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 March 31, 2008; 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
incorporation or organization)                    | (I.R.S. Employer Identification Number)                                                                                                                          
|                                                                                 
|3880 East Eagle Drive, Anaheim, California 92807                                 
|(Address of principal executive offices)                                         
|                                                                                 
|(847) 235-4566                                                                   
|(Registrants telephone number, including area code)                             
|                                                                                 
|(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.x Yeso No

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

The number of shares of common stock outstanding at May 4, 2009 was 142,303,907 shares.

Transitional Small Business Format (Check one) Yes oNo x



1



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EXPLANATORY NOTE



Between October 17, 2006 and February 27, 2007 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 mature on or about December 31, 2008, and are 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 are filing amendment number 2 (Amendment 2) to our Form 10-QSB for the period ended  March 31, 2008 (Original Filing) that was filed with the Securities and Exchange Commission (the SEC) on May 21, 2008, and subsequently amended on May 11, 2009.

The primary purpose of the Amendment is to disclose the restatement of our financial statements for the six months ended March 31, 2008, and cumulative inception to date operations for March 31, 2008. 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 15 to our financial statements for the period ended March 31, 2008.

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

The disclosures in this Amendment 2 continue to speak as of the date of the Original Filing, and do not reflect events occurring after the filing of the Original Filing, as amended. 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 Original Filing, including any amendments to those filings. The filing of this Amendment 2 shall not be deemed to be an admission that the Original Filing, 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 March 31, 2008:





2



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|                                                                    |  |                      |             |   |                                |   |             |                     |  |   |                            |   |  |   |             |  
|------------------------------------------------------------------- |  | -------------------- | ----------- | - | ------------------------------ | - | ----------- | ------------------- |  | - | -------------------------- | - |  | - | ----------- | -
|                                                                    |  |                      |             |   |                                |   |             |                     |  |   |                            |  
|                                                                    |  | As Previously
Stated |             |   | Beneficial
Conversion
Features |   |             | Option and
Warrants |  |   | As Restated
March 31, 2008 |  
|Balance Sheet                                                       |  |                      |             |   |                                |   |             |                     |  |   |                            |  
|Warrant and option liability                                        |  | $                    | 2,558,164   |   |                                | $ | -           |                     |  | $ | 2,650,935                  |   |  | $ | 5,209,099   |  
|Beneficial conversion feature liability                             |  |                      | 874,882     |   |                                |   | 11,843,152  |                     |  |   | -                          |   |  |   | 12,718,034  |  
|Additional paid-in capital                                          |  |                      | 10,837,605  |   |                                |   | -           |                     |  |   | (432,683                   | ) |  |   | 10,404,922  |  
|Deficit accumulated during developmental stage                      |  |                      | (19,620,178 | ) |                                |   | (11,843,152 | )                   |  |   | (2,218,252                 | ) |  |   | (33,681,582 | )
|                                                                    |  |                      |             |   |                                |   |             |                     |  |   |                            |   |  |   |             |  
|Statement of Operations (for the three months ended
March 31, 2008) |  |                      |             |   |                                |   |             |                     |  |   |                            |   |  |   |             |  
|Gain (loss) on change in fair value of warrant and option liability |  | $                    | 4,168,132   |   |                                | $ | -           |                     |  | $ | (2,402,795                 | ) |  | $ | 1,765,337   |  
|Gain on change in fair value of beneficial conversion liability     |  |                      | 347,780     |   |                                |   | 10,740,797  |                     |  |   | -                          |   |  |   | 11,088,577  |  
|                                                                    |  |                      |             |   |                                |   |             |                     |  |   |                            |   |  |   |             |  
|Statement of Operations (for the six months ended
March 31, 2008)   |  |                      |             |   |                                |   |             |                     |  |   |                            |   |  |   |             |  
|Gain (loss) on change in fair value of warrant and option liability |  | $                    | 4,927,906   |   |                                | $ | -           |                     |  | $ | (984,063                   | ) |  | $ | 3,943,843   |  
|Gain on change in fair value of beneficial conversion liability     |  |                      | 555,929     |   |                                |   | 18,366,949  |                     |  |   | -                          |   |  |   | 18,922,878  |  
|                                                                    |  |                      |             |   |                                |   |             |                     |  |   |                            |   |  |   |             |  
|Statement of Operations (since inception)                           |  |                      |             |   |                                |   |             |                     |  |   |                            |   |  |   |             |  
|Gain (loss) on change in fair value of warrant and option liability |  | $                    | 5,397,217   |   |                                | $ | -           |                     |  | $ | (1,124,901                 | ) |  | $ | 4,272,316   |  
|Gain on change in fair value of beneficial conversion liability     |  |                      | 551,885     |   |                                |   | 22,285,024  |                     |  |   | -                          |   |  |   | 22,836,909  |  
|General and administrative expense                                  |  |                      | 19,021,299  |   |                                |   | 3,787,032   |                     |  |   | -                          |   |  |   | 22,808,331  |  
|Interest expense and financing costs                                |  |                      | (1,857,279  | ) |                                |   | (30,536,702 | )                   |  |   | (897,793                   | ) |  |   | (33,291,774 | )
|                                                                    |  |                      |             |   |                                |   |             |                     |  |   |                            |   |  |   |             |  
|Statement of Cash Flows (for the six months ended
March 31, 2008)   |  |                      |             |   |                                |   |             |                     |  |   |                            |   |  |   |             |  
|Net income (loss)                                                   |  | $                    | (1,599,342  | ) |                                | $ | 18,366,949  |                     |  | $ | (984,063                   | ) |  | $ | 15,783,544  |  
|(Gain) loss on change in fair value of warrant and option liability |  |                      | (4,927,906  | ) |                                |   | -           |                     |  |   | 984,063                    |   |  |   | (3,943,843  | )
|Gain on change in fair value of beneficial conversion liability     |  |                      | (555,929    | ) |                                |   | (18,366,949 | )                   |  |   | -                          |   |  |   | (18,922,878 | )
|                                                                    |  |                      |             |   |                                |   |             |                     |  |   |                            |   |  |   |             |  
|Statement of Cash Flows (since inception)                           |  |                      |             |   |                                |   |             |                     |  |   |                            |   |  |   |             |  
|Net income (loss)                                                   |  | $                    | (19,620,178 | ) |                                | $ | (12,038,710 | )                   |  | $ | (2,022,694                 | ) |  | $ | (33,681,582 | )
|(Gain) loss on change in fair value of warrant and option liability |  |                      | (5,494,031  | ) |                                |   | -           |                     |  |   | 1,124,901                  |   |  |   | (4,369,130  | )
|Gain on change in fair value of beneficial conversion liability     |  |                      | (551,885    | ) |                                |   | (22,285,024 | )                   |  |   | -                          |   |  |   | (22,836,909 | )
|Non-cash compensation expense                                       |  |                      | -           |   |                                |   | 3,787,032   |                     |  |   | -                          |   |  |   | 3,787,032   |  
|Non-cash financing costs                                            |  |                      | -           |   |                                |   | 30,536,702  |                     |  |   | 897,793                    |   |  |   | 31,434,495  |  
|                                                                    |  |                      |             |   |                                |   |             |                     |  |   |                            |   |  |   |             |  





3



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Sionix Corporation  Form 10-QSB

Table of Contents



|           |                       |                                                                                                                                                                                      |   
|---------- | --------------------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ | --
|Part I     | Financial Information |                                                                                                                                                                                     
|           |                       |                                                                                                                                                                                      |   
|           | Item 1                | Financial Statements                                                                                                                                                                 | 5 
|           |                       |                                                                                                                                                                                      |   
|           |                       | Balance Sheet as of March 31, 2008 (Unaudited) (Restated)                                                                                                                            | 5 
|           |                       |                                                                                                                                                                                      |   
|           |                       | Statements of Income (Operations) (Unaudited) for the three and six months ended March 31, 2008 and March 31, 2007 and from inception (October 3, 1994) to March 31, 2008 (Restated) | 6 
|           |                       |                                                                                                                                                                                      |   
|           |                       | Statements of Stockholders Equity (Deficit) for the period from inception (October 3, 1994) to March 31, 2008 (Restated)                                                             | 7 
|           |                       |                                                                                                                                                                                      |   
|           |                       | Statements of Cash Flows (unaudited) for the six months ended March 31, 2008 and March 31, 2007 and from inception (October 3, 1994) to March 31, 2008 (Restated)                    | 9 
|           |                       |                                                                                                                                                                                      |   
|           |                       | Notes to unaudited condensed financial statements                                                                                                                                    | 10
|           |                       |                                                                                                                                                                                      |   
|           |                       | Forward-Looking Statements                                                                                                                                                           | 42
|           |                       |                                                                                                                                                                                     
|Part II    | Other Information     | 63                                                                                                                                                                                  
|           |                       |                                                                                                                                                                                      |   
|           | Item 1                | Legal Proceedings                                                                                                                                                                    | 63
|           |                       |                                                                                                                                                                                      |   
|           | Item 2                | Unregistered Sales of Equity Securities and Use of Proceeds                                                                                                                          | 63
|           |                       |                                                                                                                                                                                      |   
|           | Item 3                | Defaults upon Senior Securities                                                                                                                                                      | 63
|           |                       |                                                                                                                                                                                      |   
|           | Item 4                | Submission of Matters to a Vote of Security Holders                                                                                                                                  | 63
|           |                       |                                                                                                                                                                                      |   
|           | Item 5                | Other Information                                                                                                                                                                    | 63
|           |                       |                                                                                                                                                                                      |   
|           | Item 6                | Exhibits                                                                                                                                                                             | 64
|           |                       |                                                                                                                                                                                      |   
|SIGNATURES |                       | 65                                                                                                                                                                                  
|           |                       |                                                                                                                                                                                     







4



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PART I  FINANCIAL INFORMATION

ITEM 1

FINANCIAL STATEMENTS

SIONIX CORPORATION

(A DEVELOPMENT STAGE COMPANY)

BALANCE SHEET (UNAUDITED)

|                                                                                                                             |  |               |             |  
|---------------------------------------------------------------------------------------------------------------------------- |  | ------------- | ----------- | -
|                                                                                                                             |  | March 31,     |            
|                                                                                                                             |  | 2008          |            
|                                                                                                                             |  | (Unaudited)   |            
|                                                                                                                             |  | (As Restated) |            
|ASSETS                                                                                                                       |  |               |            
|CURRENT ASSETS                                                                                                               |  |               |            
|Cash and cash equivalents                                                                                                    |  | $             | 102,755     |  
|Other current assets                                                                                                         |  |               | 35,000      |  
|TOTAL CURRENT ASSETS                                                                                                         |  |               | 137,755     |  
|                                                                                                                             |  |               |             |  
|PROPERTY AND EQUIPMENT, net                                                                                                  |  |               | 24,518      |  
|                                                                                                                             |  |               |             |  
|DEPOSITS                                                                                                                     |  |               | 4,600       |  
|TOTAL ASSETS                                                                                                                 |  |               | 166,873     |  
|                                                                                                                             |  |               |             |  
|LIABILITIES AND STOCKHOLDERS' DEFICIT                                                                                        |  |               |             |  
|CURRENT LIABILITIES                                                                                                          |  |               |             |  
|Accounts payable                                                                                                             |  | $             | 503,124     |  
|Accrued expenses                                                                                                             |  |               | 2,423,254   |  
|Liquidated damages liability                                                                                                 |  |               | 153,750     |  
|Notes payable  related parties                                                                                              |  |               | 124,000     |  
|Convertible notes, net of debt discounts of $2,096,029                                                                       |  |               | 1,525,971   |  
|10% subordinated convertible notes, net of debt discounts of $72,611                                                         |  |               | 352,389     |  
|Warrant and option liability                                                                                                 |  |               | 5,209,099   |  
|Beneficial conversion liability                                                                                              |  |               | 12,718,034  |  
|TOTAL CURRENT LIABILITIES                                                                                                    |  |               | 23,009,621  |  
|                                                                                                                             |  |               |             |  
|STOCKHOLDERS' DEFICIT                                                                                                        |  |               |             |  
|Common stock (150,000,000 shares authorized; 107,117,101 shares issued and 107,012,474
shares outstanding; par value $0.001) |  |               | 107,012     |  
|Additional paid-in capital                                                                                                   |  |               | 10,404,922  |  
|Shares to be issued                                                                                                          |  |               | 326,900     |  
|Deficit accumulated during development stage                                                                                 |  |               | (33,681,582 | )
|TOTAL STOCKHOLDERS' DEFICIT                                                                                                  |  |               | (22,842,748 | )
|TOTAL LIABILITIES AND STOCKHOLDERS' DEFICIT                                                                                  |  | $             | 166,873     |  

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





5



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SIONIX CORPORATION

(A DEVELOPMENT STAGE COMPANY)

STATEMENTS OF OPERATIONS

(UNAUDITED)

|                                                                       |  |                      |             |   |                    |   |             |                      |  |   |             |   |  |                 |             |   |  |   |             |  
|---------------------------------------------------------------------- |  | -------------------- | ----------- | - | ------------------ | - | ----------- | -------------------- |  | - | ----------- | - |  | --------------- | ----------- | - |  | - | ----------- | -
|                                                                       |  |                      |             |   |                    |   |             |                      |  |   |             |   |  | Cumulative from |            
|                                                                       |  | For the three months |             |   | For the six months |   |             | Inception            | 
|                                                                       |  | ended March 31,      |             |   | ended March 31,    |   |             | (October 3, 1994) to | 
|                                                                       |  | 2008                 |             |   | 2007               |   |             | 2008                 |  |   | 2007        |   |  | March 31, 2008  |            
|                                                                       |  | (As Restated)        |             |   |                    |   |             | (As Restated)        |  |   |             |   |  | (As Restated)   |            
|                                                                       |  |                      |             |   |                    |   |             |                      |  |   |             |   |  |                 |            
|Revenues                                                               |  | $                    | -           |   |                    | $ | -           |                      |  | $ | -           |   |  | $               | -           |   |  | $ | -           |  
|                                                                       |  |                      |             |   |                    |   |             |                      |  |   |             |   |  |                 |             |   |  |   |             |  
|Operating expenses                                                     |  |                      |             |   |                    |   |             |                      |  |   |             |   |  |                 |             |   |  |   |             |  
|General and administrative                                             |  |                      | 627,224     |   |                    |   | 333,644     |                      |  |   | 5,691,794   |   |  |                 | 610,368     |   |  |   | 22,808,331  |  
|Research and development                                               |  |                      | 329,028     |   |                    |   | -           |                      |  |   | 565,932     |   |  |                 | -           |   |  |   | 2,541,872   |  
|Depreciation and amortization                                          |  |                      | 8,157       |   |                    |   | 7,995       |                      |  |   | 16,314      |   |  |                 | 15,788      |   |  |   | 548,419     |  
|Total operating expenses                                               |  |                      | 964,409     |   |                    |   | 341,639     |                      |  |   | 6,274,040   |   |  |                 | 626,156     |   |  |   | 25,898,622  |  
|Loss from operations                                                   |  |                      | (964,409    | ) |                    |   | (341,639    | )                    |  |   | (6,274,040  | ) |  |                 | (626,156    | ) |  |   | (25,898,622 | )
|                                                                       |  |                      |             |   |                    |   |             |                      |  |   |             |   |  |                 |             |   |  |   |             |  
|Other income (expense)                                                 |  |                      |             |   |                    |   |             |                      |  |   |             |   |  |                 |             |   |  |   |             |  
|Interest income                                                        |  |                      | 366         |   |                    |   | 505         |                      |  |   | 1,279       |   |  |                 | 611         |   |  |   | 59,822      |  
|Interest expense and financing costs                                   |  |                      | (554,065    | ) |                    |   | (51,346     | )                    |  |   | (680,350    | ) |  |                 | (160,274    | ) |  |   | (33,291,774 | )
|Gain on change in fair value of
warrant and option liability           |  |                      | 1,765,338   |   |                    |   | -           |                      |  |   | 3,943,843   |   |  |                 | -           |   |  |   | 4,272,316   |  
|Gain on change in fair value of
beneficial conversion liability        |  |                      | 11,088,577  |   |                    |   |             |                      |  |   | 18,922,878  |   |  |                 |             |   |  |   | 22,836,909  |  
|Impairment of intangibles                                              |  |                      | -           |   |                    |   | -           |                      |  |   | -           |   |  |                 |             |   |  |   | (1,267,278  | )
|Inventory obsolescence                                                 |  |                      | -           |   |                    |   | -           |                      |  |   | -           |   |  |                 |             |   |  |   | (365,078    | )
|Legal settlement                                                       |  |                      | -           |   |                    |   | -           |                      |  |   | -           |   |  |                 | -           |   |  |   | 344,949     |  
|Loss on settlement of debt                                             |  |                      | -           |   |                    |   | -           |                      |  |   | -           |   |  |                 | -           |   |  |   | (230,268    | )
|Loss on lease termination                                              |  |                      | (129,166    | ) |                    |   | -           |                      |  |   | (129,166    | ) |  |                 | -           |   |  |   | (129,166    | )
|Total other income (expense)                                           |  |                      | 12,171,050  |   |                    |   | (50,841     | )                    |  |   | 22,058,484  |   |  |                 | (159,663    | ) |  |   | (7,769,568  | )
|Loss before income taxes                                               |  |                      | 11,206,641  |   |                    |   | (392,480    | )                    |  |   | 15,784,444  |   |  |                 | (785,819    | ) |  |   | (33,668,190 | )
|Income taxes                                                           |  |                      | -           |   |                    |   |             |                      |  |   | 900         |   |  |                 | 900         |   |  |   | 13,392      |  
|Net income (loss)                                                      |  | $                    | 11,206,641  |   |                    | $ | (392,480    | )                    |  | $ | 15,783,544  |   |  | $               | (786,719    | ) |  | $ | (33,681,582 | )
|                                                                       |  |                      |             |   |                    |   |             |                      |  |   |             |   |  |                 |             |   |  |   |             |  
|Basic income (loss) per share                                          |  | $                    | 0.10        |   |                    | $ | (0.00       | )                    |  | $ | 0.15        |   |  | $               | (0.01       | ) |  |   |             |  
|Dilutive income (loss) per share                                       |  | $                    | 0.10        |   |                    | $ | (0.00       | )                    |  |   | 0.15        |   |  | $               | (0.01       | ) |  |   |             |  
|                                                                       |  |                      |             |   |                    |   |             |                      |  |   |             |   |  |                 |             |   |  |   |             |  
|Basic weighted average number of
shares of common stock outstanding    |  |                      | 107,494,374 |   |                    |   | 105,459,175 |                      |  |   | 107,494,374 |   |  |                 | 105,459,175 |   |  |   |             |  
|Dilutive weighted average number of
shares of common stock outstanding |  |                      | 107,494,374 |   |                    |   | 105,459,175 |                      |  |   | 107,494,374 |   |  |                 | 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 | )
|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     | )





7



---





SIONIX CORPORATION

(A Development Stage Company)

STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT) (CONTINUED)

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) |        
|                                                    |  |              |             |   |            |   |         |         |         |   |            |       |  |            |              |   |             |       |   |             |            |   |               |      |  |           |         |   |  |         |             |   |       |   |             |  
|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  | )
|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 | )
|Conversion of note payable into common stock        |  |              | 227,273     |   |            |   | 227     |         |         |   | 49,773     |       |  |            | -            |   |             |       | - |             |            |   | -             |      |  |           | -       |   |  |         | -           |   |       |   | 50,000      |  
|Common stock issued for services                    |  |              | 150,000     |   |            |   | 150     |         |         |   | 24,850     |       |  |            | -            |   |             |       | - |             |            |   | -             |      |  |           | -       |   |  |         | -           |   |       |   | 25,000      |  
|Common stock to be issued for cash                  |  |              | -           |   |            |   | -       |         |         |   | -          |       |  |            | 283,000      |   |             |       | - |             |            |   | -             |      |  |           | -       |   |  |         | -           |   |       |   | 283,000     |  
|Issuance of warrants with stock                     |  |              | -           |   |            |   | -       |         |         |   | (767,429   | )     |  |            | -            |   |             |       | - |             |            |   | -             |      |  |           | -       |   |  |         | -           |   |       |   | (767,429    | )
|Net income                                          |  |              | -           |   |            |   | -       |         |         |   | -          |       |  |            | -            |   |             |       | - |             |            |   | -             |      |  |           | -       |   |  |         | 15,783,544  |   |       |   | 15,783,544  |  
|Balance at March 31, 2008, restated, unaudited      |  |              | 107,012,474 |   |            | $ | 107,012 |         |         | $ | 10,404,922 |       |  | $          | 326,900      |   |             | $     | - |             |            | $ | -             |      |  | $         | -       |   |  | $       | (33,681,582 | ) |       | $ | (22,842,748 | )



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





8



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SIONIX CORPORATION

(A DEVELOPMENT STAGE COMPANY)

STATEMENTS OF CASH FLOWS (UNAUDITED)

|                                                                             |  |                    |             |   |                      |   |          |                |  |   |             |  
|---------------------------------------------------------------------------- |  | ------------------ | ----------- | - | -------------------- | - | -------- | -------------- |  | - | ----------- | -
|                                                                             |  |                    |             |   |                      |   |          | Cumulative     | 
|                                                                             |  | For the Six Months |             |   | from Inception       |  
|                                                                             |  | Ended March 31,    |             |   | (October 3, 1994) to |  
|                                                                             |  | 2008               |             |   | 2007                 |   |          | March 31, 2008 | 
|                                                                             |  | (As Restated)      |             |   |                      |   |          | (As Restated)  | 
|OPERATING ACTIVITIES:                                                        |  |                    |             |   |                      |   |          |                | 
|Net income (loss)                                                            |  | $                  | 15,783,544  |   |                      | $ | (786,719 | )              |  | $ | (33,681,582 | )
|Adjustments to reconcile net loss to net cash used in operating activities:  |  |                    |             |   |                      |   |          |                |  |   |             |  
|Depreciation                                                                 |  |                    | 16,314      |   |                      |   | 15,788   |                |  |   | 635,337     |  
|Amortization of beneficial conversion features discount and warrant discount |  |                    | 833,775     |   |                      |   | 117,524  |                |  |   | 1,716,793   |  
|Stock based compensation expense - employee                                  |  |                    | 1,791,360   |   |                      |   | -        |                |  |   | 3,627,317   |  
|Stock based compensation expense - consultant                                |  |                    | 3,171,049   |   |                      |   | 32,929   |                |  |   | 6,232,732   |  
|Gain on change in fair value of warrant and option liability                 |  |                    | (3,943,843  | ) |                      |   | -        |                |  |   | (4,369,130  | )
|Gain on change in  fair value of beneficial conversion liability             |  |                    | (18,922,878 | ) |                      |   | -        |                |  |   | (22,836,909 | )
|Non-cash financing costs                                                     |  |                    | -           |   |                      |   | -        |                |  |   | 31,434,495  |  
|Non-cash compensation costs                                                  |  |                    | -           |   |                      |   | -        |                |  |   | 3,787,032   |  
|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     |  
|Loss on termination of lease                                                 |  |                    | 129,166     |   |                      |   | -        |                |  |   | 129,166     |  
|Write-off of beneficial conversion features                                  |  |                    | (380,440    | ) |                      |   | -        |                |  |   | (380,440    | )
|Accrual of liquidating damages                                               |  |                    | 138,375     |   |                      |   | -        |                |  |   | 153,750     |  
|Other                                                                        |  |                    | -           |   |                      |   | -        |                |  |   | (799,044    | )
|Increase in assets:                                                          |  |                    |             |   |                      |   |          |                |  |   |             |  
|Other current assets                                                         |  |                    | (33,650     | ) |                      |   | -        |                |  |   | (35,000     | )
|Other assets                                                                 |  |                    | -           |   |                      |   | (10,350  | )              |  |   | (104,600    | )
|Increase (decrease) in liabilities:                                          |  |                    |             |   |                      |   |          |                |  |   |             |  
|Accounts payable                                                             |  |                    | 345,724     |   |                      |   | (50,366  | )              |  |   | 503,123     |  
|Accrued expenses                                                             |  |                    | 174,508     |   |                      |   | 334,853  |                |  |   | 2,181,320   |  
|Net cash used in operating activities                                        |  |                    | (896,996    | ) |                      |   | (346,341 | )              |  |   | (10,004,154 | )
|                                                                             |  |                    |             |   |                      |   |          |                |  |   |             |  
|INVESTING ACTIVITIES:                                                        |  |                    |             |   |                      |   |          |                |  |   |             |  
|Acquisition of property and equipment                                        |  |                    | (29,164     | ) |                      |   | (12,972  | )              |  |   | (400,619    | )
|Acquisition of patents                                                       |  |                    | -           |   |                      |   | -        |                |  |   | (154,061    | )
|Net cash used in investing activities                                        |  |                    | (29,164     | ) |                      |   | (12,972  | )              |  |   | (554,680    | )
|                                                                             |  |                    |             |   |                      |   |          |                |  |   |             |  
|FINANCING ACTIVITITES:                                                       |  |                    |             |   |                      |   |          |                |  |   |             |  
|Payment on notes payable to officer                                          |  |                    | (19,260     | ) |                      |   | (28,800  | )              |  |   | (218,502    | )
|Proceeds from notes payable from 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     | ) |                      |   | (150,000 | )              |  |   | 428,664     |  
|Proceeds from convertible notes payable                                      |  |                    | -           |   |                      |   | 750,000  |                |  |   | 1,861,000   |  
|Proceeds from 10% subordinated notes payable                                 |  |                    | 425,000     |   |                      |   | -        |                |  |   | 425,000     |  
|Issuance of common stock                                                     |  |                    | -           |   |                      |   | -        |                |  |   | 7,386,094   |  
|Receipt of cash for stock to be issued                                       |  |                    | 283,000     |   |                      |   | -        |                |  |   | 326,900     |  
|Net cash provided by financing activities                                    |  |                    | 656,404     |   |                      |   | 571,200  |                |  |   | 10,661,589  |  
|                                                                             |  |                    |             |   |                      |   |          |                |  |   |             |  
|Net increase (decrease) in cash and cash equivalents                         |  |                    | (269,756    | ) |                      |   | 211,887  |                |  |   | 102,755     |  
|                                                                             |  |                    |             |   |                      |   |          |                |  |   |             |  
|CASH AND CASH EQUIVALENTS, BEGINNING                                         |  |                    | 372,511     |   |                      |   | 4,544    |                |  |   | -           |  
|CASH AND CASH EQUIVALENTS, ENDING                                            |  | $                  | 102,755     |   |                      | $ | 216,431  |                |  | $ | 102,755     |  
|                                                                             |  |                    |             |   |                      |   |          |                |  |   |             |  
|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

March 31, 2008

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 six month period ended March 31, 2008 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 collectability based on a number of factors, including past transaction and collection history with a customer and the creditworthiness of the customer. The Company plans to perform ongoing credit evaluations of its customers' financial condition. If the Company determines that collectability of the sales price is not reasonably assured, revenue recognition will be deferred until such time as collection becomes reasonably assured, which is generally upon receipt of payment from the customer. The Company 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.



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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.

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 and six months ended March 31, 2008, 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 and six month



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period ended March 31, 2008. 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 and six months ended March 31, 2008 and 2007, 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.

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



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NOTE 3   PROPERTY AND EQUIPMENT

Property and equipment consisted of the following at March 31, 2008:

|                              |  |   |          |  
|----------------------------- |  | - | -------- | -
|Equipment and machinery       |  | $ | 213,166  |  
|Furniture and fixtures        |  |   | 24,594   |  
|                              |  |   | 237,760  |  
|Less accumulated depreciation |  |   | (213,242 | )
|                              |  |   |          |  
|Net Property and Equipment    |  | $ | 24,518   |  

Depreciation expenses for the three and six months ended March 31, 2008 were $8,157 and $16,314, respectively. Depreciation expenses for the three and six months ended March 31, 2007 were $7,995 and $15,788, respectively.

NOTE 4   ACCRUED EXPENSES (Restated)

Accrued expenses consisted of the following at March 31, 2008:

|                                                |  |   |           | 
|----------------------------------------------- |  | - | --------- | 
|Accrued salaries and amounts withheld therefrom |  | $ | 1,480,048 | 
|Advisory board compensation                     |  |   | 576,000   | 
|Interest payable                                |  |   | 250,624   | 
|Other accruals                                  |  |   | 116,582   | 
|                                                |  |   |           | 
|Total accrued expenses                          |  | $ | 2,423,254 | 

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 March 31, 2008, notes payable amounted to $124,000. The Company recorded $3,204 and $6,443 of interest expense on those notes during the three and six months ended March 31, 2008, respectively.

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 March 31, 2008, 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.



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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 March 31, 2008, the outstanding principal amount of the convertible notes was $750,000 and the unamortized embedded beneficial conversion feature discount was $40,556, for a net convertible debt of $709,444.

For the three months ended March 31, 2008, interest expense was $18,958, 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.

For the six months ended March 31, 2008, interest expense was $38,334, and amortization expense for the embedded beneficial conversion feature discount was $250,000, 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.

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 March 31, 2008, the outstanding principal amount of the convertible notes was $86,000 and the unamortized embedded beneficial conversion feature discount was $38,223, for a net convertible debt of $47,777.



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For the three months ended March 31, 2008, interest expense was $2,144, 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.

For the six months ended March 31, 2008, interest expense was $4,335, and amortization expense for the embedded beneficial conversion feature discount was $28,666, 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.

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 March 31, 2008, 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.



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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.

As of March 31, 2008, the outstanding principal amount of the convertible notes was $975,000, unamortized warrant discount was $86,650 and unamortized embedded beneficial conversion feature discount was $119,600, for a net convertible debt of $768,750, and the number of outstanding warrants was 2,329,546.

For the three months ended March 31, 2008, interest expense was $20,444, amortization expense for the warrant discount was $111,031, 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 $153,553, which was also included in interest expense in the other income (expense) section of the statement of operations.

For the six months ended March 31, 2008, interest expense was $40,663, amortization expense for the warrant discount was $218,578, 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 $302,255, which was also included in interest expense in the other income (expense) section of the statement of operations.

NOTE 7   10% SUBORDINATED NOTES PAYABLE (Restated)

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

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

The grant date fair value of the warrants was determined to be $125,462 which was calculated using the Black-Sholes valuation model, using the following assumptions: risk free rate of return ranging from 2.64% to 3.26%, volatility ranging from 97.08% to 98.27%, dividend yield of 0% and expected life of six years. As a result, the relative fair value of the warrants was $96,814.

As of March 31, 2008, the principal outstanding totaled $425,000, unamortized warrant discount totaled $72,611, and the net amount of the note payable was $352,389.

For the three and six months ended March 31, 2008, interest expense was $8,938, and amortization expense for the warrant discount was $24,204, which was included in interest expense in the other income (expense) section of the statement of operations.

NOTE 8   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 March 31, 2008, 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.



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The Company followed the guidance of EITF 00-19, paragraph 9, which states that all contracts classified as liabilities should be measured at fair value at each balance sheet date, with changes in fair value reported in earnings and disclosed in the financial statements as long as the contracts remain classified as liabilities.The Company analyzed the options as of March 31, 2008 by following the guidance of SFAS 133, paragraph 6 to ascertain if the options issued remained derivatives as of March 31, 2008. All of the criteria in the original analysis were met, and the options issued were determined to be within the scope and definition of a derivative. The Company next followed the guidance of EITF 00-19, paragraph 19, which states that if a company is required to obtain shareholder approval to increase the companys authorized shares in order to net-share or physically settle a contract, share settlement is not controlled by the company, and the contract is required to 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 $457,114 as of March 31, 2008, calculated using the Black Sholes valuation model with the following assumptions: risk free rate of return of 1.56%; volatility of 72.53%; dividend yield of 0%; and an expected term of 3 years.

The decrease in the fair value of the options was recorded by decreasing warrant liability on the balance sheet by $766,474 for the three months ended March 31, 2008.

The decrease in the fair value of the options was recorded by decreasing warrant liability on the balance sheet by $1,469,800 for the six months ended March 31, 2008.

Warrants Related to Convertible Notes 3

On July 17, 2007 the Company completed an offering of $1,025,000 of Convertible Notes 3 to a group of institutional and accredited investors which included warrants to purchase 2,795,454 shares of common stock (2,329,546 shares of common stock to holders of the Convertible Notes 3 and 465,908 shares of common stock as a placement fee) at an exercise price of $0.50 per share. An amendment dated March 13, 2008 reduces the exercise price of the warrants to $0.30 per share.

The Company followed the guidance of SFAS 133, paragraph 6, to determine if the warrants were within the scope and definition of a derivative at the date of issuance. The warrants had one or more underlings and one or more notional amounts, required no initial investment and required or permitted net settlement. Therefore, the warrants were determined to be derivatives at the date of issuance. In order to determine how to classify the warrants, the Company followed the guidance of EITF 00-19, paragraphs 7 and 8, which state that 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 $865,431 ($741,371 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. Therefore, the relative fair value of the warrants attributable to the holders of the Convertible Notes 3 was determined to be $430,189.

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 March 31, 2008 by following the guidance of SFAS 133, paragraph 6 to ascertain if the warrants issued remained derivatives as of March 31, 2008. All of the criteria in the original analysis were met, and the warrants issued were determined to be within the scope and definition of a derivative. The Company next followed the guidance of EITF 00-19, paragraph 19, which states that if a company is required to obtain shareholder approval to increase the companys authorized shares in order to net-share or physically settle a contract, share settlement is not controlled by the company, and the contract is required to be classified as a liability.

The fair value of the warrants was determined to be $149,493 ($124,735 attributable to the holders of the Convertible Notes 3 and $24,748 attributable to the placement fee)as of March 31, 2008, which was calculated using the Black Sholes valuation model with the following assumptions: risk free rate of return of 1.56%; volatility of 72.53%; dividend yield of 0%; and an expected term of 4.17 to 4.25 years. Therefore, the relative fair value of the warrants attributable to the holders of the Convertible Notes 3 was determined to be $111,202.

The decrease in the fair value of the warrants for the three months ended March 31, 2008 was recorded by decreasing warrant liabilities on the balance sheet by $185,827 ($143,242 attributable to the holders of the Convertible Notes 3 and $42,585 attributable to the placement fee).



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The decrease in the fair value of the warrants for the six months ended March 31, 2008 was recorded by decreasing warrant liabilities on the balance sheet by $363,982 ($268,469 attributable to the holders of the Convertible Notes 3 and $95,513 attributable to the placement fee).

Warrants Issued to Advisory Board Members

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

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

The Company analyzed the warrants by applying FASB 133, paragraph 6 to ascertain if the warrants remained derivatives as of March 31, 2008. All of the criteria in the original analysis were met, and the warrants issued were determined to be within the scope and definition of a derivative. EITF 00-19, paragraph 8 was applied which states that if share settlement is not controlled by a company, the contract is required to be classified as a liability. Paragraph 9 also states that contracts classified as liabilities should be measured at fair value at each balance sheet date, with changes in fair value reported in earnings and disclosed in the financial statements as long as the contracts remain classified as liabilities.

The fair value of the warrants was determined to be $549,672 as of March 31, 2008, using the Black Sholes valuation model with the following assumptions: risk free rate of return of 1.56%; volatility of 72.53%; dividend yield of 0%; and an expected term of 4.67 years.

The decrease in the fair value of the warrants was $983,628 for the three months ended March 31, 2008, and recorded by decreasing the warrant liability on the balance sheet.

The decrease in the fair value of the warrants was $1,008,033 for the six months ended March 31, 2008, and recorded by decreasing the warrant liability on the balance sheet.

Option Issued to Director

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

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.



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The Company analyzed the option by applying FASB 133, paragraph 6 to ascertain if the option remained a derivative as of March 31, 2008. All of the criteria in the original analysis were met, and the option issued was determined to be within the scope and definition of a derivative. EITF 00-19, paragraph 8 was applied which states that if share settlement is not controlled by the company, the contract is required to be classified as a liability. Paragraph 9 also states that contracts classified as liabilities should be measured at fair value at each balance sheet date, with changes in fair value reported in earnings and disclosed in the financial statements as long as the contracts remain classified as liabilities.

The fair value of the option was determined to be $63,620 as of March 31, 2008, using the Black Sholes valuation model with the following assumptions: risk free rate of return of 1.56%; volatility of 72.53%; dividend yield of 0%; and an expected term of 4.67 years.

The decrease in the fair value of the option was $113,845 for the three months ended March 31, 2008, and recorded by decreasing the warrant liability on the balance sheet.

The decrease in the fair value of the option was $107,900 for the six months ended March 31, 2008, 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.

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 March 31, 2008. All of the criteria in the original analysis were met, and the option issued was determined to be within the scope and definition of a derivative. EITF 00-19, paragraph 8 was applied which states that if share settlement is not controlled by the company, the contract is required to be classified as a liability. Paragraph 9 also states that contracts classified as liabilities should be measured at fair value at each balance sheet date, with changes in fair value reported in earnings and disclosed in the financial statements as long as the contracts remain classified as liabilities.

The fair value of the option was determined to be $63,620 as of March 31, 2008 using the Black Sholes valuation model with the following assumptions: risk free rate of return of 1.56%; volatility of 72.53%; dividend yield of 0%; and an expected term of 4.67 years.

The decrease in the fair value of the option was $113,845 for the three months ended March 31, 2008, and recorded by decreasing the warrant liability on the balance sheet.

The decrease in the fair value of the option was $107,900 for the six months ended March 31, 2008, 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 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 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



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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.

The Company analyzed the option as of March 31, 2008 by applying FASB 133, paragraph 6 to ascertain if the option issued remained a derivative as of March 31, 2008. All of the criteria in the original analysis were met, and the option issued was determined to be within the scope and definition of a derivative. EITF 00-19, paragraph 8 was applied which states that if share settlement is not controlled by a company, the contract is required to be classified as a liability. Paragraph 9 also states that contracts classified as liabilities should be measured at fair value at each balance sheet date, with changes in fair value reported in earnings and disclosed in the financial statements as long as the contracts remain classified as liabilities.

The fair value of the option was $543,267 as of March 31, 2008, which was calculated using the Black Sholes valuation model with the following assumptions: risk free rate of return of 1.56%; volatility of 72.53%; dividend yield of 0%; and an expected term of 4.67 years.

The decrease in the fair value of the option was $972,165 for the three months ended March 31, 2008, and was recorded by decreasing the warrant liability on the balance sheet.

The decrease in the fair value of the option was $905,054 for the six months ended March 31, 2008, and was recorded by decreasing the warrant liability on the balance sheet.

Warrant Issued to Consultant

On December 19, 2007, the Company entered into a one year Consulting Agreement with Mark Maron pursuant to which Mr. Maron was appointed as Special Adviser to the Company. As compensation for his services, the Company granted to 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 March 31, 2008. All of the criteria in the original analysis were met, and the warrant was determined to be within the scope and definition of a derivative. EITF 00-19, paragraph 8 was applied which states that if share settlement is not controlled by the company, the contract is required to be classified as a liability. Paragraph 9 also states that contracts classified as liabilities should be measured at fair value at each balance sheet date, with changes in fair value reported in earnings and disclosed in the financial statements as long as the contracts remain classified as liabilities.



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The fair value of the option was $543,267 as of March 31, 2008, which was calculated using the Black Sholes valuation model with the following assumptions: risk free rate of return of 1.56%; volatility of 72.53%; dividend yield of 0%; and an expected term of 4.67 years.

The decrease in the fair value of the option was $972,165 for the three months ended March 31, 2008, and was recorded by decreasing the warrant liability on the balance sheet.

The decrease in the fair value of the option was $905,054 for the six months ended March 31, 2008, and was recorded by decreasing the warrant liability on the balance sheet.

Warrants Related to 10% Subordinated Debentures

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

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

The fair value of the warrants was determined to be $125,462 at the date of issuance, which was calculated using the Black Sholes valuation model, using the following assumptions: risk free rate of return of ranging from 2.64% to 3.26%, volatility ranging from 97.08% to 98.27%, dividend yield of 0% and expected life of six years. Therefore, the relative fair value of the warrants was determined to be $96,814.

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

The Company analyzed the warrants by applying FASB 133, paragraph 6 to ascertain if the warrants remained derivatives as of March 31, 2008. All of the criteria in the original analysis were met, and the warrants issued were determined to be within the scope and definition of a derivative. EITF 00-19, paragraph 8 was applied which states that if share settlement is not controlled by the company, the contract is required to be classified as a liability. Paragraph 9 also states that contracts classified as liabilities should be measured at fair value at each balance sheet date, with changes in fair value reported in earnings and disclosed in the financial statements as long as the contracts remain classified as liabilities.

The fair value of the warrants was determined to be $50,811 as of March 31, 2008, using the Black Sholes valuation model with the following assumptions: risk free rate of return of 1.56%; volatility of 72.53%; dividend yield of 0%; and an expected term of 5.83 years. Therefore, the relative fair value of the warrants was determined to be $45,385.

The decrease in the fair value of the options was $51,429 for the three and six months ended March 31, 2008, and recorded by decreasing the warrant liability on the balance sheet.

Warrants Related to $750,000 Stock Issuance

On March 14, 2008 the Company began an offering of units consisting of common stock and warrants to purchase shares of its common stock to a group of institutional and accredited investors. The Company raised a total of $750,000 through this offering. The Company issued warrants to purchase 15,000,000 shares of common stock at an exercise price of $0.10 per share. The warrants expire three years from the date of issuance.

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



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The fair value of the warrants was determined to be $470,004 at the date of issuance, which was calculated using the Black Sholes valuation model, using the following assumptions: risk free rate of return of 1.32% to 1.57%, volatility of 72.53% to 75.80%, dividend yield of 0%, and expected term of 3 years. Therefore, the relative fair value of the warrants was determined to be $165,022.

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

The Company analyzed the warrants by applying FASB 133, paragraph 6 to ascertain if the warrants remained derivatives as of March 31, 2008. All of the criteria in the original analysis were met, and the warrants were determined to be within the scope and definition of a derivative. EITF 00-19, paragraph 8 was applied which states that if share settlement is not controlled by the company, the contract is required to be classified as a liability. Paragraph 9 also states that contracts classified as liabilities should be measured at fair value at each balance sheet date, with changes in fair value reported in earnings and disclosed in the financial statements as long as the contracts remain classified as liabilities.

The fair value of the warrants was determined to be $403,602 as of March 31, 2008, which was calculated using the Black Sholes valuation model, using the following assumptions: risk free rate of return of 1.56%, volatility of 72.53%, dividend yield of 0% and expected term of 2.92 years. Therefore, the relative fair value of the warrants was determined to be $156,268.

The decrease in the fair value of the warrants of $8,754 for the three and six months ended March 31, 2008 was recorded in decrease in warrant liability in the other income (expense) section of the statement of operations.

NOTE 9   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 include embedded beneficial conversion features that allow 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 March 31, 2008. 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 $874,882 as of March 31, 2008, which was calculated using the Black Sholes valuation modelwith the following assumptions: risk free rate of return of 1.56%; volatility of 72.53%; dividend yield of 0% and an expected term of .08 to .75 years.

The decrease in the fair value of the embedded beneficial conversion features for the three months ended March 31, 2008 were recorded by decreasing beneficial conversion features liability on the balance sheet by $347,740.



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The decrease in the fair value of the embedded beneficial conversion features for the six months ended March 31, 2008 were recorded by decreasing beneficial conversion features liability on the balance sheet by $555,929.

NOTE 10   STOCKHOLDERS EQUITY (Restated)

Common Stock

The Company has 150,000,000 authorized shares with $0.001 par value. As of March 31, 2008, the Company had 107,494,374 shares issued and 107,012,474 shares outstanding.

During the three and six months ended March 31, 2008 the Company issued a total of 377,273 shares of common stock. 150,000 shares were issued for legal services and 227,273 shares were issued upon conversion of $50,000 of Convertible Note 3.

Stock Options

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

|                                     |  |          |      |  |             |  |            |           |  |   |   | 
|------------------------------------ |  | -------- | ---- |  | ----------- |  | ---------- | --------- |  | - | - | 
|                                     |  | Weighted |      |  |             |  |            |           | 
|                                     |  | Average  |      |  | Number of   |  |            | Aggregate | 
|                                     |  | Exercise |      |  | Outstanding |  |            | Intrinsic | 
|                                     |  | Price    |      |  | Options     |  |            | Value     | 
|                                     |  |          |      |  |             |  |            |           | 
|Outstanding as of September 30, 2007 |  | $        | 0.15 |  |             |  | 7,034,140  |           |  | $ | - | 
|Granted                              |  |          | 0.25 |  |             |  | 10,539,312 |           |  |   | - | 
|Forfeited                            |  |          | -    |  |             |  | -          |           |  |   | - | 
|Exercised                            |  |          | -    |  |             |  | -          |           |  |   | - | 
|Outstanding as of March 31, 2008     |  | $        | 0.21 |  |             |  | 17,573,452 |           |  | $ | - | 

Outstanding Options:

|              |  |             |            |  |             |  |            |             |  |  |             |  |  |             |      |  |  |   |      | 
|------------- |  | ----------- | ---------- |  | ----------- |  | ---------- | ----------- |  |  | ----------- |  |  | ----------- | ---- |  |  | - | ---- | 
|              |  |             |            |  |             |  |            | Weighted    |  |  | Weighted    |  |  | Weighted    |     
|              |  |             |            |  |             |  |            | Average     |  |  | Average     |  |  | Average     |     
|              |  |             |            |  |             |  |            | Remaining   |  |  | Exercise    |  |  | Exercise    |     
|              |  | Stock       |            |  | Stock       |  |            | Contractual |  |  | Price of    |  |  | Price of    |     
|Exercise      |  | Options     |            |  | Options     |  |            | Life        |  |  | Options     |  |  | Options     |     
|Price         |  | Outstanding |            |  | Exercisable |  |            | in Years    |  |  | Outstanding |  |  | Exercisable |     
|              |  |             |            |  |             |  |            |             |  |  |             |  |  |             |     
|$0.15 - $0.25 |  |             | 17,573,452 |  |             |  | 11,595,934 |             |  |  | 400         |  |  | $           | 0.21 |  |  | $ | 0.21 | 

Stock Warrants

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 |  | $        | 0.30 |  |             |  | 2,795,454  |           |  | $ | - | 
|Granted                              |  |          | 0.22 |  |             |  | 23,277,312 |           |  |   | - | 
|Forfeited                            |  |          | -    |  |             |  | -          |           |  |   | - | 
|Exercised                            |  |          | -    |  |             |  | -          |           |  |   | - | 
|Outstanding as of March 31, 2008     |  | $        | 0.22 |  |             |  | 26,074,766 |           |  | $ | - | 

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 |     
|             |  |             |            |  |             |  |            |             |  |  |             |  |  |             |     
|$0.10 -$0.40 |  |             | 26,074,766 |  |             |  | 26,074,766 |             |  |  | 4.31        |  |  | $           | 0.23 |  |  | $ | 0.23 | 





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NOTE 11   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 March 31, 2008, the Company has incurred cumulative losses of $33,681,582 including net income for the six months ended March 31, 2008 of $15,783,544. 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 12   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, 2012, and $10,523 plus common area maintenance charges from August 1, 2013 through July 31, 2014. The future aggregate minimum annual lease payments arising from this lease agreement are as follows.



|                                 |  |   |         | 
|-------------------------------- |  | - | ------- | 
|For the Year Ended September 30, |  |   |        
|                                 |  |   |        
|2009                             |  | $ | 104,490 | 
|2010                             |  |   | 108,660 | 
|2011                             |  |   | 93,550  | 



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

NOTE 13     SUBSEQUENT EVENTS (Restated)

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.



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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.

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.

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.

Issuance of $50,000 in Notes Payable

On July 15, 2009, the Company entered into a short-term promissory note payable for $50,000. Interest accrues at 10% per annum and matures on October 15, 2009. A total of 100,000 shares of common stock was issued in accordance with the note.

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.

Termination of Chief Executive Officer

On February 26, 2009, the Companys Board of Directors terminated Mr. James Houtz as our Chief Executive Officer. Mr. Houtz remains a director but not an officer of the Company.



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NOTE 14   RESTATEMENT

Subsequent to filing Form 10-QSB for the six months ended March 31, 2008, the Company determined that the beneficial conversion feature discounts and warrant discounts related to the issuance of the convertible notes payable were not properly accounted for, and certain warrants and options were omitted. As a result, the Company recorded the following adjustments.

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 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 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 fiscal 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 Company began the analysis for the restatement by applying FASB 133, paragraph 6 to ascertain if the options remained derivatives as of March 31, 2008. 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 $457,114 as of March 31, 2008 and was calculated using the Black Sholes valuation model with the following assumptions: risk free rate of return of 1.56%; volatility of 72.53%; dividend yield of 0%; and an expected term of 3 years.

The decrease in the fair value of the options was $766,474 for the three months ended March 31, 2008, and recorded by decreasing the warrant liability on the balance sheet.

The decrease in the fair value of the options was $1,469,800 for the six months ended March 31, 2008, 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 March 31, 2008 was $766,474 and included in decrease in warrant liability in the other income (expense) section of the statement of operations.



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The change in the fair value of the options for the six months ended March 31, 2008 was $1,469,800 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 for the six months ended March 31, 2008 was the result of the change in the fair value of the options of $1,469,800.

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. On December 13, 2007 the advisory board members agreed to forfeit the ability to convert their compensation into shares of common stock in exchange for warrants exercisable at $0.25 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 March 31, 2008, no payments have been made to any advisory board members, there has been no conversion by any Advisory Board members of the accrued liability into shares of common stock, and no warrant has been exercised.

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 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.

On December 13, 2007 the advisory board members agreed to forfeit the ability to convert their compensation into shares of common stock in exchange for warrants. As a result, the beneficial conversion feature of $576,000 and the unamortized beneficial conversion feature discount of $195,560 were written off for a net of $380,440.

The beneficial conversion features discount amortization was $15,104 for the three and six months ended March 31, 2008, 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 or six months ended March 31, 2008.

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 and six months ended March 31, 2008.

The beneficial conversion feature of $576,000 and the beneficial conversion feature discount of $195,560 were written off for a net of $380,440 and has been included in the other income (expense) section of the statement of income (operations) for the three and six months ended March 31, 2008.



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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, and the net write off of beneficial conversion feature and beneficial conversion feature discount of $380,440 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 $24,366 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, $24,366 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 March 31, 2008.

Statement of Operations

There was no change in the fair value of the warrants for the three months ended March 31, 2008, due to their expiration.

Statement of Cash Flows

There was no change in the statement of cash flows for the three months ended March 31, 2008.

Beneficial Conversion Features

As of March 31, 2008, the Company had Convertible Bridge Notes outstanding totaling $1,811,000 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.



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Balance Sheet

The Company began the analysis for the restatement as of and for the six months ended March 31, 2008 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 $874,882 as of March 31, 2008, which was calculated using the Black Sholes valuation model with the following assumptions: risk free rate of return of 1.56%; volatility of 72.53%; dividend yield of 0%; and an expected term of .08 to .33 years.

The decrease in the fair value of the beneficial conversion features was determined to be $347,850 for the three months ended March 31, 2008, and was recorded in beneficial conversion features liability on the balance sheet.

The decrease in the fair value of the beneficial conversion features was determined to be $555,929 for the six months ended March 31, 2008, and was recorded in beneficial conversion features liability on the balance sheet.

The amortization of the beneficial conversion features discount was $285,610 for the three months ended March 31, 2008, which increased convertible notes.

The amortization of the beneficial conversion features discount was $573,646 for the six months ended March 31, 2008, 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 $347,850 for the three months ended March 31, 2008, and was recorded in increase (decrease) in beneficial conversion features liability, in the other income (expense) section of the statement of operations.

The decrease in the fair value of the beneficial conversion features was determined to be $555,929 for the six months ended March 31, 2008, 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 $285,610 for the three months ended March 31, 2008, and was recorded in interest expense in the other income (expense) section of the statement of operations.

The amortization of the beneficial conversion features discount was $573,646 for the six months ended March 31, 2008, 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 for the three months ended March 31, 2008 were the result of the decrease in the fair value of the beneficial conversion features liability of $347,850 and the amortization of the beneficial conversion features discounts of $285,610 on the statement of operations.

Changes in the statement of cash flows for the six months ended March 31, 2008 were the result of the decrease in the fair value of the beneficial conversion features liability of $555,929 and the amortization of the beneficial conversion features discounts of $573,646 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 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



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the convertible bridge notes, 465,908 shares of common stock as a placement fee) at an exercise price of $0.50 per share. An amendment to the convertible notes dated March 13, 2008 reduced the exercise price to $0.30 per share.

Balance Sheet

The Company began the analysis for the restatement of the financial statements as of and for the six months ended March 31, 2008 by applying FASB 133, paragraph 6 to ascertain if the warrants issued remained derivatives as of March 31, 2008. All of the criteria in the original analysis were met, and the warrants issued were determined to be within the scope and definition of a derivative. EITF 00-19, paragraph 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.

The fair value of the warrants was determined to be $135,950 as of March 31, 2008, and was calculated using the Black Sholes valuation model with the following assumptions: risk free rate of return of 1.56%; volatility of 72.53%; dividend yield of 0%; and an expected term of 4.17 to 4.25 years.

The decrease in the fair value of the warrants was determined to be $185,827 for the three months ended March 31, 2008, and recorded by decreasing warrant liabilities on the balance sheet by $185,827 ($143,242 related to the holders of the convertible bridge notes, and $42,585 related to the placement fee).

The decrease in the fair value of the warrants was determined to be $363,982 for the six months ended March 31, 2008, and recorded by decreasing warrant liabilities on the balance sheet by $363,982 ($268,470 related to the holders of the convertible bridge notes, and $95,512 related to the placement fee).

The amortization of the warrant discount was $213,353 for the six months ended March 31, 2008, 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 determined to be $185,827 for the three months ended March 31, 2008, and recorded in decrease in warrants in the other income (expense) section of the statement of operations.

The decrease in the fair value of the warrants was determined to be $363,982 for the six months ended March 31, 2008, 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 for the six months ended March 31, 2008 were the result of the decrease in the amount of $363,982 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.

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.

Balance Sheet

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



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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 warrant was determined to be $543,267 as of March 31, 2008, and was calculated using the Black Sholes valuation model with the following assumptions: risk free rate of return of 1.56%; volatility of 72.53%; dividend yield of 0%; and an expected term of 4.67 years.

The decrease in the fair value of the warrant was $972,165 for the three months ended March 31, 2008, and was recorded by decreasing the warrant liability on the balance sheet.

The decrease in the fair value of the warrant was $905,054 for the six months ended March 31, 2008, and was recorded by decreasing the warrant liability on the balance sheet.

Statement of Operations

The decrease in the fair value of the warrant was $972,165 for the three months ended March 31, 2008, and was recorded by decreasing the warrant liability on the balance sheet.

The decrease in the fair value of the warrant was $905,054 for the six months ended March 31, 2008, and was recorded by decreasing the warrant liability on the balance sheet.

Statement of Cash Flows

The change in the statement of cash flows for the six months ended March 31, 2008 was the result of the change in the fair value of the warrant of $905,054.

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.

Balance Sheet

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.



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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 March 31, 2008 by applying FASB 133, paragraph 6 to ascertain if the option remained a derivative as of March 31, 2008. 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 $543,267 as of March 31, 2008, and was calculated using the Black Sholes valuation model with the following assumptions: risk free rate of return of 1.56%; volatility of 72.53%; dividend yield of 0%; and an expected term of 4.67 years.

The decrease in the fair value of the option was $972,165 for the three months ended March 31, 2008, and was recorded by decreasing the warrant liability on the balance sheet.

The decrease in the fair value of the option was $905,054 for the six months ended March 31, 2008, and was recorded by decreasing the warrant liability on the balance sheet.

Statement of Operations

The decrease in the fair value of the option was $972,165 for the three months ended March 31, 2008, and was recorded by decreasing the warrant liability on the balance sheet.

The decrease in the fair value of the option was $905,054 for the six months ended March 31, 2008, and was recorded by decreasing the warrant liability on the balance sheet.

Statement of Cash Flows

The change in the statement of cash flows for the six months ended March 31, 2008 was the result of the change in the fair value of the option of $905,054.

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.

Balance Sheet

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 March 31, 2008. 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.



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The fair value of the option was determined to be $63,620 as of March 31, 2008, using the Black Sholes valuation model with the following assumptions: risk free rate of return of 1.56%; volatility of 72.53%; dividend yield of 0%; and an expected term of 4.67 years.

The decrease in the fair value of the option was $113,845 for the three months ended March 31, 2008, and recorded by decreasing the warrant liability on the balance sheet.

The decrease in the fair value of the option was $107,900 for the six months ended March 31, 2008, and recorded by decreasing the warrant liability on the balance sheet.

Statement of Operations

The decrease in the fair value of the option was $113,845 for the three months ended March 31, 2008, and recorded by decreasing the warrant liability on the balance sheet.

The decrease in the fair value of the option was $107,900 for the six months ended March 31, 2008, and recorded by decreasing the warrant liability on the balance sheet.

Statement of Cash Flows

The change in the statement of cash flows for the six months ended March 31, 2008 was the result of the change in the fair value of the option of $107,900.

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.

Balance Sheet

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 March 31, 2008. All of the criteria in the original analysis were met, and the option issued was determined to be within the scope and definition of a derivative. EITF 00-19, paragraph 8 was applied which states that if share settlement is not controlled by the company, the contract is required to be classified as a liability. Paragraph 9, 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 $63,620 as of March 31, 2008 using the Black Sholes valuation model with the following assumptions: risk free rate of return of 1.56%; volatility of 72.53%; dividend yield of 0%; and an expected term of 4.67 years.

The decrease in the fair value of the option was $113,845 for the three months ended March 31, 2008, and recorded by decreasing the warrant liability on the balance sheet.

The decrease in the fair value of the option was $107,900 for the six months ended March 31, 2008, and recorded by decreasing the warrant liability on the balance sheet.



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Statement of Operations

The decrease in the fair value of the option was $113,845 for the three months ended March 31, 2008, and recorded by decreasing the warrant liability on the balance sheet.

The decrease in the fair value of the option was $107,900 for the six months ended March 31, 2008, and recorded by decreasing the warrant liability on the balance sheet.

Statement of Cash Flows

The change in the statement of cash flows for the six months ended March 31, 2008 was the result of the change in the fair value of the option of $107,900.



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Table 1  2008

|                                                                    |  |            |             |   |           |  |            |              |  |         |            |   |  |            |         |   |               |        |          |            |         |        |           |   |  |           |           |   |           |         |           |              |  |        |          |   |        |        |         |        |          |  |         |         |           |         |           |         |  |   |         |   |  |           |             |  
|------------------------------------------------------------------- |  | ---------- | ----------- | - | --------- |  | ---------- | ------------ |  | ------- | ---------- | - |  | ---------- | ------- | - | ------------- | ------ | -------- | ---------- | ------- | ------ | --------- | - |  | --------- | --------- | - | --------- | ------- | --------- | ------------ |  | ------ | -------- | - | ------ | ------ | ------- | ------ | -------- |  | ------- | ------- | --------- | ------- | --------- | ------- |  | - | ------- | - |  | --------- | ----------- | -
|                                                                    |  |            |             |   |           |  |            |              |  |         |            |   |  | Beneficial |         |   | Warrant       |        |          |            |         |        |           |   |  |           |           |   |           |         |           |              |  |        |          |   |        |        |         |        |          | 
|                                                                    |  |            |             |   |           |  |            |              |  |         |            |   |  | Conversion |         |   | Related to    |        |          |            |         |        |           |   |  |           |           |   |           |         |           |              |  |        |          |   |        |        |         |        |          | 
|                                                                    |  |            |             |   |           |  |            |              |  |         |            |   |  | Features   |         |   | $1,025,000 of |        |          |            |         |        |           |   |  |           |           |   |           |         |           |              |  |        | Warrants |   |        |        |         |        |          | 
|                                                                    |  |            |             |   | 2001      |  |            |              |  |         | Warrants   |   |  | and        |         |   | Convertible   |        |          |            |         |        | Option    |   |  |           |           |   | Warrant   |         |           |              |  |        | Related  |   |        |        |         |        |          | 
|                                                                    |  |            |             |   | Executive |  |            |              |  |         | Related to |   |  | Beneficial |         |   | Bridge Notes  |        |          |            |         |        | Issued to |   |  |           |           |   | Issued to |         |           | 10%          |  |        | to       |   |        |        |         |        |          | 
|                                                                    |  | As         |             |   | Officers  |  |            | Advisory     |  |         | 2004 Stock |   |  | Conversion |         |   | and           |        |          | Warrant    |         |        | Chief     |   |  | Warrant   |           |   | Chief     |         |           | Subordinated |  |        | $750,000 |   |        |        |         |        |          | 
|                                                                    |  | Previously |             |   | Option    |  |            | Board        |  |         | Purchase   |   |  | Features   |         |   | Warrant       |        |          | Issued to  |         |        | Executive |   |  | Issued to |           |   | Financial |         |           | Notes        |  |        | Stock    |   |        |        |         |        | As       | 
|                                                                    |  | Stated     |             |   | Plan      |  |            | Compensation |  |         | Agreement  |   |  | Discount   |         |   | Discount      |        |          | Consultant |         |        | Officer   |   |  | Director  |           |   | Officer   |         |           | Payable      |  |        | Issuance |   |        | Other  |         |        | Restated | 
|Balance Sheet                                                       |  |            |             |   |           |  |            |              |  |         |            |   |  |            |         |   |               |        |          |            |         |        |           |   |  |           |           |   |           |         |           |              |  |        |          |   |        |        |         |        |          | 
|Cash and cash equivalent                                            |  | $          | 102,604     |   |           |  |            |              |  |         |            |   |  |            |         |   |               |        |          |            |         |        |           |   |  |           |           |   |           |         |           |              |  |        |          |   |        |        | $       | 151    |          |  | $       | 102,755 |          
|Accounts payable                                                    |  |            | 470,137     |   |           |  |            |              |  |         |            |   |  |            |         |   |               |        |          |            |         |        |           |   |  |           |           |   |           |         |           |              |  |        |          |   |        |        |         | 32,987 |          |  |         | 503,124 |          
|Accrued expenses                                                    |  |            | 1,847,254   |   |           |  |            |              |  | 576,000 |            |   |  |            |         |   |               |        |          |            |         |        |           |   |  |           |           |   |           |         |           |              |  |        |          |   |        |        |         |        |          |  |         |         | 2,423,254 |        
|Convertible Notes, net                                              |  |            | 1,306,593   |   |           |  |            |              |  |         |            |   |  |            |         |   | 12,913        |        |          |            | 206,465 |        |           |   |  |           |           |   |           |         |           |              |  |        |          |   |        |        |         |        |          |  |         |         |           |         | 1,525,971 |        
|10% subordinated notes payable                                      |  |            | 332,182     |   |           |  |            |              |  |         |            |   |  |            |         |   |               |        |          |            |         |        |           |   |  |           |           |   |           |         |           |              |  |        |          |   | 20,169 |        |         |        |          |  |         | 38      |           |         |           | 352,389 | 
|Warrant liability                                                   |  |            | 974,632     |   |           |  | 457,114    |              |  |         | 549,672    |   |  |            |         |   |               |        |          |            |         | 36,522 |           |   |  | 128,358   |           |   |           | 128,358 |           |              |  | 63,620 |          |   |        | 63,620 |         |        |          |  |         |         |           | 156,268 |           |         |  |   |         |   |  | 2,558,164 |            
|Beneficial conversion feature liability                             |  |            | 857,678     |   |           |  |            |              |  |         |            |   |  |            |         |   |               | 17,204 |          |            |         |        |           |   |  |           |           |   |           |         |           |              |  |        |          |   |        |        |         |        |          |  |         |         |           |         |           |         |  |   |         |   |  | 874,882   |            
|Additional paid-in capital                                          |  |            | 12,815,792  |   |           |  | (2,271,879 | )            |  |         | (269,848   | ) |  |            | (45,663 | ) |               |        | 473,797  |            |         |        | 135,406   |   |  |           |           |   |           |         |           |              |  |        |          |   |        |        |         |        |          |  |         |         |           |         |           |         |  |   |         |   |  |           | 10,837,605  |  
|Deficit accumulated during development stage                        |  |            | (19,149,208 | ) |           |  | 1,814,765  |              |  |         | (855,824   | ) |  |            | 45,663  |   |               |        | (503,914 | )          |         |        | (378,393  | ) |  |           | (128,358  | ) |           |         | (128,358  | )            |  |        | (63,620  | ) |        |        | (63,620 | )      |          |  | (20,169 | )       |           |         | (156,268  | )       |  |   | (32,874 | ) |  |           | (19,620,178 | )
|                                                                    |  |            |             |   |           |  |            |              |  |         |            |   |  |            |         |   |               |        |          |            |         |        |           |   |  |           |           |   |           |         |           |              |  |        |          |   |        |        |         |        |          |  |         |         |           |         |           |         |  |   |         |   |  |           |             |  
|Statement of Operations (for the three months ended March 31, 2008) |  |            |             |   |           |  |            |              |  |         |            |   |  |            |         |   |               |        |          |            |         |        |           |   |  |           |           |   |           |         |           |              |  |        |          |   |        |        |         |        |          |  |         |         |           |         |           |         |  |   |         |   |  |           |             |  
|General and administrative                                          |  | $          | 395,890     |   |           |  |            |              |  |         |            |   |  |            |         |   |               |        |          |            |         |        |           |   |  |           |           |   |           |         |           |              |  |        |          |   |        |        |         |        |          |  |         |         |           | $       | 165,022   |         |  | $ | 32,540  |   |  | $         | 593,452     |  
|Research and development                                            |  |            | 328,694     |   |           |  |            |              |  |         |            |   |  |            |         |   |               |        |          |            |         |        |           |   |  |           |           |   |           |         |           |              |  |        |          |   |        |        |         |        |          |  |         |         |           |         |           |         |  |   | 334     |   |  |           | 329,028     |  
|Interest expense                                                    |  |            | (492,546    | ) |           |  |            |              |  |         |            |   |  |            |         |   |               |        | 16,677   |            |         |        | (78,022   | ) |  |           |           |   |           |         |           |              |  |        |          |   |        |        |         |        |          |  | (20,169 | )       |           |         |           |         |  |   |         |   |  |           | (574,060    | )
|Decrease (increase) in warrant liability                            |  |            | 273,778     |   |           |  | 766,474    |              |  |         | 983,628    |   |  |            |         |   |               |        |          |            |         |        | (36,522   | ) |  |           | 972,165   |   |           |         | 972,165   |              |  |        | 113,845  |   |        |        | 113,845 |        |          |  |         |         |           |         | 8,754     |         |  |   |         |   |  |           | 4,168,132   |  
|Increase in beneficial conversion feature liability                 |  |            | 364,944     |   |           |  |            |              |  |         |            |   |  |            |         |   |               |        | (17,204  | )          |         |        |           |   |  |           |           |   |           |         |           |              |  |        |          |   |        |        |         |        |          |  |         |         |           |         |           |         |  |   |         |   |  |           | 347,740     |  
|Basic and dilutive loss per share                                   |  |            | -           |   |           |  |            |              |  |         |            |   |  |            |         |   |               |        |          |            |         |        |           |   |  |           |           |   |           |         |           |              |  |        |          |   |        |        |         |        |          |  |         |         |           |         |           |         |  |   |         |   |  |           | -           |  
|                                                                    |  |            |             |   |           |  |            |              |  |         |            |   |  |            |         |   |               |        |          |            |         |        |           |   |  |           |           |   |           |         |           |              |  |        |          |   |        |        |         |        |          |  |         |         |           |         |           |         |  |   |         |   |  |           |             |  
|Statement of Operations (for the six months ended March 31, 2008)   |  |            |             |   |           |  |            |              |  |         |            |   |  |            |         |   |               |        |          |            |         |        |           |   |  |           |           |   |           |         |           |              |  |        |          |   |        |        |         |        |          |  |         |         |           |         |           |         |  |   |         |   |  |           |             |  
|General and administrative                                          |  | $          | 1,526,663   |   |           |  |            |              |  | $       | 1,557,705  |   |  |            |         |   |               |        |          |            |         |        |           |   |  | $         | 1,033,412 |   |           | $       | 1,033,412 |              |  | $      | 171,520  |   |        | $      | 171,520 |        |          |  |         |         |           | $       | 165,022   |         |  | $ | 32,540  |   |  | $         | 5,691,794   |  
|Research and development                                            |  |            | 565,598     |   |           |  |            |              |  |         |            |   |  |            |         |   |               |        |          |            |         |        |           |   |  |           |           |   |           |         |           |              |  |        |          |   |        |        |         |        |          |  |         |         |           |         |           |         |  |   | 334     |   |  |           | 565,932     |  
|Interest expense                                                    |  |            | (906,150    | ) |           |  |            |              |  |         |            |   |  |            |         |   |               |        | 32,816   |            |         |        | (167,287  | ) |  |           |           |   |           |         |           |              |  |        |          |   |        |        |         |        |          |  | (20,169 | )       |           |         |           |         |  |   |         |   |  |           | (1,060,790  | )
|Decrease (increase) in warrant liability                            |  |            | 427,991     |   |           |  | 1,469,800  |              |  |         | 1,008,033  |   |  |            |         |   |               |        |          |            |         |        | (12,580   | ) |  |           | 905,054   |   |           |         | 905,054   |              |  |        | 107,900  |   |        |        | 107,900 |        |          |  |         |         |           |         | 8,754     |         |  |   |         |   |  |           | 4,927,906   |  
|Increase in beneficial conversion feature liability                 |  |            | 637,688     |   |           |  |            |              |  |         |            |   |  |            |         |   |               |        | (81,759  | )          |         |        |           |   |  |           |           |   |           |         |           |              |  |        |          |   |        |        |         |        |          |  |         |         |           |         |           |         |  |   |         |   |  |           | 555,929     |  
|Write-off of beneficial conversion feature                          |  |            |             |   |           |  |            |              |  |         | 380,440    |   |  |            |         |   |               |        |          |            |         |        |           |   |  |           |           |   |           |         |           |              |  |        |          |   |        |        |         |        |          |  |         |         |           |         |           |         |  |   |         |   |  |           | 380,440     |  







35



---





Table 1  2008 (continued)

|                                                                             |  |            |            |   |           |   |            |              |  |   |            |   |  |            |        |  |               |   |          |            |  |   |           |   |  |           |           |   |           |   |           |              |  |   |          |   |  |       |          |   |          |   |         |   |  |   |          |   |  |   |          |   |  |   |            |  
|---------------------------------------------------------------------------- |  | ---------- | ---------- | - | --------- | - | ---------- | ------------ |  | - | ---------- | - |  | ---------- | ------ |  | ------------- | - | -------- | ---------- |  | - | --------- | - |  | --------- | --------- | - | --------- | - | --------- | ------------ |  | - | -------- | - |  | ----- | -------- | - | -------- | - | ------- | - |  | - | -------- | - |  | - | -------- | - |  | - | ---------- | -
|                                                                             |  |            |            |   |           |   |            |              |  |   |            |   |  | Beneficial |        |  | Warrant       |   |          |            |  |   |           |   |  |           |           |   |           |   |           |              |  |   |          |   |  |       |          |   |          |  
|                                                                             |  |            |            |   |           |   |            |              |  |   |            |   |  | Conversion |        |  | Related to    |   |          |            |  |   |           |   |  |           |           |   |           |   |           |              |  |   |          |   |  |       |          |   |          |  
|                                                                             |  |            |            |   |           |   |            |              |  |   |            |   |  | Features   |        |  | $1,025,000 of |   |          |            |  |   |           |   |  |           |           |   |           |   |           |              |  |   | Warrants |   |  |       |          |   |          |  
|                                                                             |  |            |            |   | 2001      |   |            |              |  |   | Warrants   |   |  | and        |        |  | Convertible   |   |          |            |  |   | Option    |   |  |           |           |   | Warrant   |   |           |              |  |   | Related  |   |  |       |          |   |          |  
|                                                                             |  |            |            |   | Executive |   |            |              |  |   | Related to |   |  | Beneficial |        |  | Bridge Notes  |   |          |            |  |   | Issued to |   |  |           |           |   | Issued to |   |           | 10%          |  |   | to       |   |  |       |          |   |          |  
|                                                                             |  | As         |            |   | Officers  |   |            | Advisory     |  |   | 2004 Stock |   |  | Conversion |        |  | and           |   |          | Warrant    |  |   | Chief     |   |  | Warrant   |           |   | Chief     |   |           | Subordinated |  |   | $750,000 |   |  |       |          |   |          |  
|                                                                             |  | Previously |            |   | Option    |   |            | Board        |  |   | Purchase   |   |  | Features   |        |  | Warrant       |   |          | Issued to  |  |   | Executive |   |  | Issued to |           |   | Financial |   |           | Notes        |  |   | Stock    |   |  |       |          |   | As       |  
|                                                                             |  | Stated     |            |   | Plan      |   |            | Compensation |  |   | Agreement  |   |  | Discount   |        |  | Discount      |   |          | Consultant |  |   | Officer   |   |  | Director  |           |   | Officer   |   |           | Payable      |  |   | Issuance |   |  | Other |          |   | Restated |  
|Basic and dilutive loss per share                                            |  |            | -          |   |           |   |            |              |  |   |            |   |  |            |        |  |               |   |          |            |  |   |           |   |  |           |           |   |           |   |           |              |  |   |          |   |  |       |          |   |          |   |         |   |  |   |          |   |  |   |          |   |  |   | -          |  
|Statement of Operations (since 
inception)                                   |  |            |            |   |           |   |            |              |  |   |            |   |  |            |        |  |               |   |          |            |  |   |           |   |  |           |           |   |           |   |           |              |  |   |          |   |  |       |          |   |          |   |         |   |  |   |          |   |  |   |          |   |  |   |            |  
|General and administrative                                                   |  | $          | 14,680,234 |   |           | $ | 28,361     |              |  | $ | 2,240,253  |   |  | $          | 24,366 |  |               |   |          |            |  |   |           |   |  | $         | 1,033,412 |   |           | $ | 1,033,412 |              |  | $ | 171,520  |   |  | $     | 171,520  |   |          |   |         |   |  | $ | 165,022  |   |  | $ | (526,801 | ) |  | $ | 19,021,299 |  
|Research and development                                                     |  |            | 2,015,071  |   |           |   |            |              |  |   |            |   |  |            |        |  |               |   |          |            |  |   |           |   |  |           |           |   |           |   |           |              |  |   |          |   |  |       |          |   |          |   |         |   |  |   |          |   |  |   | 526,801  |   |  |   | 2,541,872  |  
|Interest expense                                                             |  |            | (1,463,002 | ) |           |   |            |              |  |   |            |   |  |            |        |  |               |   | (303,313 | )          |  |   | (255,021  | ) |  |           |           |   |           |   |           |              |  |   |          |   |  |       |          |   |          |   | (20,169 | ) |  |   |          |   |  |   | (196,214 | ) |  |   | (2,237,719 | )
|Decrease in warrant liability                                                |  |            | 427,991    |   |           |   | 1,814,765  |              |  |   | 1,008,033  |   |  |            | 70,029 |  |               |   |          |            |  |   | 41,737    |   |  |           | 905,054   |   |           |   | 905,054   |              |  |   | 107,900  |   |  |       | 107,900  |   |          |   |         |   |  |   | 8,754    |   |  |   |          |   |  |   | 5,397,217  |  
|Increase in beneficial conversion feature liability                          |  |            | 637,688    |   |           |   |            |              |  |   | (4,044     | ) |  |            |        |  |               |   | (81,759  | )          |  |   |           |   |  |           |           |   |           |   |           |              |  |   |          |   |  |       |          |   |          |   |         |   |  |   |          |   |  |   |          |   |  |   | 551,885    |  
|Write-off of beneficial conversion feature                                   |  |            |            |   |           |   |            |              |  |   | 380,440    |   |  |            |        |  |               |   |          |            |  |   |           |   |  |           |           |   |           |   |           |              |  |   |          |   |  |       |          |   |          |   |         |   |  |   |          |   |  |   |          |   |  |   | 380,440    |  
|                                                                             |  |            |            |   |           |   |            |              |  |   |            |   |  |            |        |  |               |   |          |            |  |   |           |   |  |           |           |   |           |   |           |              |  |   |          |   |  |       |          |   |          |   |         |   |  |   |          |   |  |   |          |   |  |   |            |  
|Statement of Cash Flows (for the six months ended March 31, 2008)            |  |            |            |   |           |   |            |              |  |   |            |   |  |            |        |  |               |   |          |            |  |   |           |   |  |           |           |   |           |   |           |              |  |   |          |   |  |       |          |   |          |   |         |   |  |   |          |   |  |   |          |   |  |   |            |  
|Net loss                                                                     |  | $          | (2,077,833 | ) |           | $ | 1,469,800  |              |  | $ | (169,232   | ) |  |            |        |  |               | $ | (48,943  | )          |  | $ | (179,867  | ) |  | $         | (128,358  | ) |           | $ | (128,358  | )            |  | $ | (63,620  | ) |  | $     | (63,620  | ) |          | $ | (20,169 | ) |  | $ | (156,268 | ) |  | $ | (32,874  | ) |  | $ | (1,599,342 | )
|Amortization of beneficial conversion features discount and warrant discount |  |            | 669,025    |   |           |   |            |              |  |   | 10,072     |   |  |            |        |  |               |   | (32,816  | )          |  |   | 167,287   |   |  |           |           |   |           |   |           |              |  |   |          |   |  |       |          |   |          |   | 20,169  |   |  |   |          |   |  |   | 38       |   |  |   | 833,775    |  
|Stock based compensation expense- employee                                   |  |            | 414,908    |   |           |   |            |              |  |   |            |   |  |            |        |  |               |   |          |            |  |   |           |   |  |           | 1,033,412 |   |           |   |           |              |  |   | 171,520  |   |  |       | 171,520  |   |          |   |         |   |  |   |          |   |  |   |          |   |  |   | 1,791,360  |  
|Stock based compensation expense- consultant                                 |  |            | 439,909    |   |           |   |            |              |  |   | 1,557,705  |   |  |            |        |  |               |   |          |            |  |   |           |   |  |           |           |   |           |   | 1,008,413 |              |  |   |          |   |  |       |          |   |          |   |         |   |  |   | 165,022  |   |  |   |          |   |  |   | 3,171,049  |  
|(Decrease) increase in warrant liability                                     |  |            | (427,991   | ) |           |   | (1,469,800 | )            |  |   | (1,008,033 | ) |  |            |        |  |               |   |          |            |  |   | 12,580    |   |  |           | (905,054  | ) |           |   | (905,054  | )            |  |   | (107,900 | ) |  |       | (107,900 | ) |          |   |         |   |  |   | (8,754   | ) |  |   |          |   |  |   | (4,927,906 | )
|Increase in beneficial conversion  feature liability                         |  |            | (637,688   | ) |           |   |            |              |  |   |            |   |  |            |        |  |               |   | 81,759   |            |  |   |           |   |  |           |           |   |           |   |           |              |  |   |          |   |  |       |          |   |          |   |         |   |  |   |          |   |  |   |          |   |  |   | (555,929   | )
|Write-off of beneficial conversion
feature                                   |  |            |            |   |           |   |            |              |  |   |            |   |  |            |        |  |               |   |          |            |  |   |           |   |  |           |           |   |           |   |           |              |  |   |          |   |  |       |          |   |          |   |         |   |  |   |          |   |  |   |          |   |  |   |            |  
|Accounts payable                                                             |  |            | 312,738    |   |           |   |            |              |  |   |            |   |  |            |        |  |               |   |          |            |  |   |           |   |  |           |           |   |           |   |           |              |  |   |          |   |  |       |          |   |          |   |         |   |  |   |          |   |  |   | 32,987   |   |  |   | 345,725    |  
|Accrued expenses                                                             |  |            | 159,581    |   |           |   |            |              |  |   | 576,000    |   |  |            |        |  |               |   |          |            |  |   |           |   |  |           |           |   |           |   |           |              |  |   |          |   |  |       |          |   |          |   |         |   |  |   |          |   |  |   |          |   |  |   | 735,581    |  
|Cash and cash equivalents                                                    |  |            | 102,604    |   |           |   |            |              |  |   |            |   |  |            |        |  |               |   |          |            |  |   |           |   |  |           |           |   |           |   |           |              |  |   |          |   |  |       |          |   |          |   |         |   |  |   |          |   |  |   | 151      |   |  |   | 102,755    |  







36



---







|                                                                            |  |            |             |   |           |   |            |              |  |   |            |   |  |            |         |   |               |   |          |            |  |   |           |   |  |           |           |   |           |   |           |              |  |   |          |   |  |       |          |   |          |   |         |   |  |   |          |   |  |   |            |   |  |   |             |  
|--------------------------------------------------------------------------- |  | ---------- | ----------- | - | --------- | - | ---------- | ------------ |  | - | ---------- | - |  | ---------- | ------- | - | ------------- | - | -------- | ---------- |  | - | --------- | - |  | --------- | --------- | - | --------- | - | --------- | ------------ |  | - | -------- | - |  | ----- | -------- | - | -------- | - | ------- | - |  | - | -------- | - |  | - | ---------- | - |  | - | ----------- | -
|                                                                            |  |            |             |   |           |   |            |              |  |   |            |   |  | Beneficial |         |   | Warrant       |   |          |            |  |   |           |   |  |           |           |   |           |   |           |              |  |   |          |   |  |       |          |   |          |  
|                                                                            |  |            |             |   |           |   |            |              |  |   |            |   |  | Conversion |         |   | Related to    |   |          |            |  |   |           |   |  |           |           |   |           |   |           |              |  |   |          |   |  |       |          |   |          |  
|                                                                            |  |            |             |   |           |   |            |              |  |   |            |   |  | Features   |         |   | $1,025,000 of |   |          |            |  |   |           |   |  |           |           |   | Warrant   |   |           |              |  |   | Warrants |   |  |       |          |   |          |  
|                                                                            |  |            |             |   | 2001      |   |            |              |  |   | Warrants   |   |  | and        |         |   | Convertible   |   |          |            |  |   | Option    |   |  |           |           |   | Issued    |   |           |              |  |   | Related  |   |  |       |          |   |          |  
|                                                                            |  |            |             |   | Executive |   |            |              |  |   | Related to |   |  | Beneficial |         |   | Bridge Notes  |   |          |            |  |   | Issued to |   |  |           |           |   | to        |   |           | 10%          |  |   | To       |   |  |       |          |   |          |  
|                                                                            |  | As         |             |   | Officers  |   |            | Advisory     |  |   | 2004 Stock |   |  | Conversion |         |   | and           |   |          | Warrant    |  |   | Chief     |   |  | Warrant   |           |   | Chief     |   |           | Subordinated |  |   | $750,000 |   |  |       |          |   |          |  
|                                                                            |  | Previously |             |   | Option    |   |            | Board        |  |   | Purchase   |   |  | Features   |         |   | Warrant       |   |          | Issued to  |  |   | Executive |   |  | Issued to |           |   | Financial |   |           | Notes        |  |   | Stock    |   |  |       |          |   | As       |  
|                                                                            |  | Stated     |             |   | Plan      |   |            | Compensation |  |   | Agreement  |   |  | Discount   |         |   | Discount      |   |          | Consultant |  |   | Officer   |   |  | Director  |           |   | Officer   |   |           | Payable      |  |   | Issuance |   |  | Other |          |   | Restated |  
|Statement of Cash Flows (since
 inception)                                  |  |            |             |   |           |   |            |              |  |   |            |   |  |            |         |   |               |   |          |            |  |   |           |   |  |           |           |   |           |   |           |              |  |   |          |   |  |       |          |   |          |   |         |   |  |   |          |   |  |   |            |   |  |   |             |  
|Net loss                                                                    |  | $          | (19,377,983 | ) |           | $ | 1,786,404  |              |  | $ | (855,824   | ) |  | $          | 45,663  |   |               | $ | (385,072 | )          |  | $ | (213,284  | ) |  | $         | (128,358  | ) |           | $ | (128,358  | )            |  | $ | (63,620  | ) |  | $     | (63,620  | ) |          | $ | (20,169 | ) |  | $ | (156,268 | ) |  | $ | (59,689    | ) |  | $ | (19,620,178 | )
|Amortization of beneficial conversion feature discount and warrant discount |  |            | 984,402     |   |           |   |            |              |  |   | 153,888    |   |  |            |         |   |               |   | 303,313  |            |  |   | 255,021   |   |  |           |           |   |           |   |           |              |  |   |          |   |  |       |          |   |          |   | 20,169  |   |  |   |          |   |  |   |            |   |  |   | 1,716,793   |  
|Stock based compensation expense - employee                                 |  |            | 414,908     |   |           |   |            |              |  |   |            |   |  |            |         |   |               |   |          |            |  |   |           |   |  |           |           |   |           |   | 1,033,412 |              |  |   | 171,520  |   |  |       | 171,520  |   |          |   |         |   |  |   |          |   |  |   | 1,835,957  |   |  |   | 3,627,317   |  
|Stock based compensation expense - non-employee                             |  |            | 439,909     |   |           |   | 636,661    |              |  |   | 1,557,705  |   |  |            | 24,366  |   |               |   |          |            |  |   |           |   |  |           | 1,033,412 |   |           |   |           |              |  |   |          |   |  |       |          |   |          |   |         |   |  |   | 156,268  |   |  |   | 2,287,597  |   |  |   | 6,135,918   |  
|Warrants issued for consulting services                                     |  |            | 106,111     |   |           |   |            |              |  |   |            |   |  |            |         |   |               |   |          |            |  |   |           |   |  |           |           |   |           |   |           |              |  |   |          |   |  |       |          |   |          |   |         |   |  |   |          |   |  |   | (106,111   | ) |  |   | -           |  
|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                                               |  |            | (427,991    | ) |           |   | (1,814,765 | )            |  |   | (1,008,033 | ) |  |            | (70,029 | ) |               |   |          |            |  |   | (41,737   | ) |  |           | (905,054  | ) |           |   | (905,054  | )            |  |   | (107,900 | ) |  |       | (107,900 | ) |          |   |         |   |  |   | (8,754   | ) |  |   |            |   |  |   | (5,397,217  | )
|Decrease in beneficial conversion feature liability                         |  |            | (637,689    | ) |           |   |            |              |  |   |            |   |  |            |         |   |               |   | 85,804   |            |  |   |           |   |  |           |           |   |           |   |           |              |  |   |          |   |  |       |          |   |          |   |         |   |  |   |          |   |  |   |            |   |  |   | (551,885    | )
|Write-off of beneficial conversion feature                                  |  |            |             |   |           |   |            |              |  |   | (380,440   | ) |  |            |         |   |               |   |          |            |  |   |           |   |  |           |           |   |           |   |           |              |  |   |          |   |  |       |          |   |          |   |         |   |  |   |          |   |  |   | (380,440   | ) |  |   |             |  
|Loss on termination of lease                                                |  |            |             |   |           |   |            |              |  |   |            |   |  |            |         |   |               |   |          |            |  |   |           |   |  |           |           |   |           |   |           |              |  |   |          |   |  |       |          |   |          |   |         |   |  |   |          |   |  |   | 129,166    |   |  |   | 129,166     |  
|Accrual of liquidating damages                                              |  |            | 138,375     |   |           |   |            |              |  |   |            |   |  |            |         |   |               |   |          |            |  |   |           |   |  |           |           |   |           |   |           |              |  |   |          |   |  |       |          |   |          |   |         |   |  |   |          |   |  |   | 15,375     |   |  |   | 153,750     |  
|Decrease in other receivables                                               |  |            |             |   |           |   |            |              |  |   |            |   |  |            |         |   |               |   |          |            |  |   |           |   |  |           |           |   |           |   |           |              |  |   |          |   |  |       |          |   |          |   |         |   |  |   |          |   |  |   |            |   |  |   | -           |  
|Increase in deposits                                                        |  |            |             |   |           |   |            |              |  |   |            |   |  |            |         |   |               |   |          |            |  |   |           |   |  |           |           |   |           |   |           |              |  |   |          |   |  |       |          |   |          |   |         |   |  |   |          |   |  |   |            |   |  |   | -           |  
|Other                                                                       |  |            |             |   |           |   |            |              |  |   |            |   |  |            |         |   |               |   |          |            |  |   |           |   |  |           |           |   |           |   |           |              |  |   |          |   |  |       |          |   |          |   |         |   |  |   |          |   |  |   |            |   |  |   | -           |  
|Other current assets                                                        |  |            | (545,727    | ) |           |   |            |              |  |   |            |   |  |            |         |   |               |   |          |            |  |   |           |   |  |           |           |   |           |   |           |              |  |   |          |   |  |       |          |   |          |   |         |   |  |   |          |   |  |   | 510,727    |   |  |   | (35,000     | )
|Other receivables                                                           |  |            | 3,000       |   |           |   |            |              |  |   |            |   |  |            |         |   |               |   |          |            |  |   |           |   |  |           |           |   |           |   |           |              |  |   |          |   |  |       |          |   |          |   |         |   |  |   |          |   |  |   |            |   |  |   |             |  
|Deposits                                                                    |  |            | (204,600    | ) |           |   |            |              |  |   |            |   |  |            |         |   |               |   |          |            |  |   |           |   |  |           |           |   |           |   |           |              |  |   |          |   |  |       |          |   |          |   |         |   |  |   |          |   |  |   |            |   |  |   |             |  
|Other assets                                                                |  |            | 140,370     |   |           |   |            |              |  |   |            |   |  |            |         |   |               |   |          |            |  |   |           |   |  |           |           |   |           |   |           |              |  |   |          |   |  |       |          |   |          |   |         |   |  |   |          |   |  |   | (244,970   | ) |  |   | (104,600    | )
|Accounts payable                                                            |  |            | 540,139     |   |           |   |            |              |  |   |            |   |  |            |         |   |               |   |          |            |  |   |           |   |  |           |           |   |           |   |           |              |  |   |          |   |  |       |          |   |          |   |         |   |  |   |          |   |  |   | (37,015    | ) |  |   | 503,124     |  
|Accrued expenses                                                            |  |            | 1,991,622   |   |           |   |            |              |  |   | 189,698    |   |  |            |         |   |               |   |          |            |  |   |           |   |  |           |           |   |           |   |           |              |  |   |          |   |  |       |          |   |          |   |         |   |  |   |          |   |  |   |            |   |  |   | 2,181,320   |  
|Acquisition of machinery and equipment                                      |  |            | (437,112    | ) |           |   |            |              |  |   |            |   |  |            |         |   |               |   |          |            |  |   |           |   |  |           |           |   |           |   |           |              |  |   |          |   |  |       |          |   |          |   |         |   |  |   |          |   |  |   | 36,493     |   |  |   | (400,619    | )
|Proceeds from issuance of notes                                             |  |            |             |   |           |   |            |              |  |   |            |   |  |            |         |   |               |   |          |            |  |   |           |   |  |           |           |   |           |   |           |              |  |   |          |   |  |       |          |   |          |   |         |   |  |   |          |   |  |   | -          |   |  |   |             |  
|Proceeds from convertible notes payable                                     |  |            | 2,544,191   |   |           |   |            |              |  |   |            |   |  |            |         |   |               |   |          |            |  |   |           |   |  |           |           |   |           |   |           |              |  |   |          |   |  |       |          |   |          |   |         |   |  |   |          |   |  |   | (683,191   | ) |  |   | 1,861,000   |  
|Proceeds from 10% subordinated notes payable                                |  |            |             |   |           |   |            |              |  |   |            |   |  |            |         |   |               |   |          |            |  |   |           |   |  |           |           |   |           |   |           |              |  |   |          |   |  |       |          |   |          |   |         |   |  |   | 425,000  |   |  |   | 425,000    |   |  |   |             |  
|Receipt from (payments to) equity line of credit                            |  |            | 456,000     |   |           |   |            |              |  |   |            |   |  |            |         |   |               |   |          |            |  |   |           |   |  |           |           |   |           |   |           |              |  |   |          |   |  |       |          |   |          |   |         |   |  |   |          |   |  |   | (27,336    | ) |  |   | 428,664     |  
|Proceeds from notes payable to related party                                |  |            |             |   |           |   |            |              |  |   |            |   |  |            |         |   |               |   |          |            |  |   |           |   |  |           |           |   |           |   |           |              |  |   |          |   |  |       |          |   |          |   |         |   |  |   | 457,433  |   |  |   | 457,433    |   |  |   |             |  
|Payments on notes payable to related party                                  |  |            |             |   |           |   |            |              |  |   |            |   |  |            |         |   |               |   |          |            |  |   |           |   |  |           |           |   |           |   |           |              |  |   |          |   |  |       |          |   |          |   |         |   |  |   | (5,000   | ) |  |   | (5,000     | ) |  |   |             |  
|Payment on notes to officers                                                |  |            | (51,596     | ) |           |   |            |              |  |   |            |   |  |            |         |   |               |   |          |            |  |   |           |   |  |           |           |   |           |   |           |              |  |   |          |   |  |       |          |   |          |   |         |   |  |   |          |   |  |   | (166,906   | ) |  |   | (218,502    | )
|Issuance of common stock for cash                                           |  |            | 7,376,094   |   |           |   |            |              |  |   |            |   |  |            |         |   |               |   |          |            |  |   |           |   |  |           |           |   |           |   |           |              |  |   |          |   |  |       |          |   |          |   |         |   |  |   |          |   |  |   | 10,000     |   |  |   | 7,386,094   |  
|Receipt of cash for stock to be issued                                      |  |            | 336,900     |   |           |   |            |              |  |   |            |   |  |            |         |   |               |   |          |            |  |   |           |   |  |           |           |   |           |   |           |              |  |   |          |   |  |       |          |   |          |   |         |   |  |   |          |   |  |   | (10,000    | ) |  |   | 326,900     |  





37



---





Table 2 - 2007

|                                                                             |  |            |          |   |          |           |  |              |  |   |           |   |            |            |  |            |          |            |         |            |             |         |           |  |  |           |  |  |           |  |  |              |           |  |       |     |          |    |  |  |  |  |  |  |  |  |         |   |   |          |  
|---------------------------------------------------------------------------- |  | ---------- | -------- | - | -------- | --------- |  | ------------ |  | - | --------- | - | ---------- | ---------- |  | ---------- | -------- | ---------- | ------- | ---------- | ----------- | ------- | --------- |  |  | --------- |  |  | --------- |  |  | ------------ | --------- |  | ----- | --- | -------- | -- |  |  |  |  |  |  |  |  | ------- | - | - | -------- | -
|                                                                             |  |            |          |   |          |           |  |              |  |   |           |   |            |            |  |            |          |            |         |            |             | Warrant |           |  |  |           |  |  |           |  |  |              |           |  |       |     |          |    |  |  |  |  |  |  |  |  |         |   |   |         
|                                                                             |  |            |          |   |          |           |  |              |  |   |           |   |            |            |  |            |          |            |         |            |             | Related |           |  |  |           |  |  |           |  |  |              |           |  |       |     |          |    |  |  |  |  |  |  |  |  |         |   |   |         
|                                                                             |  |            |          |   |          |           |  |              |  |   |           |   |            |            |  |            |          |            |         |            |             | to      |           |  |  |           |  |  |           |  |  |              |           |  |       |     |          |    |  |  |  |  |  |  |  |  |         |   |   |         
|                                                                             |  |            |          |   |          |           |  |              |  |   |           |   |            |            |  |            |          | Beneficial |         |            | $1,025,000  |         |           |  |  |           |  |  |           |  |  |              |           |  |       |     |          |    |  |  |  |  |  |  |  |  |         |   |  
|                                                                             |  |            |          |   |          |           |  |              |  |   |           |   |            |            |  |            |          | Conversion |         |            | of          |         |           |  |  |           |  |  |           |  |  |              |           |  |       |     |          |    |  |  |  |  |  |  |  |  |         |   |  
|                                                                             |  |            |          |   |          |           |  |              |  |   |           |   |            | Warrants   |  |            |          | Features   |         |            | Convertible |         |           |  |  |           |  |  |           |  |  |              |           |  |       |     |          |    |  |  |  |  |  |  |  |  |         |   |  
|                                                                             |  |            |          |   |          | 2001      |  |              |  |   |           |   | Related to |            |  | And        |          |            | Notes   |            |             |         |           |  |  | Option    |  |  |           |  |  |              | Warrant   |  |       |     |          |    |  |  |  |  |  |  | 
|                                                                             |  |            |          |   |          | Executive |  |              |  |   |           |   | 2004       |            |  | Beneficial |          |            | Bridge  |            |             | Warrant |           |  |  | Issued to |  |  | Warrant   |  |  |              | Issued to |  |       | 10% |          |    |  |  |  |  |  | 
|                                                                             |  | As         |          |   | Officers |           |  | Advisory     |  |   | Stock     |   |            | Conversion |  |            | and      |            |         | Issued     |             |         | Executive |  |  | Issued    |  |  | Chief     |  |  | Subordinated |           |  |       |     |          |    |  | 
|                                                                             |  | Previously |          |   | Option   |           |  | Board        |  |   | Purchase  |   |            | Features   |  |            | Warrant  |            |         | to         |             |         | Chief     |  |  | to        |  |  | Financial |  |  | Notes        |           |  |       |     |          | As | 
|                                                                             |  | Stated     |          |   | Plans    |           |  | Compensation |  |   | Agreement |   |            | Discount   |  |            | Discount |            |         | Consultant |             |         | Officer   |  |  | Director  |  |  | Officer   |  |  | Payable      |           |  | Other |     | Restated |   
|                                                                             |  |            |          |   |          |           |  |              |  |   |           |   |            |            |  |            |          |            |         |            |             |         |           |  |  |           |  |  |           |  |  |              |           |  |       |     |          |    |  |  |  |  |  |  |  |  |         |   |   |          |  
|Statement of Operations (for the  three months ended March 31, 2007)         |  |            |          |   |          |           |  |              |  |   |           |   |            |            |  |            |          |            |         |            |             |         |           |  |  |           |  |  |           |  |  |              |           |  |       |     |          |    |  |  |  |  |  |  |  |  |         |   |   |          |  
|General and administrative                                                   |  | $          | 282,804  |   |          |           |  |              |  | $ | 50,840    |   |            |            |  |            |          |            |         |            |             |         |           |  |  |           |  |  |           |  |  |              |           |  |       |     |          |    |  |  |  |  |  |  |  |  |         |   | $ | 333,644  |  
|Basic and dilutive loss per share                                            |  |            | -        |   |          |           |  |              |  |   |           |   |            |            |  |            |          |            |         |            |             |         |           |  |  |           |  |  |           |  |  |              |           |  |       |     |          |    |  |  |  |  |  |  |  |  |         |   |   | -        |  
|                                                                             |  |            |          |   |          |           |  |              |  |   |           |   |            |            |  |            |          |            |         |            |             |         |           |  |  |           |  |  |           |  |  |              |           |  |       |     |          |    |  |  |  |  |  |  |  |  |         |   |   |          |  
|Statement of Operations (for the six months ended March 31, 2007)            |  |            |          |   |          |           |  |              |  |   |           |   |            |            |  |            |          |            |         |            |             |         |           |  |  |           |  |  |           |  |  |              |           |  |       |     |          |    |  |  |  |  |  |  |  |  |         |   |   |          |  
|General and administrative                                                   |  | $          | 487,224  |   |          |           |  |              |  | $ | 123,144   |   |            |            |  |            |          |            |         |            |             |         |           |  |  |           |  |  |           |  |  |              |           |  |       |     |          |    |  |  |  |  |  |  |  |  |         |   | $ | 610,368  |  
|Interest expense                                                             |  |            | (70,588  | ) |          |           |  |              |  |   |           |   |            |            |  |            |          |            | (89,686 | )          |             |         |           |  |  |           |  |  |           |  |  |              |           |  |       |     |          |    |  |  |  |  |  |  |  |  |         |   |   | (160,274 | )
|Basic and dilutive loss per share                                            |  |            | -        |   |          |           |  |              |  |   |           |   |            |            |  |            |          |            |         |            |             |         |           |  |  |           |  |  |           |  |  |              |           |  |       |     |          |    |  |  |  |  |  |  |  |  |         |   |   | -        |  
|                                                                             |  |            |          |   |          |           |  |              |  |   |           |   |            |            |  |            |          |            |         |            |             |         |           |  |  |           |  |  |           |  |  |              |           |  |       |     |          |    |  |  |  |  |  |  |  |  |         |   |   |          |  
|Statement of Cash Flows (for the six months ended March 31, 2007)            |  |            |          |   |          |           |  |              |  |   |           |   |            |            |  |            |          |            |         |            |             |         |           |  |  |           |  |  |           |  |  |              |           |  |       |     |          |    |  |  |  |  |  |  |  |  |         |   |   |          |  
|Net loss                                                                     |  | $          | (573,889 | ) |          |           |  |              |  | $ | (123,144  | ) |            |            |  |            |          | $          | (89,686 |            |             |         |           |  |  |           |  |  |           |  |  |              |           |  |       |     |          |    |  |  |  |  |  |  |  |  |         |   | $ | (786,719 | )
|Amortization of beneficial conversion features discount and warrant discount |  |            | 27,838   |   |          |           |  |              |  |   |           |   |            |            |  |            |          |            | 89,686  |            |             |         |           |  |  |           |  |  |           |  |  |              |           |  |       |     |          |    |  |  |  |  |  |  |  |  |         |   |   | 117,524  |  
|Accrued interest                                                             |  |            | 42,750   |   |          |           |  |              |  |   |           |   |            |            |  |            |          |            |         |            |             |         |           |  |  |           |  |  |           |  |  |              |           |  |       |     |          |    |  |  |  |  |  |  |  |  | (42,750 | ) |   | -        |  
|Accrued expenses                                                             |  |            | 168,959  |   |          |           |  |              |  |   | 123,144   |   |            |            |  |            |          |            |         |            |             |         |           |  |  |           |  |  |           |  |  |              |           |  |       |     |          |    |  |  |  |  |  |  |  |  | 42,750  |   |   | 334,853  |  









38



---





NOTE 15   SECOND RESTATEMENT

As discussed in Note 14  RESTATEMENT, the Company restated its March 31, 2008 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 mature on or about December 31, 2008, and are 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 March 31, 2008. The analysis and results were as follows:

Warrants and Options Liability

As of March 31, 2008, the Company had 26,074,766 warrants outstanding and 11,595,934 options outstanding that were vested at that date.

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 March 31, 2008, the Company determined the fair value of all warrants and options to be $3,610,562 and $1,598,536, respectively, using the Black Sholes model with the following assumptions:

·

risk free rate of return between 1.79% and 2.46%;

·

volatility between 242% and 263%;

·

dividend yield of 0%; and

·

expected term between 2.95 years and 5.76 years.

Statement of Operations

For the three and six months ended March 31, 2008, the Company recorded $2,402,795 and $984,063, respectively, as a loss 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 $984,063.

Beneficial Conversion Liability

As of March 31, 2008, the Company had $1,955,000 in convertible notes and accrued compensation that could be converted into 102,090,403 shares.





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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 March 31, 2008, the Company determined the fair value of the embedded conversion features to be $12,718,034 using the Black Sholes model with the following assumptions:

·

risk free rate of return between 1.22% and 1.55%;

·

volatility between 119% and 120%;

·

dividend yield of 0%; and

·

expected term of 0.05 years to 0.75 years.

Statement of Operations

For the three and six months ended March 31, 2008, the Company recorded $10,740,797 and $18,366,949, respectively, 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 $18,366,949 change in fair value of the beneficial conversion liability.





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The following table shows the effect of each of the changes discussed above on the Companys balance sheet, statement of operation, and statement of cash flows for the six months ended March 31, 2008.

|                                                                       |  |                      |             |   |                                |  |             |                     |  |  |                            |   |  |  |             |  
|---------------------------------------------------------------------- |  | -------------------- | ----------- | - | ------------------------------ |  | ----------- | ------------------- |  |  | -------------------------- | - |  |  | ----------- | -
|                                                                       |  | As Previously Stated |             |   | Beneficial
Conversion
Features |  |             | Option and
Warrants |  |  | As Restated
March 31, 2008 |  
|Balance Sheet                                                          |  |                      |             |   |                                |  |             |                     |  |  |                            |  
|Warrant and option liability                                           |  |                      | 2,558,164   |   |                                |  | -           |                     |  |  | 2,650,935                  |   |  |  | 5,209,099   |  
|Beneficial conversion feature liability                                |  |                      | 874,882     |   |                                |  | 11,843,152  |                     |  |  | -                          |   |  |  | 12,718,034  |  
|Additional paid in capital                                             |  |                      | 10,837,605  |   |                                |  | -           |                     |  |  | 432,683                    |   |  |  | 10,404,922  |  
|Deficit accumulated during developmental stage                         |  |                      | (19,620,178 | ) |                                |  | (11,843,152 | )                   |  |  | (2,218,252                 | ) |  |  | (33,681,582 | )
|                                                                       |  |                      |             |   |                                |  |             |                     |  |  |                            |   |  |  |             |  
|Statement of Operations (for the three months ended
March 31, 2008)    |  |                      |             |   |                                |  |             |                     |  |  |                            |   |  |  |             |  
|Gain (loss) on change in fair value of warrant and option liability    |  |                      | 4,168,132   |   |                                |  | -           |                     |  |  | (2,402,795                 | ) |  |  | 1,765,337   |  
|Gain (loss) on change in fair value of beneficial conversion liability |  |                      | 347,780     |   |                                |  | 10,740,797  |                     |  |  | -                          |   |  |  | 11,088,577  |  
|                                                                       |  |                      |             |   |                                |  |             |                     |  |  |                            |   |  |  |             |  
|Statement of Operations (for the six months ended
March 31, 2008)      |  |                      |             |   |                                |  |             |                     |  |  |                            |   |  |  |             |  
|Gain (loss) on change in fair value of warrant and option liability    |  |                      | 4,927,906   |   |                                |  | -           |                     |  |  | (984,063                   | ) |  |  | 3,943,843   |  
|Gain on change in fair value of beneficial conversion liability        |  |                      | 555,929     |   |                                |  | 18,366,949  |                     |  |  | -                          |   |  |  | 18,922,878  |  
|                                                                       |  |                      |             |   |                                |  |             |                     |  |  |                            |   |  |  |             |  
|Statement of Operations (since inception)                              |  |                      |             |   |                                |  |             |                     |  |  |                            |   |  |  |             |  
|Gain (loss) on change in fair value of warrant and option liability    |  |                      | 5,397,217   |   |                                |  | -           |                     |  |  | (1,124,901                 | ) |  |  | 4,272,316   |  
|Gain on change in fair value of beneficial conversion liability        |  |                      | 551,885     |   |                                |  | 22,285,024  |                     |  |  | -                          |   |  |  | 22,836,909  |  
|General and administrative expense                                     |  |                      | 19,021,299  |   |                                |  | 3,787,032   |                     |  |  | -                          |   |  |  | 22,808,331  |  
|Interest expense and financing costs                                   |  |                      | (1,857,279  | ) |                                |  | (30,536,702 | )                   |  |  | (897,793                   | ) |  |  | (33,291,774 | )
|                                                                       |  |                      |             |   |                                |  |             |                     |  |  |                            |   |  |  |             |  
|Statement of Cash Flows (for the six months ended
March 31, 2008)      |  |                      |             |   |                                |  |             |                     |  |  |                            |   |  |  |             |  
|Net income (loss)                                                      |  |                      | (1,599,342  | ) |                                |  | 18,366,949  |                     |  |  | (984,063                   | ) |  |  | 15,783,544  |  
|(Gain) loss on change in fair value of warrant and option liability    |  |                      | (4,927,906  | ) |                                |  | -           |                     |  |  | 984,063                    |   |  |  | (3,943,843  | )
|Gain on change in fair value of beneficial conversion liability        |  |                      | (555,929    | ) |                                |  | (18,366,949 | )                   |  |  | -                          |   |  |  | (18,922,878 | )
|                                                                       |  |                      |             |   |                                |  |             |                     |  |  |                            |   |  |  |             |  
|Statement of Cash Flows (since inception)                              |  |                      |             |   |                                |  |             |                     |  |  |                            |   |  |  |             |  
|Net income (loss)                                                      |  |                      | (19,620,178 | ) |                                |  | (12,038,710 | )                   |  |  | (2,022,694                 | ) |  |  | (33,681,582 | )
|(Gain) loss on change in fair value of warrant and option liability    |  |                      | (5,494,031  | ) |                                |  | -           |                     |  |  | 1,124,901                  |   |  |  | (4,369,130  | )
|Gain on change in fair value of beneficial conversion liability        |  |                      | (551,885    | ) |                                |  | (22,285,024 | )                   |  |  | -                          |   |  |  | (22,836,909 | )
|Non-cash compensation expense                                          |  |                      | -           |   |                                |  | 3,787,032   |                     |  |  | -                          |   |  |  | 3,787,032   |  
|Non-cash financing costs                                               |  |                      | -           |   |                                |  | 30,536,702  |                     |  |  | 897,793                    |   |  |  | 31,434,495  |  







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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.





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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 to 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

Subsequent to filing Form 10-QSB for the six months ended March 31, 2008, the Company determined that the beneficial conversion feature discounts and warrant discounts related to the issuance of the convertible notes payable were not properly accounted for, and certain warrants and options were omitted. As a result, the Company recorded the following adjustments.

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.





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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 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 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 fiscal 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 Company began the analysis for the restatement by applying FASB 133, paragraph 6 to ascertain if the options remained derivatives as of March 31, 2008. 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 $457,114 as of March 31, 2008 and was calculated using the Black Sholes valuation model with the following assumptions: risk free rate of return of 1.56%; volatility of 72.53%; dividend yield of 0%; and an expected term of 3 years.

The decrease in the fair value of the options was $766,474 for the three months ended March 31, 2008, and recorded by decreasing the warrant liability on the balance sheet.

The decrease in the fair value of the options was $1,469,800 for the six months ended March 31, 2008, 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 March 31, 2008 was $766,474 and included in decrease in warrant liability in the other income (expense) section of the statement of operations.

The change in the fair value of the options for the six months ended March 31, 2008 was $1,469,800 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 for the six months ended March 31, 2008 was the result of the change in the fair value of the options of $1,469,800.





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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. On December 13, 2007 the advisory board members agreed to forfeit the ability to convert their compensation into shares of common stock in exchange for warrants exercisable at $0.25 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 March 31, 2008, no payments have been made to any advisory board members, there has been no conversion by any Advisory Board members of the accrued liability into shares of common stock, and no warrant has been exercised.

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 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.

On December 13, 2007 the advisory board members agreed to forfeit the ability to convert their compensation into shares of common stock in exchange for warrants. As a result, the beneficial conversion feature of $576,000 and the unamortized beneficial conversion feature discount of $195,560 were written off for a net of $380,440.

The beneficial conversion features discount amortization was $15,104 for the three and six months ended March 31, 2008, 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 or six months ended March 31, 2008.

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 and six months ended March 31, 2008.

The beneficial conversion feature of $576,000 and the beneficial conversion feature discount of $195,560 were written off for a net of $380,440 and have been included in the other income (expense) section of the statement of income (operations) for the three and six months ended March 31, 2008.

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, and the net write off of beneficial conversion feature and beneficial conversion feature discount of $380,440 on the statement of operations.





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Warrants Related to 2004 Stock Purchase Agreement

Under the terms of a 2004 Stock Purchase Agreement, the Company issued warrants to purchase 1,463,336 shares of common stock at an exercise price of $0.03 which 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 $24,366 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, $24,366 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 March 31, 2008.

Statement of Operations

There was no change in the fair value of the warrants for the three months ended March 31, 2008, due to their expiration.

Statement of Cash Flows

There was no change in the statement of cash flows for the three months ended March 31, 2008.

Beneficial Conversion Features

As of March 31, 2008, the Company had Convertible Bridge Notes outstanding totaling $1,811,000 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

The Company began the analysis for the restatement as of and for the six months ended March 31, 2008 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





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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 $874,882 as of March 31, 2008, which was calculated using the Black Sholes valuation model with the following assumptions: risk free rate of return of 1.56%; volatility of 72.53%; dividend yield of 0%; and an expected term of .08 to .33 years.

The decrease in the fair value of the beneficial conversion features was determined to be $347,850 for the three months ended March 31, 2008, and was recorded in beneficial conversion features liability on the balance sheet.

The decrease in the fair value of the beneficial conversion features was determined to be $555,929 for the six months ended March 31, 2008, and was recorded in beneficial conversion features liability on the balance sheet.

The amortization of the beneficial conversion features discount was $285,610 for the three months ended March 31, 2008, which increased convertible notes.

The amortization of the beneficial conversion features discount was $573,646 for the six months ended March 31, 2008, 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 $347,850 for the three months ended March 31, 2008, and was recorded in increase (decrease) in beneficial conversion features liability, in the other income (expense) section of the statement of operations.

The decrease in the fair value of the beneficial conversion features was determined to be $555,929 for the six months ended March 31, 2008, 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 $285,610 for the three months ended March 31, 2008, and was recorded in interest expense in the other income (expense) section of the statement of operations.

The amortization of the beneficial conversion features discount was $573,646 for the six months ended March 31, 2008, 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 for the three months ended March 31, 2008 were the result of the decrease in the fair value of the beneficial conversion features liability of $347,850 and the amortization of the beneficial conversion features discounts of $285,610 on the statement of operations.

Changes in the statement of cash flows for the six months ended March 31, 2008 were the result of the decrease in the fair value of the beneficial conversion features liability of $555,929 and the amortization of the beneficial conversion features discounts of $573,646 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 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. An amendment to the convertible notes dated March 13, 2008 reduced the exercise price to $0.30 per share.





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Balance Sheet

The Company began the analysis for the restatement of the financial statements as of and for the six months ended March 31, 2008 by applying FASB 133, paragraph 6 to ascertain if the warrants issued remained derivatives as of March 31, 2008. All of the criteria in the original analysis were met, and the warrants issued were determined to be within the scope and definition of a derivative. EITF 00-19, paragraph 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.

The fair value of the warrants was determined to be $135,950 as of March 31, 2008, and was calculated using the Black Sholes valuation model with the following assumptions: risk free rate of return of 1.56%; volatility of 72.53%; dividend yield of 0%; and an expected term of 4.17 to 4.25 years.

The decrease in the fair value of the warrants was determined to be $185,827 for the three months ended March 31, 2008, and recorded by decreasing warrant liabilities on the balance sheet by $185,827 ($143,242 related to the holders of the convertible bridge notes, and $42,585 related to the placement fee).

The decrease in the fair value of the warrants was determined to be $363,982 for the six months ended March 31, 2008, and recorded by decreasing warrant liabilities on the balance sheet by $363,982 ($268,470 related to the holders of the convertible bridge notes, and $95,512 related to the placement fee).

The amortization of the warrant discount was $213,353 for the six months ended March 31, 2008, 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 determined to be $185,827 for the three months ended March 31, 2008, and recorded in decrease in warrants in the other income (expense) section of the statement of operations.

The decrease in the fair value of the warrants was determined to be $363,982 for the six months ended March 31, 2008, 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 for the six months ended March 31, 2008 were the result of the decrease in the amount of $363,982 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.

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 to 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.

Balance Sheet

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.





48



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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 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 warrant was determined to be $543,267 as of March 31, 2008, and was calculated using the Black Sholes valuation model with the following assumptions: risk free rate of return of 1.56%; volatility of 72.53%; dividend yield of 0%; and an expected term of 4.67 years.

The decrease in the fair value of the warrant was $972,165 for the three months ended March 31, 2008, and was recorded by decreasing the warrant liability on the balance sheet.

The decrease in the fair value of the warrant was $905,054 for the six months ended March 31, 2008, and was recorded by decreasing the warrant liability on the balance sheet.

Statement of Operations

The decrease in the fair value of the warrant was $972,165 for the three months ended March 31, 2008, and was recorded by decreasing the warrant liability on the balance sheet.

The decrease in the fair value of the warrant was $905,054 for the six months ended March 31, 2008, and was recorded by decreasing the warrant liability on the balance sheet.

Statement of Cash Flows

The change in the statement of cash flows for the six months ended March 31, 2008 was the result of the change in the fair value of the warrant of $905,054.

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.

Balance Sheet

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.





49



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The Company analyzed the option as of March 31, 2008 by applying FASB 133, paragraph 6 to ascertain if the option remained a derivative as of March 31, 2008. 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 $543,267 as of March 31, 2008, and was calculated using the Black Sholes valuation model with the following assumptions: risk free rate of return of 1.56%; volatility of 72.53%; dividend yield of 0%; and an expected term of 4.67 years.

The decrease in the fair value of the option was $972,165 for the three months ended March 31, 2008, and was recorded by decreasing the warrant liability on the balance sheet.

The decrease in the fair value of the option was $905,054 for the six months ended March 31, 2008, and was recorded by decreasing the warrant liability on the balance sheet.

Statement of Operations

The decrease in the fair value of the option was $972,165 for the three months ended March 31, 2008, and was recorded by decreasing the warrant liability on the balance sheet.

The decrease in the fair value of the option was $905,054 for the six months ended March 31, 2008, and was recorded by decreasing the warrant liability on the balance sheet.

Statement of Cash Flows

The change in the statement of cash flows for the six months ended March 31, 2008 was the result of the change in the fair value of the option of $905,054.

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.

Balance Sheet

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 March 31, 2008. 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 $63,620 as of March 31, 2008, using the Black Sholes valuation model with the following assumptions: risk free rate of return of 1.56%; volatility of 72.53%; dividend yield of 0%; and an expected term of 4.67 years.





50



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The decrease in the fair value of the option was $113,845 for the three months ended March 31, 2008, and recorded by decreasing the warrant liability on the balance sheet.

The decrease in the fair value of the option was $107,900 for the six months ended March 31, 2008, and recorded by decreasing the warrant liability on the balance sheet.

Statement of Operations

The decrease in the fair value of the option was $113,845 for the three months ended March 31, 2008, and recorded by decreasing the warrant liability on the balance sheet.

The decrease in the fair value of the option was $107,900 for the six months ended March 31, 2008, and recorded by decreasing the warrant liability on the balance sheet.

Statement of Cash Flows

The change in the statement of cash flows for the six months ended March 31, 2008 was the result of the change in the fair value of the option of $107,900.

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.

Balance Sheet

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 March 31, 2008. All of the criteria in the original analysis were met, and the option issued was determined to be within the scope and definition of a derivative. EITF 00-19, paragraph 8 was applied which states that if share settlement is not controlled by the company, the contract is required to be classified as a liability. Paragraph 9, 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 $63,620 as of March 31, 2008 using the Black Sholes valuation model with the following assumptions: risk free rate of return of 1.56%; volatility of 72.53%; dividend yield of 0%; and an expected term of 4.67 years.

The decrease in the fair value of the option was $113,845 for the three months ended March 31, 2008, and recorded by decreasing the warrant liability on the balance sheet.

The decrease in the fair value of the option was $107,900 for the six months ended March 31, 2008, and recorded by decreasing the warrant liability on the balance sheet.

Statement of Operations

The decrease in the fair value of the option was $113,845 for the three months ended March 31, 2008, and recorded by decreasing the warrant liability on the balance sheet.





51



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The decrease in the fair value of the option was $107,900 for the six months ended March 31, 2008, and recorded by decreasing the warrant liability on the balance sheet.

Statement of Cash Flows

The change in the statement of cash flows for the six month ended March 31, 2008 was the result of the change in the fair value of the option of $107,900.





52



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Table 1  2008

|                                                                    |  |            |             |   |           |  |            |              |  |         |            |   |  |            |         |   |               |        |          |            |         |        |           |   |  |           |           |   |           |         |           |              |  |        |          |   |        |        |         |        |          |  |         |         |           |         |           |         |  |   |         |   |  |           |             |  
|------------------------------------------------------------------- |  | ---------- | ----------- | - | --------- |  | ---------- | ------------ |  | ------- | ---------- | - |  | ---------- | ------- | - | ------------- | ------ | -------- | ---------- | ------- | ------ | --------- | - |  | --------- | --------- | - | --------- | ------- | --------- | ------------ |  | ------ | -------- | - | ------ | ------ | ------- | ------ | -------- |  | ------- | ------- | --------- | ------- | --------- | ------- |  | - | ------- | - |  | --------- | ----------- | -
|                                                                    |  |            |             |   |           |  |            |              |  |         |            |   |  | Beneficial |         |   | Warrant       |        |          |            |         |        |           |   |  |           |           |   |           |         |           |              |  |        |          |   |        |        |         |        |          | 
|                                                                    |  |            |             |   |           |  |            |              |  |         |            |   |  | Conversion |         |   | Related to    |        |          |            |         |        |           |   |  |           |           |   |           |         |           |              |  |        |          |   |        |        |         |        |          | 
|                                                                    |  |            |             |   |           |  |            |              |  |         |            |   |  | Features   |         |   | $1,025,000 of |        |          |            |         |        |           |   |  |           |           |   |           |         |           |              |  |        | Warrants |   |        |        |         |        |          | 
|                                                                    |  |            |             |   | 2001      |  |            |              |  |         | Warrants   |   |  | and        |         |   | Convertible   |        |          |            |         |        | Option    |   |  |           |           |   | Warrant   |         |           |              |  |        | Related  |   |        |        |         |        |          | 
|                                                                    |  |            |             |   | Executive |  |            |              |  |         | Related to |   |  | Beneficial |         |   | Bridge Notes  |        |          |            |         |        | Issued to |   |  |           |           |   | Issued to |         |           | 10%          |  |        | to       |   |        |        |         |        |          | 
|                                                                    |  | As         |             |   | Officers  |  |            | Advisory     |  |         | 2004 Stock |   |  | Conversion |         |   | and           |        |          | Warrant    |         |        | Chief     |   |  | Warrant   |           |   | Chief     |         |           | Subordinated |  |        | $750,000 |   |        |        |         |        |          | 
|                                                                    |  | Previously |             |   | Option    |  |            | Board        |  |         | Purchase   |   |  | Features   |         |   | Warrant       |        |          | Issued to  |         |        | Executive |   |  | Issued to |           |   | Financial |         |           | Notes        |  |        | Stock    |   |        |        |         |        | As       | 
|                                                                    |  | Stated     |             |   | Plan      |  |            | Compensation |  |         | Agreement  |   |  | Discount   |         |   | Discount      |        |          | Consultant |         |        | Officer   |   |  | Director  |           |   | Officer   |         |           | Payable      |  |        | Issuance |   |        | Other  |         |        | Restated | 
|Balance Sheet                                                       |  |            |             |   |           |  |            |              |  |         |            |   |  |            |         |   |               |        |          |            |         |        |           |   |  |           |           |   |           |         |           |              |  |        |          |   |        |        |         |        |          | 
|Cash and cash equivalent                                            |  | $          | 102,604     |   |           |  |            |              |  |         |            |   |  |            |         |   |               |        |          |            |         |        |           |   |  |           |           |   |           |         |           |              |  |        |          |   |        |        | $       | 151    |          |  | $       | 102,755 |          
|Accounts payable                                                    |  |            | 470,137     |   |           |  |            |              |  |         |            |   |  |            |         |   |               |        |          |            |         |        |           |   |  |           |           |   |           |         |           |              |  |        |          |   |        |        |         | 32,987 |          |  |         | 503,124 |          
|Accrued expenses                                                    |  |            | 1,847,254   |   |           |  |            |              |  | 576,000 |            |   |  |            |         |   |               |        |          |            |         |        |           |   |  |           |           |   |           |         |           |              |  |        |          |   |        |        |         |        |          |  |         |         | 2,423,254 |        
|Convertible Notes, net                                              |  |            | 1,306,593   |   |           |  |            |              |  |         |            |   |  |            |         |   | 12,913        |        |          |            | 206,465 |        |           |   |  |           |           |   |           |         |           |              |  |        |          |   |        |        |         |        |          |  |         |         |           |         | 1,525,971 |        
|10% subordinated notes payable                                      |  |            | 332,182     |   |           |  |            |              |  |         |            |   |  |            |         |   |               |        |          |            |         |        |           |   |  |           |           |   |           |         |           |              |  |        |          |   | 20,169 |        |         |        |          |  |         | 38      |           |         |           | 352,389 | 
|Warrant liability                                                   |  |            | 974,632     |   |           |  | 457,114    |              |  |         | 549,672    |   |  |            |         |   |               |        |          |            |         | 36,522 |           |   |  | 128,358   |           |   |           | 128,358 |           |              |  | 63,620 |          |   |        | 63,620 |         |        |          |  |         |         |           | 156,268 |           |         |  |   |         |   |  | 2,558,164 |            
|Beneficial conversion feature liability                             |  |            | 857,678     |   |           |  |            |              |  |         |            |   |  |            |         |   |               | 17,204 |          |            |         |        |           |   |  |           |           |   |           |         |           |              |  |        |          |   |        |        |         |        |          |  |         |         |           |         |           |         |  |   |         |   |  | 874,882   |            
|Additional paid-in capital                                          |  |            | 12,815,792  |   |           |  | (2,271,879 | )            |  |         | (269,848   | ) |  |            | (45,663 | ) |               |        | 473,797  |            |         |        | 135,406   |   |  |           |           |   |           |         |           |              |  |        |          |   |        |        |         |        |          |  |         |         |           |         |           |         |  |   |         |   |  |           | 10,837,605  |  
|Deficit accumulated during development stage                        |  |            | (19,149,208 | ) |           |  | 1,814,765  |              |  |         | (855,824   | ) |  |            | 45,663  |   |               |        | (503,914 | )          |         |        | (378,393  | ) |  |           | (128,358  | ) |           |         | (128,358  | )            |  |        | (63,620  | ) |        |        | (63,620 | )      |          |  | (20,169 | )       |           |         | (156,268  | )       |  |   | (32,874 | ) |  |           | (19,620,178 | )
|                                                                    |  |            |             |   |           |  |            |              |  |         |            |   |  |            |         |   |               |        |          |            |         |        |           |   |  |           |           |   |           |         |           |              |  |        |          |   |        |        |         |        |          |  |         |         |           |         |           |         |  |   |         |   |  |           |             |  
|Statement of Operations (for the three months ended March 31, 2008) |  |            |             |   |           |  |            |              |  |         |            |   |  |            |         |   |               |        |          |            |         |        |           |   |  |           |           |   |           |         |           |              |  |        |          |   |        |        |         |        |          |  |         |         |           |         |           |         |  |   |         |   |  |           |             |  
|General and administrative                                          |  | $          | 395,890     |   |           |  |            |              |  |         |            |   |  |            |         |   |               |        |          |            |         |        |           |   |  |           |           |   |           |         |           |              |  |        |          |   |        |        |         |        |          |  |         |         |           | $       | 165,022   |         |  | $ | 32,540  |   |  | $         | 593,452     |  
|Research and development                                            |  |            | 328,694     |   |           |  |            |              |  |         |            |   |  |            |         |   |               |        |          |            |         |        |           |   |  |           |           |   |           |         |           |              |  |        |          |   |        |        |         |        |          |  |         |         |           |         |           |         |  |   | 334     |   |  |           | 329,028     |  
|Interest expense                                                    |  |            | (492,546    | ) |           |  |            |              |  |         |            |   |  |            |         |   |               |        | 16,677   |            |         |        | (78,022   | ) |  |           |           |   |           |         |           |              |  |        |          |   |        |        |         |        |          |  | (20,169 | )       |           |         |           |         |  |   |         |   |  |           | (574,060    | )
|Decrease (increase) in warrant liability                            |  |            | 273,778     |   |           |  | 766,474    |              |  |         | 983,628    |   |  |            |         |   |               |        |          |            |         |        | (36,522   | ) |  |           | 972,165   |   |           |         | 972,165   |              |  |        | 113,845  |   |        |        | 113,845 |        |          |  |         |         |           |         | 8,754     |         |  |   |         |   |  |           | 4,168,132   |  
|Increase in beneficial conversion feature liability                 |  |            | 364,944     |   |           |  |            |              |  |         |            |   |  |            |         |   |               |        | (17,204  | )          |         |        |           |   |  |           |           |   |           |         |           |              |  |        |          |   |        |        |         |        |          |  |         |         |           |         |           |         |  |   |         |   |  |           | 347,740     |  
|Basic and dilutive loss per share                                   |  |            | -           |   |           |  |            |              |  |         |            |   |  |            |         |   |               |        |          |            |         |        |           |   |  |           |           |   |           |         |           |              |  |        |          |   |        |        |         |        |          |  |         |         |           |         |           |         |  |   |         |   |  |           | -           |  
|                                                                    |  |            |             |   |           |  |            |              |  |         |            |   |  |            |         |   |               |        |          |            |         |        |           |   |  |           |           |   |           |         |           |              |  |        |          |   |        |        |         |        |          |  |         |         |           |         |           |         |  |   |         |   |  |           |             |  
|Statement of Operations (for the six months ended March 31, 2008)   |  |            |             |   |           |  |            |              |  |         |            |   |  |            |         |   |               |        |          |            |         |        |           |   |  |           |           |   |           |         |           |              |  |        |          |   |        |        |         |        |          |  |         |         |           |         |           |         |  |   |         |   |  |           |             |  
|General and administrative                                          |  | $          | 1,526,663   |   |           |  |            |              |  | $       | 1,557,705  |   |  |            |         |   |               |        |          |            |         |        |           |   |  | $         | 1,033,412 |   |           | $       | 1,033,412 |              |  | $      | 171,520  |   |        | $      | 171,520 |        |          |  |         |         |           | $       | 165,022   |         |  | $ | 32,540  |   |  | $         | 5,691,794   |  
|Research and development                                            |  |            | 565,598     |   |           |  |            |              |  |         |            |   |  |            |         |   |               |        |          |            |         |        |           |   |  |           |           |   |           |         |           |              |  |        |          |   |        |        |         |        |          |  |         |         |           |         |           |         |  |   | 334     |   |  |           | 565,932     |  
|Interest expense                                                    |  |            | (906,150    | ) |           |  |            |              |  |         |            |   |  |            |         |   |               |        | 32,816   |            |         |        | (167,287  | ) |  |           |           |   |           |         |           |              |  |        |          |   |        |        |         |        |          |  | (20,169 | )       |           |         |           |         |  |   |         |   |  |           | (1,060,790  | )
|Decrease (increase) in warrant liability                            |  |            | 427,991     |   |           |  | 1,469,800  |              |  |         | 1,008,033  |   |  |            |         |   |               |        |          |            |         |        | (12,580   | ) |  |           | 905,054   |   |           |         | 905,054   |              |  |        | 107,900  |   |        |        | 107,900 |        |          |  |         |         |           |         | 8,754     |         |  |   |         |   |  |           | 4,927,906   |  
|Increase in beneficial conversion feature liability                 |  |            | 637,688     |   |           |  |            |              |  |         |            |   |  |            |         |   |               |        | (81,759  | )          |         |        |           |   |  |           |           |   |           |         |           |              |  |        |          |   |        |        |         |        |          |  |         |         |           |         |           |         |  |   |         |   |  |           | 555,929     |  
|Write-off of beneficial conversion feature                          |  |            |             |   |           |  |            |              |  |         | 380,440    |   |  |            |         |   |               |        |          |            |         |        |           |   |  |           |           |   |           |         |           |              |  |        |          |   |        |        |         |        |          |  |         |         |           |         |           |         |  |   |         |   |  |           | 380,440     |  







53



---





Table 1  2008 (continued)

|                                                                             |  |            |            |   |           |   |            |              |  |   |            |   |  |            |        |  |               |   |          |            |  |   |           |   |  |           |           |   |           |   |           |              |  |   |          |   |  |       |          |   |          |   |         |   |  |   |          |   |  |   |          |   |  |   |            |  
|---------------------------------------------------------------------------- |  | ---------- | ---------- | - | --------- | - | ---------- | ------------ |  | - | ---------- | - |  | ---------- | ------ |  | ------------- | - | -------- | ---------- |  | - | --------- | - |  | --------- | --------- | - | --------- | - | --------- | ------------ |  | - | -------- | - |  | ----- | -------- | - | -------- | - | ------- | - |  | - | -------- | - |  | - | -------- | - |  | - | ---------- | -
|                                                                             |  |            |            |   |           |   |            |              |  |   |            |   |  | Beneficial |        |  | Warrant       |   |          |            |  |   |           |   |  |           |           |   |           |   |           |              |  |   |          |   |  |       |          |   |          |  
|                                                                             |  |            |            |   |           |   |            |              |  |   |            |   |  | Conversion |        |  | Related to    |   |          |            |  |   |           |   |  |           |           |   |           |   |           |              |  |   |          |   |  |       |          |   |          |  
|                                                                             |  |            |            |   |           |   |            |              |  |   |            |   |  | Features   |        |  | $1,025,000 of |   |          |            |  |   |           |   |  |           |           |   |           |   |           |              |  |   | Warrants |   |  |       |          |   |          |  
|                                                                             |  |            |            |   | 2001      |   |            |              |  |   | Warrants   |   |  | and        |        |  | Convertible   |   |          |            |  |   | Option    |   |  |           |           |   | Warrant   |   |           |              |  |   | Related  |   |  |       |          |   |          |  
|                                                                             |  |            |            |   | Executive |   |            |              |  |   | Related to |   |  | Beneficial |        |  | Bridge Notes  |   |          |            |  |   | Issued to |   |  |           |           |   | Issued to |   |           | 10%          |  |   | to       |   |  |       |          |   |          |  
|                                                                             |  | As         |            |   | Officers  |   |            | Advisory     |  |   | 2004 Stock |   |  | Conversion |        |  | and           |   |          | Warrant    |  |   | Chief     |   |  | Warrant   |           |   | Chief     |   |           | Subordinated |  |   | $750,000 |   |  |       |          |   |          |  
|                                                                             |  | Previously |            |   | Option    |   |            | Board        |  |   | Purchase   |   |  | Features   |        |  | Warrant       |   |          | Issued to  |  |   | Executive |   |  | Issued to |           |   | Financial |   |           | Notes        |  |   | Stock    |   |  |       |          |   | As       |  
|                                                                             |  | Stated     |            |   | Plan      |   |            | Compensation |  |   | Agreement  |   |  | Discount   |        |  | Discount      |   |          | Consultant |  |   | Officer   |   |  | Director  |           |   | Officer   |   |           | Payable      |  |   | Issuance |   |  | Other |          |   | Restated |  
|Basic and dilutive loss per share                                            |  |            | -          |   |           |   |            |              |  |   |            |   |  |            |        |  |               |   |          |            |  |   |           |   |  |           |           |   |           |   |           |              |  |   |          |   |  |       |          |   |          |   |         |   |  |   |          |   |  |   |          |   |  |   | -          |  
|Statement of Operations (since  inception)                                   |  |            |            |   |           |   |            |              |  |   |            |   |  |            |        |  |               |   |          |            |  |   |           |   |  |           |           |   |           |   |           |              |  |   |          |   |  |       |          |   |          |   |         |   |  |   |          |   |  |   |          |   |  |   |            |  
|General and administrative                                                   |  | $          | 14,680,234 |   |           | $ | 28,361     |              |  | $ | 2,240,253  |   |  | $          | 24,366 |  |               |   |          |            |  |   |           |   |  | $         | 1,033,412 |   |           | $ | 1,033,412 |              |  | $ | 171,520  |   |  | $     | 171,520  |   |          |   |         |   |  | $ | 165,022  |   |  | $ | (526,801 | ) |  | $ | 19,021,299 |  
|Research and development                                                     |  |            | 2,015,071  |   |           |   |            |              |  |   |            |   |  |            |        |  |               |   |          |            |  |   |           |   |  |           |           |   |           |   |           |              |  |   |          |   |  |       |          |   |          |   |         |   |  |   |          |   |  |   | 526,801  |   |  |   | 2,541,872  |  
|Interest expense                                                             |  |            | (1,463,002 | ) |           |   |            |              |  |   |            |   |  |            |        |  |               |   | (303,313 | )          |  |   | (255,021  | ) |  |           |           |   |           |   |           |              |  |   |          |   |  |       |          |   |          |   | (20,169 | ) |  |   |          |   |  |   | (196,214 | ) |  |   | (2,237,719 | )
|Decrease in warrant liability                                                |  |            | 427,991    |   |           |   | 1,814,765  |              |  |   | 1,008,033  |   |  |            | 70,029 |  |               |   |          |            |  |   | 41,737    |   |  |           | 905,054   |   |           |   | 905,054   |              |  |   | 107,900  |   |  |       | 107,900  |   |          |   |         |   |  |   | 8,754    |   |  |   |          |   |  |   | 5,397,217  |  
|Increase in beneficial conversion feature liability                          |  |            | 637,688    |   |           |   |            |              |  |   | (4,044     | ) |  |            |        |  |               |   | (81,759  | )          |  |   |           |   |  |           |           |   |           |   |           |              |  |   |          |   |  |       |          |   |          |   |         |   |  |   |          |   |  |   |          |   |  |   | 551,885    |  
|Write-off of beneficial conversion feature                                   |  |            |            |   |           |   |            |              |  |   | 380,440    |   |  |            |        |  |               |   |          |            |  |   |           |   |  |           |           |   |           |   |           |              |  |   |          |   |  |       |          |   |          |   |         |   |  |   |          |   |  |   |          |   |  |   | 380,440    |  
|                                                                             |  |            |            |   |           |   |            |              |  |   |            |   |  |            |        |  |               |   |          |            |  |   |           |   |  |           |           |   |           |   |           |              |  |   |          |   |  |       |          |   |          |   |         |   |  |   |          |   |  |   |          |   |  |   |            |  
|Statement of Cash Flows (for the six months ended March 31, 2008)            |  |            |            |   |           |   |            |              |  |   |            |   |  |            |        |  |               |   |          |            |  |   |           |   |  |           |           |   |           |   |           |              |  |   |          |   |  |       |          |   |          |   |         |   |  |   |          |   |  |   |          |   |  |   |            |  
|Net loss                                                                     |  | $          | (2,077,833 | ) |           | $ | 1,469,800  |              |  | $ | (169,232   | ) |  |            |        |  |               | $ | (48,943  | )          |  | $ | (179,867  | ) |  | $         | (128,358  | ) |           | $ | (128,358  | )            |  | $ | (63,620  | ) |  | $     | (63,620  | ) |          | $ | (20,169 | ) |  | $ | (156,268 | ) |  | $ | (32,874  | ) |  | $ | (1,599,342 | )
|Amortization of beneficial conversion features discount and warrant discount |  |            | 669,025    |   |           |   |            |              |  |   | 10,072     |   |  |            |        |  |               |   | (32,816  | )          |  |   | 167,287   |   |  |           |           |   |           |   |           |              |  |   |          |   |  |       |          |   |          |   | 20,169  |   |  |   |          |   |  |   | 38       |   |  |   | 833,775    |  
|Stock based compensation expense- employee                                   |  |            | 414,908    |   |           |   |            |              |  |   |            |   |  |            |        |  |               |   |          |            |  |   |           |   |  |           | 1,033,412 |   |           |   |           |              |  |   | 171,520  |   |  |       | 171,520  |   |          |   |         |   |  |   |          |   |  |   |          |   |  |   | 1,791,360  |  
|Stock based compensation expense- consultant                                 |  |            | 439,909    |   |           |   |            |              |  |   | 1,557,705  |   |  |            |        |  |               |   |          |            |  |   |           |   |  |           |           |   |           |   | 1,008,413 |              |  |   |          |   |  |       |          |   |          |   |         |   |  |   | 165,022  |   |  |   |          |   |  |   | 3,171,049  |  
|(Decrease) increase in warrant liability                                     |  |            | (427,991   | ) |           |   | (1,469,800 | )            |  |   | (1,008,033 | ) |  |            |        |  |               |   |          |            |  |   | 12,580    |   |  |           | (905,054  | ) |           |   | (905,054  | )            |  |   | (107,900 | ) |  |       | (107,900 | ) |          |   |         |   |  |   | (8,754   | ) |  |   |          |   |  |   | (4,927,906 | )
|Increase in beneficial conversion  feature liaiblity                         |  |            | (637,688   | ) |           |   |            |              |  |   |            |   |  |            |        |  |               |   | 81,759   |            |  |   |           |   |  |           |           |   |           |   |           |              |  |   |          |   |  |       |          |   |          |   |         |   |  |   |          |   |  |   |          |   |  |   | (555,929   | )
|Write-off of beneficial conversion
feature                                   |  |            |            |   |           |   |            |              |  |   |            |   |  |            |        |  |               |   |          |            |  |   |           |   |  |           |           |   |           |   |           |              |  |   |          |   |  |       |          |   |          |   |         |   |  |   |          |   |  |   |          |   |  |   |            |  
|Accounts payable                                                             |  |            | 312,738    |   |           |   |            |              |  |   |            |   |  |            |        |  |               |   |          |            |  |   |           |   |  |           |           |   |           |   |           |              |  |   |          |   |  |       |          |   |          |   |         |   |  |   |          |   |  |   | 32,987   |   |  |   | 345,725    |  
|Accrued expenses                                                             |  |            | 159,581    |   |           |   |            |              |  |   | 576,000    |   |  |            |        |  |               |   |          |            |  |   |           |   |  |           |           |   |           |   |           |              |  |   |          |   |  |       |          |   |          |   |         |   |  |   |          |   |  |   |          |   |  |   | 735,581    |  
|Cash and cash equivalents                                                    |  |            | 102,604    |   |           |   |            |              |  |   |            |   |  |            |        |  |               |   |          |            |  |   |           |   |  |           |           |   |           |   |           |              |  |   |          |   |  |       |          |   |          |   |         |   |  |   |          |   |  |   | 151      |   |  |   | 102,755    |  









54



---







|                                                                            |  |            |             |   |           |   |            |              |  |   |            |   |  |            |         |   |               |   |          |            |  |   |           |   |  |           |           |   |           |   |           |              |  |   |          |   |  |       |          |   |          |   |         |   |  |   |          |   |  |   |            |   |  |   |             |  
|--------------------------------------------------------------------------- |  | ---------- | ----------- | - | --------- | - | ---------- | ------------ |  | - | ---------- | - |  | ---------- | ------- | - | ------------- | - | -------- | ---------- |  | - | --------- | - |  | --------- | --------- | - | --------- | - | --------- | ------------ |  | - | -------- | - |  | ----- | -------- | - | -------- | - | ------- | - |  | - | -------- | - |  | - | ---------- | - |  | - | ----------- | -
|                                                                            |  |            |             |   |           |   |            |              |  |   |            |   |  | Beneficial |         |   | Warrant       |   |          |            |  |   |           |   |  |           |           |   |           |   |           |              |  |   |          |   |  |       |          |   |          |  
|                                                                            |  |            |             |   |           |   |            |              |  |   |            |   |  | Conversion |         |   | Related to    |   |          |            |  |   |           |   |  |           |           |   |           |   |           |              |  |   |          |   |  |       |          |   |          |  
|                                                                            |  |            |             |   |           |   |            |              |  |   |            |   |  | Features   |         |   | $1,025,000 of |   |          |            |  |   |           |   |  |           |           |   |           |   |           |              |  |   | Warrants |   |  |       |          |   |          |  
|                                                                            |  |            |             |   | 2001      |   |            |              |  |   | Warrants   |   |  | and        |         |   | Convertible   |   |          |            |  |   | Option    |   |  |           |           |   | Warrant   |   |           |              |  |   | Related  |   |  |       |          |   |          |  
|                                                                            |  |            |             |   | Executive |   |            |              |  |   | Related to |   |  | Beneficial |         |   | Bridge Notes  |   |          |            |  |   | Issued to |   |  |           |           |   | Issued to |   |           | 10%          |  |   | To       |   |  |       |          |   |          |  
|                                                                            |  | As         |             |   | Officers  |   |            | Advisory     |  |   | 2004 Stock |   |  | Conversion |         |   | and           |   |          | Warrant    |  |   | Chief     |   |  | Warrant   |           |   | Chief     |   |           | Subordinated |  |   | $750,000 |   |  |       |          |   |          |  
|                                                                            |  | Previously |             |   | Option    |   |            | Board        |  |   | Purchase   |   |  | Features   |         |   | Warrant       |   |          | Issued to  |  |   | Executive |   |  | Issued to |           |   | Financial |   |           | Notes        |  |   | Stock    |   |  |       |          |   | As       |  
|                                                                            |  | Stated     |             |   | Plan      |   |            | Compensation |  |   | Agreement  |   |  | Discount   |         |   | Discount      |   |          | Consultant |  |   | Officer   |   |  | Director  |           |   | Officer   |   |           | Payable      |  |   | Issuance |   |  | Other |          |   | Restated |  
|Statement of Cash Flows (since inception)                                   |  |            |             |   |           |   |            |              |  |   |            |   |  |            |         |   |               |   |          |            |  |   |           |   |  |           |           |   |           |   |           |              |  |   |          |   |  |       |          |   |          |   |         |   |  |   |          |   |  |   |            |   |  |   |             |  
|Net loss                                                                    |  | $          | (19,377,983 | ) |           | $ | 1,786,404  |              |  | $ | (855,824   | ) |  | $          | 45,663  |   |               | $ | (385,072 | )          |  | $ | (213,284  | ) |  | $         | (128,358  | ) |           | $ | (128,358  | )            |  | $ | (63,620  | ) |  | $     | (63,620  | ) |          | $ | (20,169 | ) |  | $ | (156,268 | ) |  | $ | (59,689    | ) |  | $ | (19,620,178 | )
|Amortization of beneficial conversion feature discount and warrant discount |  |            | 984,402     |   |           |   |            |              |  |   | 153,888    |   |  |            |         |   |               |   | 303,313  |            |  |   | 255,021   |   |  |           |           |   |           |   |           |              |  |   |          |   |  |       |          |   |          |   | 20,169  |   |  |   |          |   |  |   |            |   |  |   | 1,716,793   |  
|Stock based compensation expense - employee                                 |  |            | 414,908     |   |           |   |            |              |  |   |            |   |  |            |         |   |               |   |          |            |  |   |           |   |  |           |           |   |           |   | 1,033,412 |              |  |   | 171,520  |   |  |       | 171,520  |   |          |   |         |   |  |   |          |   |  |   | 1,835,957  |   |  |   | 3,627,317   |  
|Stock based compensation expense - non-employee                             |  |            | 439,909     |   |           |   | 636,661    |              |  |   | 1,557,705  |   |  |            | 24,366  |   |               |   |          |            |  |   |           |   |  |           | 1,033,412 |   |           |   |           |              |  |   |          |   |  |       |          |   |          |   |         |   |  |   | 156,268  |   |  |   | 2,287,597  |   |  |   | 6,135,918   |  
|Warrants issued for consulting services                                     |  |            | 106,111     |   |           |   |            |              |  |   |            |   |  |            |         |   |               |   |          |            |  |   |           |   |  |           |           |   |           |   |           |              |  |   |          |   |  |       |          |   |          |   |         |   |  |   |          |   |  |   | (106,111   | ) |  |   | -           |  
|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                                               |  |            | (427,991    | ) |           |   | (1,814,765 | )            |  |   | (1,008,033 | ) |  |            | (70,029 | ) |               |   |          |            |  |   | (41,737   | ) |  |           | (905,054  | ) |           |   | (905,054  | )            |  |   | (107,900 | ) |  |       | (107,900 | ) |          |   |         |   |  |   | (8,754   | ) |  |   |            |   |  |   | (5,397,217  | )
|Decrease in beneficial conversion feature liability                         |  |            | (637,689    | ) |           |   |            |              |  |   |            |   |  |            |         |   |               |   | 85,804   |            |  |   |           |   |  |           |           |   |           |   |           |              |  |   |          |   |  |       |          |   |          |   |         |   |  |   |          |   |  |   |            |   |  |   | (551,885    | )
|Write-off of beneficial conversion feature                                  |  |            |             |   |           |   |            |              |  |   | (380,440   | ) |  |            |         |   |               |   |          |            |  |   |           |   |  |           |           |   |           |   |           |              |  |   |          |   |  |       |          |   |          |   |         |   |  |   |          |   |  |   | (380,440   | ) |  |   |             |  
|Loss on termination of lease                                                |  |            |             |   |           |   |            |              |  |   |            |   |  |            |         |   |               |   |          |            |  |   |           |   |  |           |           |   |           |   |           |              |  |   |          |   |  |       |          |   |          |   |         |   |  |   |          |   |  |   | 129,166    |   |  |   | 129,166     |  
|Accrual of liquidating damages                                              |  |            | 138,375     |   |           |   |            |              |  |   |            |   |  |            |         |   |               |   |          |            |  |   |           |   |  |           |           |   |           |   |           |              |  |   |          |   |  |       |          |   |          |   |         |   |  |   |          |   |  |   | 15,375     |   |  |   | 153,750     |  
|Decrease in other receivables                                               |  |            |             |   |           |   |            |              |  |   |            |   |  |            |         |   |               |   |          |            |  |   |           |   |  |           |           |   |           |   |           |              |  |   |          |   |  |       |          |   |          |   |         |   |  |   |          |   |  |   |            |   |  |   | -           |  
|Increase in deposits                                                        |  |            |             |   |           |   |            |              |  |   |            |   |  |            |         |   |               |   |          |            |  |   |           |   |  |           |           |   |           |   |           |              |  |   |          |   |  |       |          |   |          |   |         |   |  |   |          |   |  |   |            |   |  |   | -           |  
|Other                                                                       |  |            |             |   |           |   |            |              |  |   |            |   |  |            |         |   |               |   |          |            |  |   |           |   |  |           |           |   |           |   |           |              |  |   |          |   |  |       |          |   |          |   |         |   |  |   |          |   |  |   |            |   |  |   | -           |  
|Other current assets                                                        |  |            | (545,727    | ) |           |   |            |              |  |   |            |   |  |            |         |   |               |   |          |            |  |   |           |   |  |           |           |   |           |   |           |              |  |   |          |   |  |       |          |   |          |   |         |   |  |   |          |   |  |   | 510,727    |   |  |   | (35,000     | )
|Other receivables                                                           |  |            | 3,000       |   |           |   |            |              |  |   |            |   |  |            |         |   |               |   |          |            |  |   |           |   |  |           |           |   |           |   |           |              |  |   |          |   |  |       |          |   |          |   |         |   |  |   |          |   |  |   |            |   |  |   |             |  
|Deposits                                                                    |  |            | (204,600    | ) |           |   |            |              |  |   |            |   |  |            |         |   |               |   |          |            |  |   |           |   |  |           |           |   |           |   |           |              |  |   |          |   |  |       |          |   |          |   |         |   |  |   |          |   |  |   |            |   |  |   |             |  
|Other assets                                                                |  |            | 140,370     |   |           |   |            |              |  |   |            |   |  |            |         |   |               |   |          |            |  |   |           |   |  |           |           |   |           |   |           |              |  |   |          |   |  |       |          |   |          |   |         |   |  |   |          |   |  |   | (244,970   | ) |  |   | (104,600    | )
|Accounts payable                                                            |  |            | 540,139     |   |           |   |            |              |  |   |            |   |  |            |         |   |               |   |          |            |  |   |           |   |  |           |           |   |           |   |           |              |  |   |          |   |  |       |          |   |          |   |         |   |  |   |          |   |  |   | (37,015    | ) |  |   | 503,124     |  
|Accrued expenses                                                            |  |            | 1,991,622   |   |           |   |            |              |  |   | 189,698    |   |  |            |         |   |               |   |          |            |  |   |           |   |  |           |           |   |           |   |           |              |  |   |          |   |  |       |          |   |          |   |         |   |  |   |          |   |  |   |            |   |  |   | 2,181,320   |  
|Acquisition of machinery and equipment                                      |  |            | (437,112    | ) |           |   |            |              |  |   |            |   |  |            |         |   |               |   |          |            |  |   |           |   |  |           |           |   |           |   |           |              |  |   |          |   |  |       |          |   |          |   |         |   |  |   |          |   |  |   | 36,493     |   |  |   | (400,619    | )
|Proceeds from issuance of notes                                             |  |            |             |   |           |   |            |              |  |   |            |   |  |            |         |   |               |   |          |            |  |   |           |   |  |           |           |   |           |   |           |              |  |   |          |   |  |       |          |   |          |   |         |   |  |   |          |   |  |   | -          |   |  |   |             |  
|Proceeds from convertible notes payable                                     |  |            | 2,544,191   |   |           |   |            |              |  |   |            |   |  |            |         |   |               |   |          |            |  |   |           |   |  |           |           |   |           |   |           |              |  |   |          |   |  |       |          |   |          |   |         |   |  |   |          |   |  |   | (683,191   | ) |  |   | 1,861,000   |  
|Proceeds from 10% subordinated notes payable                                |  |            |             |   |           |   |            |              |  |   |            |   |  |            |         |   |               |   |          |            |  |   |           |   |  |           |           |   |           |   |           |              |  |   |          |   |  |       |          |   |          |   |         |   |  |   | 425,000  |   |  |   | 425,000    |   |  |   |             |  
|Receipt from (payments to) equity line of credit                            |  |            | 456,000     |   |           |   |            |              |  |   |            |   |  |            |         |   |               |   |          |            |  |   |           |   |  |           |           |   |           |   |           |              |  |   |          |   |  |       |          |   |          |   |         |   |  |   |          |   |  |   | (27,336    | ) |  |   | 428,664     |  
|Proceeds from notes payable to related party                                |  |            |             |   |           |   |            |              |  |   |            |   |  |            |         |   |               |   |          |            |  |   |           |   |  |           |           |   |           |   |           |              |  |   |          |   |  |       |          |   |          |   |         |   |  |   | 457,433  |   |  |   | 457,433    |   |  |   |             |  
|Payments on notes payable to related party                                  |  |            |             |   |           |   |            |              |  |   |            |   |  |            |         |   |               |   |          |            |  |   |           |   |  |           |           |   |           |   |           |              |  |   |          |   |  |       |          |   |          |   |         |   |  |   | (5,000   | ) |  |   | (5,000     | ) |  |   |             |  
|Payment on notes to officers                                                |  |            | (51,596     | ) |           |   |            |              |  |   |            |   |  |            |         |   |               |   |          |            |  |   |           |   |  |           |           |   |           |   |           |              |  |   |          |   |  |       |          |   |          |   |         |   |  |   |          |   |  |   | (166,906   | ) |  |   | (218,502    | )
|Issuance of common stock for cash                                           |  |            | 7,376,094   |   |           |   |            |              |  |   |            |   |  |            |         |   |               |   |          |            |  |   |           |   |  |           |           |   |           |   |           |              |  |   |          |   |  |       |          |   |          |   |         |   |  |   |          |   |  |   | 10,000     |   |  |   | 7,386,094   |  
|Receipt of cash for stock to be issued                                      |  |            | 336,900     |   |           |   |            |              |  |   |            |   |  |            |         |   |               |   |          |            |  |   |           |   |  |           |           |   |           |   |           |              |  |   |          |   |  |       |          |   |          |   |         |   |  |   |          |   |  |   | (10,000    | ) |  |   | 326,900     |  







55



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SECOND RESTATEMENT OF FINANCIAL STATEMENTS

As discussed above, the Company restated its March 31, 2008 financial statements resulting from a comment letter from the Securities and Exchange Commission. However, the restatement did not properly account for the certain derivative transactions as discussed below. As a result, the Company recorded the following adjustments as described 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 mature on or about December 31, 2008, and are 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 March 31, 2008. The analysis and results were as follows:

Warrants and Options Liability

As of March 31, 2008, the Company had 26,074,766 warrants outstanding and 11,595,934 options outstanding that were vested at that date.

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 March 31, 2008, the Company determined the fair value of all warrants and options to be $3,610,562 and $1,598,536, respectively, using the Black Sholes model with the following assumptions:

·

risk free rate of return between 1.79% and 2.46%;

·

volatility between 242% and 263%;

·

dividend yield of 0%; and

·

expected term between 2.95 years and 5.76 years.

Statement of Operations

For the three and six months ended March 31, 2008, the Company recorded $2,402,795 and $984,063, respectively, as a loss 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 $984,063.

Beneficial Conversion Liability

As of March 31, 2008, the Company had $1,955,000 in convertible notes that could be converted into 102,090,403 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 March 31, 2008, the Company determined the fair value of the embedded conversion options to be $12,718,034 using the Black Sholes model with the following assumptions:

·

risk free rate of return between 1.22% and 1.55%;

·

volatility between 119% and 120%;

·

dividend yield of 0%; and

·

expected term of 0.05 years to 0.75 years.

Statement of Operations

For the three and six months ended March 31, 2008, the Company recorded $10,740,797 and $18,366,949, respectively, 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 $18,366,949 change in fair value of the beneficial conversion liability.





56



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The following table shows the effect of each of the changes discussed above on the Companys balance sheet, statement of operation, and statement of cash flows for the six months ended March 31, 2008.

|                                                                       |  |                      |             |   |                                |  |             |                     |  |  |                            |   |  |  |             |  
|---------------------------------------------------------------------- |  | -------------------- | ----------- | - | ------------------------------ |  | ----------- | ------------------- |  |  | -------------------------- | - |  |  | ----------- | -
|                                                                       |  | As Previously
Stated |             |   | Beneficial
Conversion
Features |  |             | Option and
Warrants |  |  | As Restated
March 31, 2008 |  
|Balance Sheet                                                          |  |                      |             |   |                                |  |             |                     |  |  |                            |  
|Warrant and option liability                                           |  |                      | 2,558,164   |   |                                |  | -           |                     |  |  | 2,650,935                  |   |  |  | 5,209,099   |  
|Beneficial conversion feature liability                                |  |                      | 874,882     |   |                                |  | 11,843,152  |                     |  |  | -                          |   |  |  | 12,718,034  |  
|Additional paid in capital                                             |  |                      | 10,837,605  |   |                                |  | -           |                     |  |  | 432,683                    |   |  |  | 10,404,922  |  
|Deficit accumulated during developmental stage                         |  |                      | (19,620,178 | ) |                                |  | (11,843,152 | )                   |  |  | (2,218,252                 | ) |  |  | (33,681,582 | )
|                                                                       |  |                      |             |   |                                |  |             |                     |  |  |                            |   |  |  |             |  
|Statement of Operations (for the three months ended
March 31, 2008)    |  |                      |             |   |                                |  |             |                     |  |  |                            |   |  |  |             |  
|Gain (loss) on change in fair value of warrant and option liability    |  |                      | 4,168,132   |   |                                |  | -           |                     |  |  | (2,402,795                 | ) |  |  | 1,765,337   |  
|Gain (loss) on change in fair value of beneficial conversion liability |  |                      | 347,780     |   |                                |  | 10,740,797  |                     |  |  | -                          |   |  |  | 11,088,577  |  
|                                                                       |  |                      |             |   |                                |  |             |                     |  |  |                            |   |  |  |             |  
|Statement of Operations (for the six months ended
March 31, 2008)      |  |                      |             |   |                                |  |             |                     |  |  |                            |   |  |  |             |  
|Gain (loss) on change in fair value of warrant and option liability    |  |                      | 4,927,906   |   |                                |  | -           |                     |  |  | (984,063                   | ) |  |  | 3,943,843   |  
|Gain on change in fair value of beneficial conversion liability        |  |                      | 555,929     |   |                                |  | 18,366,949  |                     |  |  | -                          |   |  |  | 18,922,878  |  
|                                                                       |  |                      |             |   |                                |  |             |                     |  |  |                            |   |  |  |             |  
|Statement of Operations (since inception)                              |  |                      |             |   |                                |  |             |                     |  |  |                            |   |  |  |             |  
|Gain (loss) on change in fair value of warrant and option liability    |  |                      | 5,397,217   |   |                                |  | -           |                     |  |  | (1,124,901                 | ) |  |  | 4,272,316   |  
|Gain on change in fair value of beneficial conversion liability        |  |                      | 551,885     |   |                                |  | 22,285,024  |                     |  |  | -                          |   |  |  | 22,836,909  |  
|General and administrative expense                                     |  |                      | 19,021,299  |   |                                |  | 3,787,032   |                     |  |  | -                          |   |  |  | 22,808,331  |  
|Interest expense and financing costs                                   |  |                      | (1,857,279  | ) |                                |  | (30,536,702 | )                   |  |  | (897,793                   | ) |  |  | (33,291,774 | )
|                                                                       |  |                      |             |   |                                |  |             |                     |  |  |                            |   |  |  |             |  
|Statement of Cash Flows (for the six months ended
March 31, 2008)      |  |                      |             |   |                                |  |             |                     |  |  |                            |   |  |  |             |  
|Net income (loss)                                                      |  |                      | (1,599,342  | ) |                                |  | 18,366,949  |                     |  |  | (984,063                   | ) |  |  | 15,783,544  |  
|(Gain) loss on change in fair value of warrant and option liability    |  |                      | (4,927,906  | ) |                                |  | -           |                     |  |  | 984,063                    |   |  |  | (3,943,843  | )
|Gain on change in fair value of beneficial conversion liability        |  |                      | (555,929    | ) |                                |  | (18,366,949 | )                   |  |  | -                          |   |  |  | (18,922,878 | )
|                                                                       |  |                      |             |   |                                |  |             |                     |  |  |                            |   |  |  |             |  
|Statement of Cash Flows (since inception)                              |  |                      |             |   |                                |  |             |                     |  |  |                            |   |  |  |             |  
|Net income (loss)                                                      |  |                      | (19,620,178 | ) |                                |  | (12,038,710 | )                   |  |  | (2,022,694                 | ) |  |  | (33,681,582 | )
|(Gain) loss on change in fair value of warrant and option liability    |  |                      | (5,494,031  | ) |                                |  | -           |                     |  |  | 1,124,901                  |   |  |  | (4,369,130  | )
|Gain on change in fair value of beneficial conversion liability        |  |                      | (551,885    | ) |                                |  | (22,285,024 | )                   |  |  | -                          |   |  |  | (22,836,909 | )
|Non-cash compensation expense                                          |  |                      | -           |   |                                |  | 3,787,032   |                     |  |  | -                          |   |  |  | 3,787,032   |  
|Non-cash financing costs                                               |  |                      | -           |   |                                |  | 30,536,702  |                     |  |  | 897,793                    |   |  |  | 31,434,495  |  
|                                                                       |  |                      |             |   |                                |  |             |                     |  |  |                            |   |  |  |             |  







57



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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 the second quarter of the 2008 fiscal year which ended on March 31, 2008. 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 sales price is fixed or determinable and whether or not collection is reasonably assured. If the sales price is not deemed to be fixed or determinable, revenue will be recognized as the amounts become due from the customer. The Company does not plan to offer a right of return on its products and the products will generally not be subject to customer acceptance rights. The Company plans to assess collectability based on a number of factors, including past transaction and collection history with a customer and the creditworthiness of the customer. The Company plans to perform ongoing credit evaluations of its customers' financial condition. If the Company determines that collectability of the sales price is not reasonably assured, revenue recognition will be deferred until such time as collection becomes reasonably assured, which is generally upon receipt of payment from the customer. The Company 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.

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.





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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 |  |  |  | -- | 
|Purchase obligations        |  |                        | --        |  |                  |  | --      |              |  |  | --           |  |  |              | --      |  |  |  | -- | 
|Other long-term liabilities |  |                        | --        |  |                  |  | --      |              |  |  | --           |  |  |              | --      |  |  |  | -- | 



RESULTS OF OPERATIONS (THREE MONTHS ENDED MARCH 31, 2008 COMPARED TO THREE MONTHS ENDED MARCH 31, 2007).

Revenues for the three months ended March 31, 2008 and 2007 were zero, as the Company has not yet commenced the sale of its product.

The Company incurred operating expenses of $964,409 for the three months ended March 31, 2008, an increase of $622,770 or approximately 182%, as compared to $341,639 for the three months ended March 31, 2007. General and administrative expenses were $627,224 for the three months ended March 31, 2008, an increase of $293,580 or approximately 88%, as compared to $333,644 for the three months ended March 31, 2007. The increase in general and administrative expenses was primarily due to the issuance of warrants having a fair value of $96,814 to the 10% subordinated notes payable holders and $165,022 to purchasers of stock. Research and development expenses incurred during the three months ended March 31, 2008 were $329,028, and there were no research and development expenses for the three months ended March 31, 2007.

Other income and (expense) was $12,171,050 for the three months ended March 31, 2008, an increase of $12,221,891 or approximately 24,039%, as compared to $(50,841) for the three months ended March 31, 2007. Increase in gain on change in fair value of the warrant and option liability was $1,765,338 for the three months ended March 31, 2008 and represents the decrease in the fair value of the warrant and option liability. The options and warrants 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 option and warrant liability for the three months ended March 31, 2007. The increase in the gain on change in fair value of the beneficial conversion liability was $11,088,577 for the three months ended March 31, 2008 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 beneficial conversion features liability for the three months ended March 31, 2007. Interest expense increased to $554,065 during the three months ended March 31, 2008, an increase of $502,719 or approximately 979%, as compared to $51,346 for the three months ended March 31, 2007. The increase in interest expense is primarily due to the amortization of the beneficial conversion features discount of $309,814 and warrant discount of $105,806. Loss on lease termination was $129,166 for the three months ended March 31, 2008. There was no loss on termination of lease for the three months ended March 31, 2007.

Net income was $11,206,641 for the three months ended March 31, 2008, an increase of $11,599,121 or approximately 2,955%, as compared to a net loss of $392,480 for the three months ended March 31, 2007.

RESULTS OF OPERATIONS (SIX MONTHS ENDED MARCH 31, 2008 COMPARED TO SIX MONTHS ENDED MARCH 31, 2007).

Revenues for the six months ended March 31, 2008 and 2007 were zero, as the Company has not yet commenced the sale of its product.

The Company incurred operating expenses of $6,274,040 for the six months ended March 31, 2008, an increase of $5,647,884 or approximately 902%, as compared to $626,156 for the six months ended March 31, 2007. General and administrative expenses were $5,691,794 for the six months ended March 31, 2008, an increase of $5,081,426 or approximately 833%, as compared to $610,368 for the six months ended March 31, 2007. The increase in general and administrative expenses was primarily due to the issuance of warrants having a fair value of $5,010,748. Research and development expenses incurred during the six months ended March 31, 2008 were $565,932, and there were no research and development expenses for the six months ended March 31, 2007.

Other income and (expense) was $22,058,484 for the six months ended March 31, 2008, an increase of $22,218,147 or approximately 13,916%, as compared to $(159,663) for the six months ended March 31, 2008. Increase in gain on change in fair value of the warrant and option liability was $3,943,843 for the six months ended March 31, 2008 and represents the decrease in the fair value of the warrant and option liability. The options and warrants 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 option and warrant liability for the six months ended March 31, 2008. The increase in the gain on change in fair value of the beneficial





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conversion liability was $18,922,878 for the six months ended March 31, 2008 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 beneficial conversion features liability for the six months ended March 31, 2007. Interest expense increased to $680,350 during the six months ended March 31, 2008, an increase of $520,076 or approximately 324%, as compared to $160,274 for the six months ended March 31, 2007. The increase in interest expense is primarily due to the amortization of the beneficial conversion features discount and warrant discount. Loss on lease termination was $129,166 for the six months ended March 31, 2008. There was no loss on termination of lease for the six months ended March 31, 2007.

Net income was $15,783,544 for the six months ended March 31, 2008, an increase of $16,570,263 or approximately 2,106%, as compared to a net loss of $786,719 for the six months ended March 31, 2007.

LIQUIDITY AND CAPITAL RESOURCES.

Net cash flows used in our operating activities was $896,996 for the six months ended March 31, 2008, an increase of $550,655 or approximately 159%, as compared to $346,341 for the six months ended March 31, 2007. Cash flows used in operating activities, not including the increase in net loss, is primarily attributable to a decrease in warrant and option liability of $3,943,843, a decrease in beneficial conversion features of $18,922,878, and a write-off of beneficial conversion features of $380,440. The options and warrants 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 warrant liabilities or beneficial conversion features for the six months ended March 31, 2007. Cash flows provided from operating activities is primarily attributable to stock based compensation of $4,962,409, amortization of $833,775, an increase in accounts payable of $345,724, and an increase in accrued expenses of $174,508.

Net cash flows used in our investing activities was $29,164 for the purchase of equipment for the six months ended March 31, 2008, an increase of $16,192 or approximately 125%, as compared to $12,972 for the six months ended March 31, 2007.

Net cash flows provided by financing activities was $656,404 for the six months ended March 31, 2008, an increase of cash flows used of $85,204 or approximately 15%, as compared to net cash flows provided by financing activities of $571,200 for the six months ended March 31, 2007. Cash used in financing activities for the six months ended March 31, 2008 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. Cash provided from financing activities for the six months ended March31, 2008 consisted of proceeds of $425,000 from the issuance of 10% subordinated notes payable and $283,000 for the purchase of common stock. Cash provided from financing activities for the six months ended March 31, 2007 consisted of $750,000 from the issuance of convertible notes.

On March 31, 2008, the Company had cash and cash equivalents of $102,755. 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 March 31, 2008, the Company had an accumulated deficit of $32,948,779. 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.

GOING CONCERN OPINION.

The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. This basis of accounting contemplates the recovery of the Companys assets and the satisfaction of its liabilities in the normal course of business. Through March 31, 2008, the Company has incurred cumulative losses of $33,681,582 including net income for the six months ended March 31, 2008 of $15,783,544. 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.





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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 March 31, 2008, 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 March 31, 2008, 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 quarter ended March 31, 2008 could no longer be relied upon and, as described in Note 14 to the restated financial statements, have restated our financial position as of March 31, 2008 and results of operations, changes in stockholders equity and cash flows for the quarter ended March 31, 2008 and the cumulative period from October 3, 1994 (inception) to March 31, 2008. 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 detected. Management has identified the following three material weaknesses which have caused management to conclude that, as of March 31, 2008, 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.





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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 March 31, 2008, 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

From January 3, 2008 through January 25, 2008, we sold and issued in a private placement (the Private Placement) $425,000 in aggregate principal amount of our Subordinated 10% Debentures (each, a Debenture, collectively, the Debentures) along with warrants to purchase an aggregate of 850,000 shares of our common stock at an exercise price of $0.40 per share (the Warrants).

Each Debenture has a maturity date one year from its date of issuance and all outstanding principal and accrued interest of each Debenture will be due and payable on such date unless sooner declared due and payable by the holder upon the occurrence of an event of default. The Debentures accrue interest at the rate of 10% per year and are subject to pre-payment penalties ranging from 10% to 25% of the outstanding principal amount, depending on the date of pre-payment.

The Warrants have a term of six years and may be exercised on a cashless basis at the election of the holder. The warrant exercise price and number of warrant shares are subject to adjustment in the event of stock dividends, distributions or subdivisions, stock combinations or consolidations, reclassifications, exchanges or substitutions of our common stock, and the merger, consolidation or sale of substantially all of our assets.

Out of the $425,000 of Debentures and Warrants placed in the Private Placement, our placement agent, Southridge Investment Group LLC (Southridge), placed $300,000 of such amount, for which we are obligated to pay Southridge a 10% commission in the amount of $30,000 and issue Southridge a five-year warrant to purchase 85,000 shares of our common stock at an exercise price of $0.40 per share, in substantially the same form as the Warrants.

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

On February 20, 2008 we issued 227,273 shares of our common stock to holders of $50,000 in face value of our Bridge Notes. We relied on section 3(9) of the Securities Act of 1933 in issuing these securities.

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. 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 $115,313

ITEM 4

SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

None

ITEM 5

OTHER INFORMATION

None





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ITEM 6

EXHIBITS

3.1

Articles of Incorporation, as amended and restated (1)

3.2

Bylaws, as amended and restated (1)

10.1

Amended and Restated Convertible Promissory Notes in favor of Calico Capital Management, LLC, BRAX Capital, LLC and Gene Salkind, M.D.(2)

10.2

Consulting Agreement dated February 21, 2008 with John H. Foster, Ph.D.(3)

10.3

Form of Securities Purchase Agreement (4)

10.4

Form of Subordinated 10% Debenture (4)

10.5

Form of Common Stock Purchase Warrant (4)

10.6

Termination Agreement dated March 14, 2008 between Rodney L. Anderson, Joey M. Anderson and Robert A Hasson(5)

10.7

Second Amended Convertible Promissory Notes in favor of Calico Capital Management, LLC, BRAX Capital, LLC and Gene Salkind, M.D.(6)

31.1

Certification Pursuant to Rule 13a - 14(a) and 15d - 14(a)(4)*

31.2

Certification Pursuant to Rule 13a - 14(a) and 15d - 14(a)(4)*

32.1

Certification Pursuant to Section 1350 of Title 18 of the United States Code*

32.2

Certification Pursuant to Section 1350 of Title 18 of the United States Code*



(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 January 28, 2008.

(3)

Incorporated by reference from the Current Report on Form 8-K filed with the Securities and Exchange Commission on February 25, 2008.

(4)

Incorporated by reference from the Current Report on Form 8-K filed with the Securities and Exchange Commission on March 3, 2008.

(5)

Incorporated by reference from the Current Report on Form 8-K filed with the Securities and Exchange Commission on March 17, 2008.

(6)

Incorporated by reference from the Current Report on Form 8-K filed with the Securities and Exchange Commission on March 24, 2008.





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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



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







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