   |             |                      |  |   |                                |   | 
|Gain on change in fair value of warrant and option liability           |  | $                    | 759,773     |   |                                 | $ |           |                      |  | $ | 1,418,732                      |   |  | $ | 2,178,505   |  
|Gain on change in fair value of beneficail conversion liability        |  |                      | 208,149     |   |                                 |   | 7,626,152   |                      |  |   |                              |   |  |   | 7,834,301   |  
|General and administrative expense                                     |  |                      | 5,064,569   |   |                                 |   |           |                      |  |   |                              |   |  |   | 5,064,569   |  
|Interest expense and financing costs                                   |  |                      | (126,286    | ) |                                 |   |           |                      |  |   |                              |   |  |   | (126,286    | )
|                                                                       |  |                      |             |   |                                 |   |             |                      |  |   |                                |   |  |   |             |  
|Statement of Operations (since inception)                              |  |                      |             |   |                                 |   |             |                      |  |   |                                |   |  |   |             |  
|Gain on change in fair value of warrant and option liability           |  | $                    | 848,644     |   |                                 | $ |           |                      |  | $ | 1,658,334                      |   |  | $ | 2,506,978   |  
|Gain on change in fair value of beneficail conversion liability        |  |                      | 204,105     |   |                                 |   | 11,544,227  |                      |  |   |                              |   |  |   | 11,748,332  |  
|General and administrative expense                                     |  |                      | 18,394,074  |   |                                 |   | 3,787,032   |                      |  |   |                              |   |  |   | 22,181,106  |  
|Interest expense and financing costs                                   |  |                      | (922,775    | ) |                                 |   | (30,536,702 | )                    |  |   | (1,278,233                     | ) |  |   | (32,737,710 | )
|                                                                       |  |                      |             |   |                                 |   |             |                      |  |   |                                |   |  |   |             |  
|Statement of Cash Flows (for the three months ended December 31, 2007) |  |                      |             |   |                                 |   |             |                      |  |   |                                |   | 
|Net income (loss)                                                      |  | $                    | (4,467,977  | ) |                                 | $ | 7,626,152   |                      |  | $ | 1,418,732                      |   |  | $ | 4,576,907   |  
|Gain on change in fair value of warrant and option liability           |  |                      | (759,773    | ) |                                 |   |           |                      |  |   | (1,418,732                     | ) |  |   | (2,178,505  | )
|Gain on change in fair value of beneficail conversion liability        |  |                      | (208,149    | ) |                                 |   | (7,626,152  | )                    |  |   |                              |   |  |   | (7,834,301  | )
|Non-cash compensation expense                                          |  |                      | 1,791,360   |   |                                 |   |           |                      |  |   |                              |   |  |   | 1,791,360   |  
|Non-cash financing costs                                               |  |                      |           |   |                                 |   |           |                      |  |   |                              |   |  |   |           |  
|                                                                       |  |                      |             |   |                                 |   |             |                      |  |   |                                |   |  |   |             |  
|Statement of Cash Flows (since inception)                              |  |                      |             |   |                                 |   |             |                      |  |   |                                |   |  |   |             |  
|Net income (loss)                                                      |  | $                    | (22,488,813 | ) |                                 | $ | (22,779,507 | )                    |  | $ | 380,101                        |   |  | $ | (44,888,219 | )
|Gain on change in fair value of warrant and option liability           |  |                      | (1,229,084  | ) |                                 |   |           |                      |  |   | (1,658,334                     | ) |  |   | (2,887,418  | )
|Gain on change in fair value of beneficail conversion liability        |  |                      | (204,105    | ) |                                 |   | (11,544,227 | )                    |  |   |                              |   |  |   | (11,748,332 | )
|Non-cash compensation expense                                          |  |                      | 3,627,317   |   |                                 |   | 3,787,032   |                      |  |   |                              |   |  |   | 7,414,349   |  
|Non-cash financing costs                                               |  |                      | -           |   |                                 |   | 30,536,702  |                      |  |   | 1,278,233                      |   |  |   | 31,814,935  |  
|                                                                       |  |                      |             |   |                                 |   |             |                      |  |   |                                |   |  |   |             |  







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SIGNIFICANT ACCOUNTING POLICIES AND ESTIMATES. The preparation of our consolidated financial statements in accordance with U.S. GAAP requires management to make judgments, assumptions and estimates that affect the amounts reported. A critical accounting estimate is an assumption about highly uncertain matters and could have a material effect on the consolidated financial statements if another, also reasonable, amount were used or a change in the estimate is reasonably likely from period to period. We base our assumptions on historical experience and on other estimates that we believe are reasonable under the circumstances. Actual results could differ significantly from these estimates. There were no changes in accounting policies or significant changes in accounting estimates during first quarter of fiscal 2008 ended December 31, 2007. Management believes the following critical accounting policies reflect its more significant estimates and assumptions.

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

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

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

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

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

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





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

Legal Contingencies. From time to time we are a defendant in litigation. As required by Financial Accounting Standards Board Statement No. 5 "Accounting for Contingencies" (FAS 5), we determine whether an estimated loss from a loss contingency should be accrued by assessing whether a loss is deemed probable and the loss amount can be reasonably estimated, net of any applicable insurance proceeds. Estimates of potential outcomes of these contingencies are developed in consultation with outside counsel. While this assessment is based upon all available information, litigation is inherently uncertain and the actual liability to fully resolve 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.

Share Based Payments. 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.

OFF-BALANCE SHEET ARRANGEMENTS. We have no off-balance sheet arrangements, special purpose entities or financing partnerships.

CAPITAL EXPENDITURES. The Company currently has no commitments for capital expenditures.

MATERIAL TRENDS, EVENTS OR UNCERTAINTIES. Other than as discussed herein, the Company does not know of any material trends, events or uncertainties that may impact its operations in the future.

CONTRACTUAL OBLIGATIONS. The Company is committed under the following contractual obligations

|                            |  |                        |           |  |                  |  |         |              |  |  |              |  |  |              |         |  |  |  |   | 
|--------------------------- |  | ---------------------- | --------- |  | ---------------- |  | ------- | ------------ |  |  | ------------ |  |  | ------------ | ------- |  |  |  | - | 
|Contractual
Obligations     |  | Payments Due by Period |          
|                            |  | Total                  |           |  | Less than 1
Year |  |         | 1 to 3
Years |  |  | 3 to 5 Years |  |  | Over 5
Years |        
|Long-Term Debt Obligations  |  |                        |           |  |                  |  |         |              |  |  |              |  |  |              |        
|                            |  |                        |           |  |                  |  |         |              |  |  |              |  |  |              |        
|Capital lease obligations   |  |                        |           |  |                  |  |         |              |  |  |              |  |  |              |        
|                            |  |                        |           |  |                  |  |         |              |  |  |              |  |  |              |         |  |  |  |   | 
|Operating lease obligations |  |                        | 2,218,527 |  |                  |  | 432,525 |              |  |  | 910,920      |  |  |              | 875,412 |  |  |  | 0 | 
|                            |  |                        |           |  |                  |  |         |              |  |  |              |  |  |              |         |  |  |  |   | 
|Purchase obligations        |  |                        |           |  |                  |  |         |              |  |  |              |  |  |              |         |  |  |  |   | 
|                            |  |                        |           |  |                  |  |         |              |  |  |              |  |  |              |         |  |  |  |   | 
|Other long-term liabilities |  |                        |           |  |                  |  |         |              |  |  |              |  |  |              |         |  |  |  |   | 



RESULTS OF OPERATIONS (THREE MONTHS ENDED DECEMBER 31, 2007 COMPARED TO THREE MONTHS ENDED DECEMBER 31, 2006, RESTATED).

We had minimal operations during the 2006 fiscal year due to a lack of working capital. During the 2007 fiscal year, the Company began to raise money for its operations by selling debentures. As a result of these offerings, the Company was able to resume its operating activities, finalize the beta unit and begin testing of the process.

Revenues for the three months ended December 31, 2007 and 2006 were zero, as the Company has not yet commenced the sale of its product.

The Company incurred operating expenses of $5,309,630 for the three months ended December 31, 2007, an increase of $5,026,595 or approximately 1,776%, as compared to $283,035 for the three months ended December 31, 2006. General and administrative expenses were $5,064,569 for the three months ended December 31, 2007, an increase of $4,789,327 or approximately 1,740%, as compared to $275,242 for the three





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months ended December 31, 2006. The increase in general and administrative expenses was primarily due to the issuance of options and warrants having a value of $4,797,385 to Richard H. Papalian as the Companys Chief Executive Office, Mark Maron as a Special Advisor, the Advisory Board members, Rodney Anderson as a director, and Robert McCray as the Chief Financial Officer. Research and development expenses incurred during the three months ended December 31, 2007 were $236,904, and there were no research and development expenses for the three months ended December 31, 2006.

Other income and (expense) was $9,887,437 for the three months ended December 31, 2007, an increase of $9,997,741 or approximately 9,064%, as compared to $(110,304) for the three months ended December 31, 2006. Increase in gain on change in fair value of the warrant and option liability was $2,178,505 for the three months ended December 31, 2007 and represents the decrease in the fair value of the warrant and option liability. The warrants and options were required to be classified as liabilities as of June 6, 2007, and valued at fair value on each balance sheet date, with the change in value reported in earnings. Therefore, there was no increase or decrease in the change in the option and warrant liability for the three months ended December 31, 2006. The increase in the gain on change in fair value of the beneficial conversion liability was $7,834,301 and represents the decrease in the fair value of the beneficial conversion liability. The beneficial conversion features were required to be classified as liabilities as of June 6, 2007, and valued at fair value on each balance sheet date, with the change reported in earnings. Therefore, there was no increase or decrease in the change of beneficial conversion liability for the three months ended December 31, 2006. Interest expense increased to $126,286 during the three months ended December 31, 2007, an increase of $15,876 or approximately 14%, as compared to $110,410 for the three months ended December 31, 2006.

Net income was $4,567,907 for the three months ended December 31, 2007, an increase of $4,971,146 or approximately 1,261%, as compared to net loss of $394,239 for the three months ended December 31, 2006.

LIQUIDITY AND CAPITAL RESOURCES, RESTATED. Net cash flows used in our operating activities was $292,883 for the three months ended December 31, 2007, an increase of $130,707 or approximately 81%, as compared to $162,176 for the three months ended December 31, 2006. The increase in cash flows used in operating activities is primarily attributable to the issuance of options and warrants for $4,797,385, amortization of the beneficial conversion features and warrant discount of $405,651, accrual of liquidating damages for $46,125, and decrease in the beneficial conversion liability and warrant and option liability of $7,834,301 and $2,178,505, respectively.

Net cash flows used in our investing activities was $26,666 for the purchase of equipment, as compared to no use of cash for investing activities during the three months ended December 31, 2006.

Net cash flows used in financing activities was $51,596 for the three months ended December 31, 2007, an increase of cash flows used of $580,296, as compared to net cash flows provided by financing activities of $528,700 for the three months ended December 31, 2006. Cash used in the financing activities for the three months ended December 31, 2007 included a payment of $5,000 toward a note payable, payments of $27,336 toward notes payable under an equity line of credit, and payments totaling $19,260 to officers for loans made to us.

On December 31, 2007, the Company had cash and cash equivalents of $1,366. The sole source of liquidity has been borrowings from affiliates and the sale of our securities. Management anticipates that additional capital will be required to finance the Company's operations. The Company believes that anticipated proceeds from sales of securities and other financing activities, plus anticipated cash flow from operations during the 2008 fiscal year, will be sufficient to finance the Company's operations. However, the Company has no commitments for financing or sales, and there can be no assurance that such financing will be available or that the Company will not encounter unforeseen difficulties that may deplete its capital resources more rapidly than anticipated. Also, the Company may not be able to generate revenues from operations during the fiscal year and, while there are anticipated sources of revenue, none of these sources have progressed to the stage where we can rely on any of these anticipated revenue sources.

As of December 31, 2007, the Company had an accumulated deficit of $44,888,219. It can be expected that the 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.





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GOING CONCERN OPINION, RESTATED. The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. This basis of accounting contemplates the recovery of the Companys assets and the satisfaction of its liabilities in the normal course of business. Through December 31, 2007, the Company has incurred cumulative losses of $44,888,219 including net income for the three months ended December 31, 2007 of $4,576,907. As the Company has no cash flow from operations, its ability to transition from a development stage company to an operating company is entirely dependent upon obtaining adequate financing to 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 structure. 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. Its ability to meet its cash requirements for the next twelve months depends on its ability to obtain such financing. Even if obtained, any such financing will likely involve additional fees and debt service requirements. 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. 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 with cash (unless it is converted into equity) or refinanced. 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 have raised substantial doubt about the Company's ability to continue as a going concern unless it is able to obtain substantial additional financing in the short term and generate revenues over the long term. If the Company is unable to obtain financing, it would likely discontinue operations.

ITEM 3 - CONTROLS AND PROCEDURES

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

We conducted an evaluation, with the participation of our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended, (the Exchange Act), as of December 31, 2007, to ensure that information required to be disclosed by us in the reports filed or submitted by us under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities Exchange Commissions rules and forms, including to ensure that information required to be disclosed by us in the reports filed or submitted by us under the Exchange Act is accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that as of December 31, 2007, our disclosure controls and procedures were not effective at the reasonable assurance level due to the material weaknesses described below.

In light of the material weaknesses described below, we performed additional analysis and other post-closing procedures to ensure our financial statements were prepared in accordance with generally accepted accounting principles. We have determined that our financial statements for the three month quarter ended December 31, 2007 could no longer be relied upon and, as described in Note 13 to the restated financial statements, have restated our financial position as of December 31, 2007 and results of operations, changes in stockholders equity and cash flows for the quarter ended December 31, 2007 and the cumulative period from October 3, 1994 (inception) to December 31, 2007. Accordingly, we believe that the restated financial statements, included in this report, fairly present, in all material respects, our financial condition, results of operations and cash flows for the periods presented.

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 results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or





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detected. Management has identified the following three material weaknesses which have caused management to conclude that, as of December 31, 2007, our disclosure controls and procedures were not effective at the reasonable assurance level:

1.      We do not have written documentation of our internal control policies and procedures. Written documentation of key internal controls over financial reporting is a requirement of Section 404 of the Sarbanes-Oxley Act and is applicable to us for the year ending September 30, 2008. Management evaluated the impact of our failure to have written documentation of our internal controls and procedures on our assessment of our disclosure controls and procedures and has concluded that the control deficiency that resulted represented a material weakness.

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

3.      We have had, and continue to have, a significant number of audit adjustments. Audit adjustments are the result of a failure of the internal controls to prevent or detect misstatements of accounting information. The failure could be due to inadequate design of the internal controls or to a misapplication or override of controls. Management evaluated the impact of our significant number of audit adjustments and has concluded that the control deficiency that resulted represented a material weakness.

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

Remediation of Material Weaknesses

We have attempted to remediate the material weaknesses in our disclosure controls and procedures identified above by working with our independent registered public accounting firm and refining our internal procedures. In addition, we hired two consultants with significant experience in financial accounting and reporting, as well as redesigning poorly conceived accounting systems. The consultants are in the process of reviewing our internal controls and financial accounting and reporting and the restatement of the financial statements is a result of these efforts. To date, we have not been successful in reducing the number of audit adjustments, but will continue our efforts in the coming fiscal year.

Changes in Internal Control over Financial Reporting

During the fiscal quarter ended December 31, 2007, the Company has not made any change to internal control over financial reporting that has materially affected, or is reasonably likely to materially affect, the Companys internal control over financial reporting.





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PART II  OTHER INFORMATION

Item 1

Legal Proceedings

None

Item 2

Unregistered Sales of Equity Securities and Use of Proceeds

On December 19, 2007 we granted an option to Richard H. Papalian for the purchase of 8,539,312 shares of our common stock. The exercise price is $0.25 and the term of the option is five years. The right to purchase 2,561,794 shares of common stock vested on the date of grant. The right to purchase the remaining 5,977,518 shares is subject to certain performance vesting conditions. The option was issued to Mr. Papalian in reliance on Section 4(2) of the Securities Act of 1933, as amended, inasmuch as the option was issued without any form of general solicitation or general advertising and the acquirer was an accredited investor and had access to information that registration of the security would have provided.

On December 19, 2007 we granted an option to Mark Maron for the purchase of 8,539,312 shares of our common stock. The exercise price is $0.25 and the term of the option is five years. The right to purchase 2,561,794 shares of common stock vested on the date of grant. The right to purchase the remaining 5,977,518 shares is subject to certain performance vesting conditions. The option was issued to Mr. Maron in reliance on Section 4(2) of the Securities Act of 1933, as amended, inasmuch as the option was issued without any form of general solicitation or general advertising and the acquirer was an accredited investor and had access to information that registration of the security would have provided.

Item 3

Defaults upon Senior Securities

Under the terms of a Registration Rights Agreement executed in connection with an offering that closed on July 18, 2007, we were 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 certain units it sold consisting of Subordinated Convertible Debentures and Warrants. The units had a value of $1,025,000. If we did not file a registration statement with respect to the these securities within 45 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 of the closing, then we are required to pay to each purchaser damages equal to 1.5% of the purchase price paid by the purchaser for the Subordinated Convertible Debentures for each 30 days that transpires after these deadlines. The amount of the aggregate damages payable by us is limited to 15% of the purchase price. We had until August 31, 2007 to file the registration statement. We filed the registration statement on November 14, 2007, incurring a penalty for 78 days which amounted to $38,437.50. The registration statement has not been declared effective as of the date of this report, therefore we have incurred an additional penalty for 85 days totaling $42,025

Item 4

Submission of Matters to a vote of Security Holders

None

Item 5

Other Information

None

Item 6

Exhibits

3.1 Articles of Incorporation, as amended and restated(1)

3.2 Bylaws, as amended and restated(1)

10.1 Employment Agreement dated December 19, 2007 between the registrant and Richard H. Papalian (1)

10.2 Notice of Grant of Stock Option and Stock Option Agreement dated December 19, 2007 between the registrant and Richard H. Papalian(2)

10.3 Indemnification Agreement dated December 19, 2007 between the registrant and Richard H. Papalian(2)

10.4 Consulting Agreement dated December 19, 2007 between the registrant and Mark Maron(2)





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10.5 Notice of Grant of Stock Option and Stock Option Agreement dated December 19, 2007 between the registrant and Mark Maron(2)

31.1 Certificate of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. *

31.2

Certificate of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. *

32.1 Certificate of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. *

32.2 Certificate of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. *

(1) Incorporated by reference from the Current Report on Form 8-K filed with the Securities and Exchange Commission on July 15, 2003.

(2) Incorporated by reference from the Current Report on Form 8-K filed with the Securities and Exchange Commission on December 20, 2007.

* Filed herewith.





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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

Date: January 13, 2010

| |                                                                                                       
| | ------------------------------------------------------------------------------------------------------
| |                                                                                                       
| | SIONIX CORPORATION                                                                                    
| |                                                                                                       
| | /s/ David R. Wells                                                                                    
| | David R. Wells                                                                                        
| | President, Chief Financial Officer, Assistant Secretary and Principal Financial and Accounting Officer







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