UNITED
STATES




SECURITIES
AND EXCHANGE COMMISSION




Washington,
D.C. 20549




Form
10-QSB/A


(Amendment
Number 1)




Mark
One




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




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




Commission
File No. 002-95626-D




Sionix
Corporation





(Exact
name of registrant as specified in charter)





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




3880 East
Eagle Drive, Anaheim, California 92807





(Address
of principal executive offices)




(714)
678-1000





(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).oYes  x No




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




Transitional
Small Business Format (Check one) Yes oNo  x





EXPLANATORY
NOTE




On March
21, 2008 Sionix Corporation received a letter from the Securities and Exchange
Commission (the “SEC”) regarding the company’s Form 10-QSB for the period ended
December 31, 2007.  We have responded to the SEC’s comments to our
Form 10-QSB (the “Original Report”) in this amendment number 1 (the
“Amendment”).  The primary purpose of the Amendment is to disclose the
restatement of our financial statements for the three months ended December 31,
2007.  A complete discussion of the restatement is included in the
section of the Amendment titled “Management’s Discussion and Analysis of
Financial Condition and Plan of Operation” and in note 13 to our financial
statements for the three months ended December 31, 2007.




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




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


Page 2 of
65




Sionix
Corporation – Form 10-QSB


Table
of Contents




Part
      I
                                  Financial
      InformationItem
      1
                                  Financial
      StatementsBalance
      Sheet as of December 31, 2007 (Unaudited) (Restated)
                                  4Statements
      of Operations (Unaudited) for the three month ended December 31, 2007 and
      December 31, 2006 and from inception (October 3, 1994) to December 31,
      2007 (Restated)
                                  5Statements
      of Stockholders Equity (Deficit) for the period from inception (October 3,
      1994) to December 31, 2007 (Restated)
                                  6Statements
      of Cash Flows (unaudited) for the three months ended December 31, 2007 and
      December 31, 2006 and from inception (October 3, 1994) to December 31,
      2007 (Restated)
                                  9Notes
      to unaudited financial statements
                                  10Forward-Looking
      Statements
                                  41Part
      II
                                  Other
      InformationItem
      1
                                  Legal
      Proceedings
                                  63Item
      2
                                  Unregistered
      Sales of Equity Securities and Use of Proceeds
                                  63Item
      3
                                  Defaults
      upon Senior Securities
                                  63Item
      4
                                  Submission
      of Matters to a Vote of Security Holders
                                  63Item
      5
                                  Other
      Information
                                  63Item
      6
                                  Exhibits
                                  63Part
      III
                                  Signatures
                                  
                                  65Part IV
                                  Exhibit – 31.1
                                  Certifications
      required under Section 302 of the Sarbanes-Oxley Act of
    2002Part V
                                  Exhibit – 31.2
                                  Certifications
      required under Section 302 of the Sarbanes-Oxley Act of
    2002Part VI
                                  Exhibit – 32
                                  Certifications
      required under Section 906 of the Sarbanes-Oxley Act of
    2002


Page 3 of
65


Sionix
Corporation


A
Development Stage Company


Balance
Sheet (Unaudited)


December
31, 2007




RestatedASSETSCURRENT
      ASSETSCash
      and cash equivalents
                            
                            $
                            1,366Other
      current assets
                            
                            
                            2,000TOTAL
      CURRENT ASSETS
                            
                            
                            3,366PROPERTY
      AND EQUIPMENT, net
                            
                            
                            59,343DEPOSITS
                            
                            
                            104,600$
                            167,309LIABILITIES
      AND STOCKHOLDERS' DEFICITCURRENT
      LIABILITIESAccounts
      payable
                            
                            $
                            344,854Accrued
      expenses
                            
                            
                            2,353,077Liquidated
      damages liability
                            
                            
                            61,500Notes
      payable to related parties
                            
                            
                            124,000Convertible
      notes, net
                            
                            
                            1,172,051Warrant
      liability
                            
                            
                            6,464,460Beneficial
      conversion features liability
                            
                            
                            1,222,663TOTAL
      CURRENT LIABILITIES
                            
                            
                            11,742,605STOCKHOLDERS'
      DEFICITCommon
      Stock, $0.001 par value; 150,000,000 shares authorized;107,117,101
      shares issued; 106,635,201 shares outstanding
                            
                            
                            106,635Additional
      paid-in capital
                            
                            
                            10,762,982Shares
      to be issued
                            
                            
                            43,900Deficit
      accumulated during development stage
                            
                            
                            (22,488,813
                            )TOTAL
      STOCKHOLDERS' DEFICIT
                            
                            
                            (11,575,296
                            )TOTAL
      LIABILITIES AND STOCKHODLERS' DEFICIT
                            
                            $
                            167,309





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


Page 4 of
65




Sionix
Corporation


A
Development Stage Company


Statements
of Operations (Unaudited)





Cummulative fromInceptionFor the three months ended December 31,
                        
                        
                        (October 3, 1994)2007
                        
                        
                        2006
                        
                        
                        to December 31, 2007(Restated)
                        
                        
                        (Restated)
                        
                        
                        (Restated)Operating
      expensesGeneral
      and administrative
                        
                        $
                        5,064,569
                        
                        
                        $
                        275,242
                        
                        
                        $
                        18,394,074Research
      and development
                        
                        
                        236,904
                        
                        
                        
                        
                        
                        
                        
                        2,212,844Depreciation
      and amortization
                        
                        
                        8,157
                        
                        
                        
                        7,793
                        
                        
                        
                        540,262Total
      operating expenses
                        
                        
                        5,309,630
                        
                        
                        
                        283,035
                        
                        
                        
                        21,147,180Loss
      from Operations
                        
                        
                        (5,309,630
                        )
                        
                        
                        (283,035
                        )
                        
                        
                        (21,147,180
                        )Other
      income (expense)Interest
      income
                        
                        
                        917
                        
                        
                        
                        106
                        
                        
                        
                        59,460Interest
      expense
                        
                        
                        506,726
                        
                        
                        
                        (110,410
                        )
                        
                        
                        (1,683,655
                        )Decrease
      in warrant liability
                        
                        
                        759,773
                        
                        
                        
                        
                        
                        
                        
                        848,644Decrease
      (increase) in beneficial conversion features
liability
                        
                        
                        208,149
                        
                        
                        
                        
                        
                        
                        
                        204,105Impairment
      of intangibles
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        (1,267,278
                        )Inventory
      obsolesence
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        (365,078
                        )Legal
      settlement
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        344,949Loss
      on settlement of debt
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        (230,268
                        )Write-off
      of beneficial conversion feature and discount
                        
                        
                        380,440
                        
                        
                        
                        
                        
                        
                        
                        380,440Total
      Other Income (Expense)
                        
                        
                        842,553
                        
                        
                        
                        (110,304
                        )
                        
                        
                        (1,328,241
                        )Loss
      before income taxes
                        
                        
                        (4,467,077
                        )
                        
                        
                        (393,339
                        )
                        
                        
                        (22,475,421
                        )Income
      Taxes
                        
                        
                        900
                        
                        
                        
                        900
                        
                        
                        
                        13,392Net
      Loss
                        
                        $
                        (4,467,977
                        )
                        
                        $
                        (394,239
                        )
                        
                        $
                        (22,488,813
                        )Basic
      and dilutive loss per share
                        
                        $
                        (0.04
                        )
                        
                        $
                        -Basic
      and diluted wighted average nubmer of  shares of Common Stock
      outstanding*
                        
                        
                        106,635,201
                        
                        
                        
                        105,459,175




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


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


Page 5 of
65


Sionix
Corporation


A
Development Stage Company


Statement
of Stockholders’ Equity (Deficit) (Unaudited)


For
the Period from Inception (October 3, 1994) to December 31,
2007





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





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


Page 6 of
65





Sionix
Corporation


A
Development Stage Company


Statement
of Stockholders’ Equity (Deficit) (Unaudited) - Continued


For
the Period from Inception (October 3, 1994) to December 31, 2007





Deficit
                        
                        
                        TotalCommon Stock
                        
                        
                        Additional
                        
                        
                        Stock
                        
                        
                        Stock
                        
                        
                        Shares
                        
                        
                        Unamortized
                        
                        
                        Accumulated
                        
                        
                        Stockholders'Number
                        
                        
                        
                        
                        
                        Paid-in
                        
                        
                        to be
                        
                        
                        Subscription
                        
                        
                        to be
                        
                        
                        Consulting
                        
                        
                        from
                        
                        
                        Equityof Shares
                        
                        
                        Amount
                        
                        
                        Capital
                        
                        
                        Issued
                        
                        
                        Receivable
                        
                        
                        Cancelled
                        
                        
                        Fees
                        
                        
                        Inception
                        
                        
                        (Deficit)Balance
      at September 30, 2000
                        
                        
                        54,166,322
                        
                        
                        
                        54,166
                        
                        
                        
                        8,104,350
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        (8,168,751
                        )
                        
                        
                        (10,235
                        )Shares
      issued for services and prepaid expenses
                        
                        
                        2,517,376
                        
                        
                        
                        2,517
                        
                        
                        
                        530,368
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        (141,318
                        )
                        
                        
                        
                        
                        
                        
                        391,567Shares
      issued for cash
                        
                        
                        6,005,000
                        
                        
                        
                        6,005
                        
                        
                        
                        594,495
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        600,500Shares
      to be issued for cash (100,000 shares)
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        10,000
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        10,000Shares
      to be issued for debt (639,509 shares)
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        103,295
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        103,295Net
      loss for the year ended September 30,
    2001
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        (1,353,429
                        )
                        
                        
                        (1,353,429
                        )Balance
      at September 30, 2001
                        
                        
                        62,688,698
                        
                        
                        
                        62,688
                        
                        
                        
                        9,229,213
                        
                        
                        
                        113,295
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        (141,318
                        )
                        
                        
                        (9,522,180
                        )
                        
                        
                        (258,302
                        )Shares
      issued for services and prepaid expenses
                        
                        
                        1,111,710
                        
                        
                        
                        1,112
                        
                        
                        
                        361,603
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        54,400
                        
                        
                        
                        
                        
                        
                        
                        417,115Shares
      issued as a contribution
                        
                        
                        100,000
                        
                        
                        
                        100
                        
                        
                        
                        11,200
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        11,300Shares
      issued for compensation
                        
                        
                        18,838
                        
                        
                        
                        19
                        
                        
                        
                        2,897
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        2,916Shares
      issued for cash
                        
                        
                        16,815,357
                        
                        
                        
                        16,815
                        
                        
                        
                        1,560,782
                        
                        
                        
                        (10,000
                        )
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        1,567,597Shares
      issued for debt
                        
                        
                        1,339,509
                        
                        
                        
                        1,340
                        
                        
                        
                        208,639
                        
                        
                        
                        (103,295
                        )
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        106,684Shares
      to be issued for  services related to raising  equity
      (967,742 shares)
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        (300,000
                        )
                        
                        
                        300,000
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        -Cancellation
      of shares
                        
                        
                        (7,533,701
                        )
                        
                        
                        (7,534
                        )
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        (7,534
                        )Net
      loss for the year ended September 30, 2002
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        (1,243,309
                        )
                        
                        
                        (1,243,309
                        )Balance
      at September 30, 2002
                        
                        
                        74,540,411
                        
                        
                        
                        74,540
                        
                        
                        
                        11,074,334
                        
                        
                        
                        300,000
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        (86,918
                        )
                        
                        
                        (10,765,489
                        )
                        
                        
                        596,467Shares
      issued for services and prepaid expenses
                        
                        
                        2,467,742
                        
                        
                        
                        2,468
                        
                        
                        
                        651,757
                        
                        
                        
                        (300,000
                        )
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        354,225Shares
      issued for capital  equity line
                        
                        
                        8,154,317
                        
                        
                        
                        8,154
                        
                        
                        
                        891,846
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        900,000Amortization
      of consulting fees
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        86,918
                        
                        
                        
                        
                        
                        
                        
                        86,918Cancellation
      of shares
                        
                        
                        (50,000
                        )
                        
                        
                        (50
                        )
                        
                        
                        50
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        -Shares
      to be cancelled (7,349,204 shares)
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        7,349
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        (7,349
                        )
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        -Net
      loss for the year ended September 30, 2003
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        (1,721,991
                        )
                        
                        
                        (1,721,991
                        )Balance
      at September 30, 2003
                        
                        
                        85,112,470
                        
                        
                        
                        85,112
                        
                        
                        
                        12,625,336
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        (7,349
                        )
                        
                        
                        -
                        
                        
                        
                        (12,487,480
                        )
                        
                        
                        215,619Shares
      issued for capital  equity line
                        
                        
                        19,179,016
                        
                        
                        
                        19,179
                        
                        
                        
                        447,706
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        466,885Shares
      issued for services
                        
                        
                        5,100,004
                        
                        
                        
                        5,100
                        
                        
                        
                        196,997
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        (13,075
                        )
                        
                        
                        
                        
                        
                        
                        189,022Share
      to be issued for cash (963,336 shares)
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        28,900
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        28,900Shares
      to be issued for debt (500,000 shares)
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        15,000
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        15,000Cancellation
      of shares
                        
                        
                        (7,349,204
                        )
                        
                        
                        (7,349
                        )
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        7,349
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        -Issuance
      of warrants related to 2004 stock purchase
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        24,366
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        24,366Net
      loss for the year ended September 30, 2004
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        (1,593,136
                        )
                        
                        
                        (1,593,136
                        )




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


Page 7 of
65




Sionix
Corporation


A
Development Stage Company


Statement
of Stockholders’ Equity (Deficit) (Unaudited) - Continued


For
the Period from Inception (October 3, 1994) to December 31, 2007





Balance
      at September 30, 2004,  Restated
                            
                            
                            102,042,286
                            
                            
                            
                            102,042
                            
                            
                            
                            13,294,405
                            
                            
                            
                            43,900
                            
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            (13,075
                            )
                            
                            
                            (14,080,615
                            )
                            
                            
                            (653,343
                            )Amortization
      of consulting fees
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            13,075
                            
                            
                            
                            
                            
                            
                            
                            13,075Net
      loss for the year ended September 30, 2005
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            (722,676
                            )
                            
                            
                            (722,676
                            )Balance
      at September 30, 2005, Restated
                            
                            
                            102,042,286
                            
                            
                            
                            102,042
                            
                            
                            
                            13,294,405
                            
                            
                            
                            43,900
                            
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            (14,803,291
                            )
                            
                            
                            (1,362,944
                            )Net
      loss for the year ended September 30, 2006
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            (1,049,319
                            )
                            
                            
                            (1,049,319
                            )Balance
      at September 30, 2006, Restated
                            
                            
                            102,042,286
                            
                            
                            
                            102,042
                            
                            
                            
                            13,294,405
                            
                            
                            
                            43,900
                            
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            (15,852,610
                            )
                            
                            
                            (2,412,263
                            )Shares
      issued for services
                            
                            
                            4,592,915
                            
                            
                            
                            4,593
                            
                            
                            
                            80,336
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            84,929Reclassification
      of 2001Executive
      Option Plan as of July 17, 2007
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            (2,271,879
                            )
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            (2,271,879
                            )Reclassification
      of  beneficial conversion features liability related to advisory
      board  compensation as of July 17, 2007
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            (269,851
                            )
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            (269,851
                            )Reclassification
      of warrants related to 2004 stock  purchase agreement as of July
      17, 2007
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            (70,029
                            )
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            (70,029
                            )Net
      loss for the year ended September 30, 2007
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            (2,168,226
                            )
                            
                            
                            (2,168,226
                            )Balance
      at September 30, 2007, Restated
                            
                            
                            106,635,201
                            
                            
                            
                            106,635
                            
                            
                            
                            10,762,982
                            
                            
                            
                            43,900
                            
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            (18,020,836
                            )
                            
                            
                            (7,107,319
                            )Net
      loss for the three months ended December 31, 2007
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            (4,467,977
                            )
                            
                            
                            (4,467,977
                            )Balance
      at December 31, 2007,
                            
                            
                            106,635,201
                            
                            
                            $
                            106,635
                            
                            
                            $
                            10,762,982
                            
                            
                            $
                            43,900
                            
                            
                            $
                            -
                            
                            
                            $
                            -
                            
                            
                            $
                            -
                            
                            
                            $
                            (22,488,813
                            )
                            
                            $
                            (11,575,296
                            )




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


Page 8 of
65


Sionix
Corporation


A
Development Stage Company


Statement
of Cash Flows (Unaudited)





CummulativefromFor the Three Months
                        
                        
                        InceptionEnded Deceember 31,
                        
                        
                        (October 3, 1994) to2007
                        
                        
                        2006
                        
                        
                        December 31,2007(Restated)
                        
                        
                        (Restated)
                        
                        
                        (Restated)Operating
      activities:Net
      loss
                        
                        $
                        (4,467,977
                        )
                        
                        $
                        (394,239
                        )
                        
                        $
                        (22,488,813
                        )Adjustments
      to reconcile net loss to net cash used inoperating
      activities:Depreciation
                        
                        
                        8,157
                        
                        
                        
                        7,793
                        
                        
                        
                        627,180Amortization
      of beneficial conversion features discount and warrant
      discount
                        
                        
                        405,651
                        
                        
                        
                        91,528
                        
                        
                        
                        1,288,669Stock
      based compensation expense - employee
                        
                        
                        1,791,360
                        
                        
                        
                        
                        
                        
                        
                        3,627,317Stock
      based compensation expense - consultant
                        
                        
                        3,006,027
                        
                        
                        
                        32,929
                        
                        
                        
                        5,970,896Decrease
      in warrant liabilities
                        
                        
                        (759,773
                        )
                        
                        
                        
                        
                        
                        
                        (1,229,084
                        )Decrease
      in beneficial conversion features liabilities
                        
                        
                        (208,149
                        )
                        
                        
                        
                        
                        
                        
                        (204,105
                        )Write-off
      of beneficial conversion features
                        
                        
                        (380,440
                        )
                        
                        
                        
                        
                        
                        
                        (380,440
                        )Impairment
      of assets
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        514,755Write-down
      of obsolete assets
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        38,862Impairment
      of intangible assets
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        1,117,601Loss
      on settlement of debt
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        130,268Accrual
      of liquidating damages
                        
                        
                        46,125
                        
                        
                        
                        
                        
                        
                        
                        61,500Other
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        (799,044
                        )(Increase)
      decrease in assets:Other
      current assets
                        
                        
                        (650
                        )
                        
                        
                        
                        
                        
                        
                        (2,000
                        )Other
      assets
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        (104,600
                        )Increase
      (decrease) in liabilities:Accounts
      payable
                        
                        
                        187,455
                        
                        
                        
                        (59,576
                        )
                        
                        
                        344,854Accrued
      expenses
                        
                        
                        79,331
                        
                        
                        
                        159,389
                        
                        
                        
                        2,086,143Net
      cash used in operating activities
                        
                        
                        (292,883
                        )
                        
                        
                        (162,176
                        )
                        
                        
                        (9,400,041
                        )Investing
      activities:Acquisition
      of property and equipment
                        
                        
                        (26,666
                        )
                        
                        
                        
                        
                        
                        
                        (398,121
                        )Acquisition
      of patents
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        (154,061
                        )Net
      cash used in investing activities
                        
                        
                        (26,666
                        )
                        
                        
                        -
                        
                        
                        
                        (552,182
                        )Financing
      activities:Payment
      on notes payable to officer
                        
                        
                        (19,260
                        )
                        
                        
                        (18,800
                        )
                        
                        
                        (218,502
                        )Proceeds
      from notes payable, related party
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        457,433Payments
      on notes payable to related party
                        
                        
                        (5,000
                        )
                        
                        
                        
                        
                        
                        
                        (5,000
                        )Receipt
      from (payments to) equity line of credit
                        
                        
                        (27,336
                        )
                        
                        
                        (75,000
                        )
                        
                        
                        428,664Proceeds
      from convertible notes payable
                        
                        
                        
                        
                        
                        
                        622,500
                        
                        
                        
                        1,861,000Issuance
      of common stock
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        7,386,094Receipt
      of cash for stock to be issued
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        43,900Net
      cash provided by (used in) financing activities
                        
                        
                        (51,596
                        )
                        
                        
                        528,700
                        
                        
                        
                        9,953,589Net
      increase (decrease) in cash and cash equivalents
                        
                        
                        (371,145
                        )
                        
                        
                        366,524
                        
                        
                        
                        1,366Cash
      and cash equivalents balances:Beginning
      of period
                        
                        
                        372,511
                        
                        
                        
                        4,544End
      of month
                        
                        $
                        1,366
                        
                        
                        $
                        371,068
                        
                        
                        $
                        1,366Cash
      and cash equivalents paid for:Interest
                        
                        $
                        -
                        
                        
                        $
                        -
                        
                        
                        $
                        -Income
      taxes
                        
                        $
                        -
                        
                        
                        $
                        -
                        
                        
                        $
                        -





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




Page 9 of
65




Sionix
Corporation


A
Development Stage Company


December
31, 2007




Notes
to Financial Statements (Unaudited)




NOTE
      1
            ORGANIZATION
      AND DESCRIPTION OF BUSINESS




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




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




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




NOTE
      2
            SUMMARY
      OF SIGNIFICANT ACCOUNTING POLICIES




Basis
of Presentation




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




Revenue
Recognition




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




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.




Page 10
of 65




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.




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 based upon 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 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.


Page 11
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Estimates




The
preparation of financial statements requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenue and expenses during the reporting
period. Actual results could differ from those estimates




Advertising




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




Reclassification




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




Recently
Issued Accounting Pronouncements




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




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




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


Page 12
of 65




NOTE
      3
            PROPERTY
      AND EQUIPMENT




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




Equipment
      and machinery
                            
                            $
                            213,166Furniture
      and fixtures
                            
                            
                            24,594Leasehold
      improvements
                            
                            
                            26,667264,427Less
      accumulated depreciation
                            
                            
                            (205,084
                            )Net
      Property and Equipment
                            
                            $
                            59,343




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




NOTE
      4
            ACCRUED
      EXPENSES (Restated)




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




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







NOTE
      5
            NOTES
      PAYABLE TO RELATED PARTIES




The
Company has received advances in the form of unsecured promissory notes from
stockholders in order to pay ongoing operating expenses. These notes bear
interest at rates up to 13% and are due on demand. As of December 31, 2007,
notes payable amounted to $124,000. The Company recorded $3,239 of interest
expense on those notes during the three month period ended December 31,
2007.




NOTE
      6
            CONVERTIBLE
      NOTES PAYABLE (Restated)




Convertible
Notes 1




Between
October 2006 and February 2007, the Company completed an offering of $750,000 in
principal amount of convertible notes, which bear interest at 10% per annum and
mature at the earlier of (i) 18 months from the date of issuance (ii) an event
of default or (iii) the closing of any equity related financing by the Company
in which the gross proceeds are a minimum of $2,500,000. These notes are
convertible into shares of the Company’s Common Stock at $0.05 per share or
shares of any equity security issued by the Company at a conversion price equal
to the price at which such security is sold to any other party. In the event
that a registration statement covering the underlying shares was not declared
effective within 180 days after the closing, the conversion price was to be
reduced by $0.0025 per share for each 30 day period that the effectiveness of
the registration statement was delayed but in no case could the conversion price
be reduced below $0.04 per share. As of December 31, 2007, the conversion price
was $0.04 per share.




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


Page 13
of 65





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





Based on
the calculation of the fair value of the embedded beneficial conversion feature,
the Company allocated $750,000 to the beneficial conversion feature and the
beneficial conversion feature discount, and none to the convertible note at the
date of issuance. The embedded beneficial conversion feature discount, which is
$41,667 per month, is amortized to interest expense over the term of the
note.




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




For the
three months ended December 31, 2007, interest expense was $19,375, and
amortization expense for the embedded beneficial conversion feature discount was
$125,000, which was included in interest expense in the other income (expense)
section of the statement of operations.




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




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.


Page 14
of 65





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




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




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




For the
three months ended December 31, 2007, interest expense was $2,191, and
amortization expense for the embedded beneficial conversion feature discount was
$14,333, which was included in interest expense in the other income (expense)
section of the statement of operations.




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




Convertible
Notes 3




On July
17, 2007, the Company completed an offering of $1,025,000 in principal amount of
Subordinated Convertible Debentures to a group of institutional and accredited
investors, which bear interest at the rate of 8% per annum, and mature 12 months
from the date of issuance. Convertible Notes 3 are convertible into shares of
the Company’s Common Stock at an initial conversion rate of $0.22 per share,
subject to anti-dilution adjustments. As part of the above offering the Company
issued warrants to purchase 2,329,546 shares of Common Stock at an initial
exercise price of $0.50 per share.




Under the
terms of a Registration Rights Agreement signed in conjunction with this
offering, the Company is required to file a registration statement under the
Securities Act of 1933 in order to register the resale of the shares of Common
Stock issuable upon conversion of the Convertible Notes 3 and the warrant shares
(collectively, the "Registrable Securities"). If the Company did not file a
registration statement with respect to the Registrable Securities within
forty-five days following the closing of the offering, or if the registration
statement was not declared effective by the Securities and Exchange Commission
within 90 days, then the Company was required to pay to each purchaser damages
equal to 1.5% of the purchase price paid by the purchaser for Convertible Notes
3 for each 30 day period that followed these deadlines. The aggregate amount of
damages payable by the Company is limited to 15% of the purchase price. The
Company had until August 31, 2007 to file the registration statement. As of and
for the three months ended December 31, 2007, the Company recorded $61,500 and
$46,125 as liquidated damages, respectively. No derivative liability is recorded
as the amount of liquidated damage is fixed with a maximum ceiling.




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




The fair
value of the warrants was $741,371 at the date of issuance calculated using the
Black Sholes valuation modelwith the following
assumptions: risk free rate of return of 4.96% to 5.02%; volatility of 219.89%
to 226.04%; dividend yield of 0% and an expected term of 5 years.As a result, the
relative fair value of the warrants was $430,189.


Page 15
of 65


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




The fair
value of the embedded beneficial conversion features was $594,811 at the date of
issuance using the Black Sholes valuation modelwith the following
assumptions: risk free rate of return of 4.96% to 5.02%; volatility of 219.89%
to 226.04%; dividend yield of 0% and an expected term of 1 year.




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




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




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




NOTE
      7
            WARRANT
      LIABILITY (Restated)




2001
Executive Officers Stock Option Plan




In
October 2000, the Company amended its employment agreements with its executive
officers. In conjunction with the amendments the Company adopted the 2001
Executive Officers Stock Option Plan. The plan reserved 7,576,680 shares of
Common Stock for awards and, as of December 31, 2007, had issued options for the
purchase of 7,034,140 shares of Common Stock.  The options expire 5
years from the date of issuance.




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


Page 16
of 65


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




The
Company followed the guidance of EITF 00-19, paragraph 9, which states that all
contracts classified as liabilities should be measured at fair value at each
balance sheet date, with changes in fair value reported in earnings and
disclosed in the financial statements as long as the contracts remain classified
as liabilities.The Company analyzed
the options as of December 31, 2007 by following the guidance of SFAS 133,
paragraph 6 to ascertain if the options issued remained derivatives as of
December 31, 2007. All of the criteria in the original analysis were met, and
the options issued were determined to be within the scope and definition of a
derivative. The Company next followed the guidance of EITF 00-19, paragraph 19,
which states that if a company is required to obtain shareholder approval to
increase the company’s authorized shares in order to net-share or physically
settle a contract, share settlement is not controlled by the company, and the
contract is required to be classified as a liability. The Company next applied
EITF 00-19, paragraph 10, which states that if classification changes as the
result of an event, the contract should be reclassified as of the date of the
event at fair value. The event responsible for the change in classification was
the issuance of the Convertible Debentures on July 17, 2007.




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




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




Warrants
Related to Convertible Notes 3




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




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




The fair
value of the warrants was $554,249 ($430,189 attributable to the holders of the
Convertible Notes 3 and $124,060 attributable to the placement fee) at the date
of issuance calculated using the Black Sholes valuation modelwith the following
assumptions: risk free rate of return of 4.96% to 5.02%; volatility of 219.89%
to 226.04%; dividend yield of 0% and an expected term of 5 years.




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




The
Company analyzed the warrants as of December 31, 2007 by following the guidance
of SFAS 133, paragraph 6 to ascertain if the warrants issued remained
derivatives as of September 30, 2007. All of the criteria in the original
analysis were met, and the warrants issued were determined to be within the
scope and definition of a derivative. The Company next followed the guidance of
EITF 00-19, paragraph 19, which states that if a company is required to obtain
shareholder approval to increase the company’s authorized shares in order to
net-share or physically settle a contract, share settlement is not controlled by
the company, and the contract is required to be classified as a
liability.


Page 17
of 65




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




The
decrease in the fair value of the warrants for the three months ended December
31, 2007 was recorded by decreasing warrant liabilities on the balance sheet by
$178,155 ($125,228 attributable to the holders of the Convertible Notes 3 and
$52,927 attributable to the placement fee).




Warrants
Issued to Advisory Board Members




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




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




The fair
value of the warrants was $1,557,704 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 December 31, 2007. All of the criteria
in the original analysis were met, and the warrants issued were determined to be
within the scope and definition of a derivative. EITF 00-19, paragraph 8 was
applied which states that if share settlement is not controlled by a company,
the contract is required to be classified as a liability. Paragraph 9 also
states that contracts classified as liabilities should be measured at fair value
at each balance sheet date, with changes in fair value reported in earnings and
disclosed in the financial statements as long as the contracts remain classified
as liabilities.




The fair
value of the warrants was determined to be $1,533,300 as of December 31, 2007,
using the Black Sholes valuation model with the following assumptions: risk free
rate of return of 3.34%; volatility of 98.01%; dividend yield of 0%; and an
expected term of 4.92 years.




The
decrease in the fair value of the warrants was $24,404 for the three months
ended December 31, 2007, and recorded by decreasing the warrant liability on the
balance sheet.




Option
Issued to Director




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




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




Page 18
of 65




The fair
value of the option was $171,520 at the date of issuance and was calculated
using the Black Sholes valuation model with the following assumptions: risk free
interest rate of 3.22%, expected volatility of 99.86%, dividend yields of 0% and
expected term of 5 years.




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




The
Company analyzed the option by applying FASB 133,paragraph 6 to ascertain if
the option remained a derivative as of December 31, 2007. All of the criteria in
the original analysis were met, and the option issued was determined to be
within the scope and definition of a derivative. EITF 00-19, paragraph 8 was
applied which states that if share settlement is not controlled by the company,
the contract is required to be classified as a liability. Paragraph 9 also
states that contracts classified as liabilities should be measured at fair value
at each balance sheet date, with changes in fair value reported in earnings and
disclosed in the financial statements as long as the contracts remain classified
as liabilities.




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




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




Option
Issued to Chief Financial Officer




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




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




The fair
value of the option was $171,520 at the date of issuance and was calculated
using the Black Sholes valuation model with the following assumptions: risk free
interest rate of 3.22%, expected volatility of 99.86%, dividend yield of 0% and
expected term of 5 years.




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




The
Company analyzed the option by applying FASB 133,paragraph 6 to ascertain if
the option remained a derivative as of December 31, 2007. All of the criteria in
the original analysis were met, and the option issued was determined to be
within the scope and definition of a derivative. EITF 00-19, paragraph 8 was
applied which states that if share settlement is not controlled by the company,
the contract is required to be classified as a liability. Paragraph 9 also
states that contracts classified as liabilities should be measured at fair value
at each balance sheet date, with changes in fair value reported in earnings and
disclosed in the financial statements as long as the contracts remain classified
as liabilities.




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




Page 19
of 65




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




Option
Issued to Chief Executive Officer




On
December 19, 2007, the Company entered into a one year Employment Agreement with
Richard H. Papalian pursuant to which Mr. Papalian had been appointed as the
Company’s Chief Executive Officer. As compensation for his services, the Company
granted Mr. Papalian a five year option to purchase up to 8,539,312 shares of
the Company’s Common Stock at an exercise price of $0.25 per share. As per the
terms of the stock option agreement, the right to purchase 340,000 shares of
Common Stock is not exercisable until the notes dated June 6, 2007 (Convertible
Notes 2 as discussed in Note 6 above) are eligible for conversion into shares of
Common Stock. These options were not issued from the 2001 Executive Officers
Stock Option Plan.On
the grant date, the Company applied FASB 133, paragraph 6 to determine if
the option was within the scope and definition of a derivative. The option had
one or more underlings and one or more notional amounts, required no initial
investment, and required or permitted net settlement. Therefore, the option was
determined to be a derivative. In order to determine how to classify the option,
the Company followed the guidance of EITF 00-19, paragraphs 7 and 8, which state
that contractsthat require
net-cash settlement (including a requirement to net cash settle the contract if
an event occurs and if that event is outside the control of the company) are
liability instruments. In order to determine the value of the option, the
Company applied EITF 00-19, paragraph 9, which states that contracts that
require the company to deliver shares as part of a physical settlement or
net-share settlement should be initially measured at fair value.




The fair
value of the option was $1,448,321 at the date of issuance, which was calculated
using the Black Sholes valuation model with the following assumptions: risk free
rate of return of 3.26%; volatility of 98.01%; dividend yield of 0%; and an
expected term of 5 years.




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




The
Company analyzed the option as of December 31, 2007 by applying FASB 133,paragraph 6 to ascertain if
the option issued remained a derivative as of December 31, 2007. All of the
criteria in the original analysis were met, and the option issued was determined
to be within the scope and definition of a derivative. EITF 00-19, paragraph 8
was applied which states that if share settlement is not controlled by a
company, the contract is required to be classified as a liability. Paragraph 9
also states that contracts classified as liabilities should be measured at fair
value at each balance sheet date, with changes in fair value reported in
earnings and disclosed in the financial statements as long as the contracts
remain classified as liabilities.




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




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




Warrant
Issued to Consultant




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




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




Page 20
of 65




The fair
value of the warrant was $1,448,321 at the date of issuance and was calculated
using the Black Sholes valuation model with the following assumptions: risk free
interest rate of 3.26%, expected volatility of 98.01%, dividend yield of 0% and
expected term of 5 years.




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




The
Company analyzed the warrant by applying FASB 133,paragraph 6 to ascertain if
the warrant remained a derivative as of September 30, 2007. All of the criteria
in the original analysis were met, and the warrant was determined to be within
the scope and definition of a derivative. EITF 00-19, paragraph 8 was applied
which states that if share settlement is not controlled by the company, the
contract is required to be classified as a liability. Paragraph 9 also states
that contracts classified as liabilities should be measured at fair value at
each balance sheet date, with changes in fair value reported in earnings and
disclosed in the financial statements as long as the contracts remain classified
as liabilities.




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




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




NOTE
      8
            BENEFICIAL
      CONVERSION FEATURES LIABILITY
(Restated)




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




The
Company followed the guidance of SFAS 133, paragraph 6, to ascertain if the
embedded beneficial conversion features were derivatives at the date of issue.
The embedded beneficial conversion features had one or more underlings and one
or more notional amounts, required no initial investment and required or
permitted net settlement. Therefore, the embedded beneficial conversion features
were determined to be derivatives. In order to determine the classification of
the embedded conversion features, the Company applied paragraph 19 of EITF
00-19, which states that if a company is required to obtain shareholder approval
to increase the company’s authorized shares in order to net-share or physically
settle a contract, share settlement is not controlled by the company, and the
contract is required to be classified as a liability. In order to determine the
value of the embedded conversion features, the Company followed the guidance of
EITF 00-19, paragraph 9, which states that all contracts classified as
liabilities are to be measured at fair value at each balance sheet date, with
changes in fair value reported in earnings and disclosed in the financial
statements as long as the contracts remain classified as
liabilities.




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




The
Company followed the guidance of SFAS 133, paragraph 6, to ascertain if the
embedded beneficial conversion features remained derivatives as of December 31,
2007. All of the criteria in the original analysis were met, and the embedded
beneficial conversion features were determined to be within the scope and
definition of a derivative. The Company followed the guidance of SFAS 133,
paragraph 12, to determine if the embedded beneficial conversion features should
be separated from the convertible notes. All of the criteria in the original
analysis were met, and the embedded beneficial conversion features were
separated from the convertible notes. In order to determine the classification
of the embedded beneficial conversion features, the Company applied paragraph 19
of EITF 00-19, which states that if a company is required to obtain shareholder
approval to increase the company’s authorized shares in order to net-share or
physically settle a contract, share settlement is not controlled by the company,
and the contract is required to be classified as a liability. In order to determine the
value of the embedded conversion features, the Company followed the guidance of
EITF 00-19, paragraph 9, which states that all contracts classified as
liabilities are to be measured at fair value at each balance sheet date, with
changes in fair value reported in earnings and disclosed in the financial
statements as long as the contracts remain classified as
liabilities.




Page 21
of 65




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




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




NOTE
      9
            STOCKHOLDERS’
      EQUITY (Restated)




Common
Stock




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




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




Stock
Options




In
October 2000, the Company entered into amendments to the employment agreements
of each of the executive officers eliminating the provisions of stock bonuses.
In lieu of the bonus provision, the Company adopted the 2001 Executive Officers
Stock Option Plan. The Company reserved 7,576,680 shares for issuance under the
plan. The fair value of the options related to the 2001 Executive Stock Option
Plan was $1,223,588 as of December 31, 2007, which was calculated using the
Black-Sholes valuation model, using the following assumptions: risk free rate of
return of 3.34%, volatility of 98.01%, dividend yield of 0% and expected term of
3.25 years. The decrease in the fair value of the options of $703,326 for the
three month period ended December 31, 2007 was recorded in decrease in warrant
liability in the other income (expense) section of the statement of
operations.




On
December 19, 2007, the Company entered into a one year Employment Agreement with
Richard H. Papalian pursuant to which Mr. Papalian has been appointed as the
Company’s Chief Executive Officer. In terms of compensation, the Company granted
Mr. Papalian a five year option to purchase up to 8,539,312 shares of the
Company’s common stock at an exercise price of $0.25 per share. As per the terms
of the stock option agreements, initially the options shall not be exercisable
as to 340,000 shares of common stock. These options were issued outside of the
2001 Executive Officers Stock Option Plan.The fair value of the
options was $1,448,321 at the date of issuance, which was calculated using the
Black Sholes valuation model with the following assumptions: risk free interest
rate of 3.26%; expected volatility of 98.01%; dividend yields of 0%; and
expected term of 5 years. The fair value of the options was $1,515,432 as of
December 31, 2007, which was calculated using the Black-Sholes valuation model,
using the following assumptions: risk free rate of return of 3.34%, volatility
of 98.01%, dividend yield of 0% and expected term of 4.92 years. The increase in
the fair value of the options of $67,111 for the three months ended December 31,
2007 was recorded in decrease in warrant liability in the other income (expense)
section of the statement of operations.




On
December 13, 2007, the Company issued 2,000,000 options to two employees to
purchase shares of Common Stock at $0.25 per share. The options expire on
December 13, 2012. The fair value of the options was $343,039 at the date of
issuance and calculated using the Black Sholes valuation model with the
following assumptions: risk free interest rate of 3.26%; expected volatility of
98.01%; dividend yields of 0%; and expected term of 5 years. The fair value of
the options was $354,930 as of December 31, 2007, which was calculated using the
Black-Sholes valuation model, using the following assumptions: risk free rate of
return of 3.34%, volatility of 98.01%, dividend yield of 0% and expected term of
4.92 years. The increase in the fair value of the options of $11,890 for the
three months ended December 31, 2007 was recorded in decrease in warrant
liability in the other income (expense) section of the statement of
operations.




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




Page 22
of 65




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




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




Outstanding
Options:




Exercise
                        Price
                      
                      Stock
                        Options
                        Outstanding
                      
                      
                      Stock
                        Options
                        Exercisable
                      
                      
                      Weighted
                        Average
                        Remaining
                        Contractual
                        Life
                        in Years
                      
                      
                      Weighted
                        Average
                        Exercise
                        Price of
                        Options
                        Outstanding
                      
                      
                      Weighted
                        Average
                        Exercise
                        Price of
                        Options
                        Exercisable$
                      0.15
                      
                      
                      7,034,140
                      
                      
                      
                      7,034,140
                      
                      
                      
                      3.25
                      
                      
                      $
                      0.15
                      
                      
                      $
                      0.150.25
                      
                      
                      10,539,312
                      
                      
                      
                      4,134,828
                      
                      
                      
                      4.92
                      
                      
                      
                      0.25
                      
                      
                      
                      0.25




Stock
Warrants




On July
17, 2007 the Company completed an offering of $1,025,000 of Convertible Bridge
Notes to a group of institutional and accredited investors which included
warrants to purchase 2,795,454 shares of Common Stock (2,329,546 shares of
Common Stock to holders of the convertible bridge notes, 465,908 shares of
Common Stock as a placement fee) at an exercise price of $0.50 per share. The
warrants expire five years from the date of issuance. The fair value of the
warrants was $321,777 as of December 31, 2007, which was calculated using the
Black-Sholes valuation model, using the following assumptions: risk free rate of
return of 3.34%, volatility of 98.01%, dividend yield of 0% and expected term of
4.42 to 4.50 years. The decrease in the fair value of the options of $178,155
for the three month period ended December 31, 2007 was recorded in decrease in
warrant liability in the other income (expense) section of the statement of
operations.




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




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




On
December 19, 2007, the Company entered into a one year Consulting Agreement with
Mark Maron pursuant to which Mr. Maron has been appointed as Special Adviser to
the Company. As compensation for his services, the Company granted Mr. Maron a
five year warrant to purchase up to 8,539,312 shares of the Company’s common
stock at an exercise price of $0.25 per share. As per the terms of the stock
warrant agreements, initially the warrants shall not be exercisable as to
340,000 shares of common stock. These warrants were issued outside of the 2001
Executive Officers Stock Option Plan. The fair value of the warrant was
$1,448,321 at the date of issuance and was calculated using the Black Sholes
valuation model with the following assumptions: risk free interest rate of
3.26%, expected volatility of 98.01%, dividend yield of 0% and expected term of
5 years. The fair value of the warrants was $1,515,432 as of December 31, 2007,
which was calculated using the Black-Sholes valuation model using the following
assumptions: risk free rate of return of 3.34%, volatility of 98.01%, dividend
yield of 0% and expected term of 4.92 years. The increase in the fair value of
the warrants of $67,111 for the three months ended December 31, 2007 was
recorded in decrease in warrant liability in the other income (expense) section
of the statement of operations.




Page 23
of 65




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




WeightredAverage
                      
                      
                      Number
      of
                      
                      
                      AggregateExercise
                      
                      
                      Outstanding
                      
                      
                      IntrinsicPrice
                      
                      
                      Warrants
                      
                      
                      ValueOutstanding
      as of September 30, 2007
                      
                      $
                      0.50
                      
                      
                      
                      2,795,454
                      
                      
                      $
                      -Granted
                      
                      
                      0.25
                      
                      
                      
                      17,329,312
                      
                      
                      
                      -Forfeited
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -Exercised
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -Outstanding
      as of December 31, 2007
                      
                      $
                      0.28
                      
                      
                      
                      20,124,766
                      
                      
                      $
                      -




Warrants
Outstanding




Weighted
                    
                    
                    Weighted
                    
                    
                    WeightedAverage
                    
                    
                    Average
                    
                    
                    AverageRemaining
                    
                    
                    Exercise
                    
                    
                    ExerciseContractual
                    
                    
                    Price
      of
                    
                    
                    Price
      ofExercise
                    
                    Warrants
                    
                    
                    Warrants
                    
                    
                    Life
                    
                    
                    Options
                    
                    
                    OptionsPrice
                    
                    Outstanding
                    
                    
                    Exercisable
                    
                    
                    in
      Years
                    
                    
                    Outstanding
                    
                    
                    Exercisable0.50
                    
                    
                    2,795,454
                    
                    
                    
                    2,795,454
                    
                    
                    
                    4.50
                    
                    
                    $
                    0.50
                    
                    
                    $
                    0.500.25
                    
                    
                    150,000
                    
                    
                    
                    150,000
                    
                    
                    
                    4.75
                    
                    
                    $
                    0.25
                    
                    
                    $
                    0.250.25
                    
                    
                    17,179,312
                    
                    
                    
                    10,774,828
                    
                    
                    
                    4.92
                    
                    
                    
                    0.25
                    
                    
                    
                    0.25




NOTE
      10
            GOING
      CONCERN (Restated)




The
accompanying financial statements have been prepared assuming that the Company
will continue as a going concern. This basis of accounting contemplates the
recovery of the Company’s assets and the satisfaction of its liabilities in the
normal course of business. Through December 31, 2007, the Company has incurred
cumulative losses of $22,488,813 including a loss for the three months ended
December 31, 2007 of $4,467,977. 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.




Page 24
of 65




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




NOTE
      11
            COMMITMENT




On
February 19, 2007 the Company entered into a two year lease agreement beginning
March 1, 2007. According to the terms of the agreement, at the beginning of each
lease year, the then most recently published Consumer Price Index (CPI) figure
shall be determined and the monthly rental payable for the succeeding lease year
will be calculated.






As of
August 1, 2008, we entered into a 36 month lease for an industrial site
consisting of approximately 12,000 square feet of administrative offices and a
manufacturing facility. Monthly lease payments for the period from August 1,
2008 through July 31, 2009 are $8,650 plus common area maintenance charges;
monthly lease payments for the period from August 1, 2009 through July 31, 2010
are $8,995 plus common area maintenance charges and monthly lease payments for
the period from August 1, 2010 through July 31, 2011 are $9,355 plus common area
maintenance charges. The lease agreement includes an option to extend the lease
for an additional 36 months. If the option is exercised, monthly payments over
the three year term would be $9,730 plus common area maintenance charges from
August 1, 2011 through July 31, 2012, $10,118 plus common area maintenance
charges from August 1, 2012 through July 31, 2013, and $10,523 plus common area
maintenance charges from August 1, 2013 through July 31, 2014. The future
aggregate minimum annual lease payments arising from this lease agreement are as
follows:
 
 For the Year Ended September
      30,2009
                        
                        $
                        104,4902010
                        
                        
                        108,6602011
                        
                        
                        93,550
 
 Total
rent expense under the operating lease was approximately $18,470 for the year
ended September 30, 2008. (See Note 12).




NOTE
      12
              SUBSEQUENT
      EVENTS (Restated)




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




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




As part
of the offering, the Company issued warrants to purchase 850,000 shares of
Common Stock at $0.40 per share. The fair value of the warrants was $96,814 at
the date of issuance and was calculated using the Black-Sholes valuation model
using the following assumptions: risk free rate of return of 2.64% to 3.26%,
volatility ranging from 97.08% to 98.27%, dividend yield of 0% and expected term
of 5 years.




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




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




As part
of the offering, the Company issued warrants to purchase 15,000,000 shares of
Common Stock at $0.10 per share. The grant date fair value of the warrants was
$483,476 and was calculated using the Black-Sholes valuation model using the
following assumptions: risk free rate of return of 1.32% to 2.17%, volatility
ranging from 72.4% to 77.86%, dividend yield of 0% and expected life of 5
years.




Termination
of Lease




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




Conversion
of Debt Into Shares of Common Stock




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




Warrant
Issued to Legal Counsel




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




Warrant
Issued to Director (John Pavia)




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




Warrant
Issued to Director (Marcus Woods)




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




Page 25
of 65




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.




Purchase
of Machinery and Equipment




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




Termination,
Separation and Release Agreement with Chief Executive Officer




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




NOTE
      13
            RESTATEMENT




On
December 11, 2007 the Company received a letter from the Securities &
Exchange Commission relating to a registration statement on Form SB-2 filed by
the Company on November 14, 2007. In responding to the letter, the Company
recalculated the number of shares of Common Stock available for issuance and
determined that as of September 30, 2007, the number of shares of Common Stock
that would be required to be issued if all of the Company’s convertible
securities, including debt securities, options and warrants were converted or
exercised, exceeded the number of shares of authorized Common Stock. The
difference between the original calculation and the recalculation is illustrated
below.




Page 26
of 65




AsOriginally
                        
                        
                        AsCalculated
                        
                        
                        RecalculatedAuthorized
      shares per Articles of Incorportion
                        
                        
                        150,000,000
                        
                        
                        
                        150,000,000Outstanding
      shares
                        
                        
                        (106,635,201
                        )
                        
                        
                        (106,635,201
                        )Available
      shares
                        
                        
                        43,364,799
                        
                        
                        
                        43,364,799Securities
      convertible or exercisable into common stock shares:2001
      Executive Officers Stock Option Plan
                        
                        
                        7,343,032
                        
                        
                        
                        7,034,140Advisory
      Board Compensation
                        
                        
                        
                        
                        
                        
                        11,520,0002004
      Stock Purchase Agreement
                        
                        
                        
                        
                        
                        
                        1,463,336Warrants
      Related to 2004 Stock Purchase Agreement
                        
                        
                        
                        
                        
                        
                        1,463,336Warrants
      Issued for Services During the Year Ended September 30,
    2007
                        
                        
                        
                        
                        
                        
                        1,010,000Beneficial
      Conversion Features
                        
                        
                        32,009,087
                        
                        
                        
                        36,606,318Warrants
      Related to $1,025,000 of Subordinated Convertible
    Debentures
                        
                        
                        2,159,088
                        
                        
                        
                        2,795,45441,511,207
                        
                        
                        
                        61,892,584




Adjustments
to the original calculation included the following:




1.
            In
      2001, the Company adopted the 2001 Executive Officers Stock Option Plan.
      The plan has issued options to purchase 7,034,140 shares of Common Stock.
      The original calculation included options to purchase 7,343,032 shares of
      Common Stock, an overstatement of 308,892 shares of Common
      Stock.




2.
            On
      October 1, 2004, the Company formed an advisory board consisting of four
      members. Each member was to receive $5,000 monthly from October 1, 2004,
      to February 22, 2007 (for a total of $576,000), convertible into Common
      Stock at $0.05 per share ($576,000/$.05 = 11,520,000 shares of Common
      Stock). The accrued expense related to converting the shares into Common
      Stock was not included in the original
  calculation.




3.
            Under
      the terms of a 2004 Stock Purchase Agreement, the Company was to issue
      1,463,336 shares of Common Stock to certain investors that had previously
      remitted funds to the Company from February 9, 2004 to August 25, 2004.
      The shares were not included in the original
  calculation.




4.
            Under
      the terms of the 2004 Stock Purchase Agreement, the Company issued
      warrants to purchase 1,463,336 shares of Common Stock to these investors
      at an exercise price of $0.03 per share. The warrants were not included in
      the original calculation.




5.
            On
      November 14, 2006, the Company entered into agreements for services
      pursuant to which it issued warrants to purchase a total of 1,010,000
      shares of Common Stock.  850,000 shares may be purchased at an
      exercise price of $0.05 per share and 160,000 shares may be purchased at
      an exercise price of $0.25 per share.  The warrants expire on
      November 13, 2011. The warrants were not included in the original
      calculation.




6.
            As
      of September 30, 2007, the Company had Convertible Bridge Notes
      outstanding totaling $1,861,000 that included embedded beneficial
      conversion features that allowed for the conversion of the notes into
      shares of Common Stock at rates between $0.01 and $0.22, and matured
      between June 2008 and December 2008. The Bridge Notes accrue interest at
      rates between 8% and 10%, and any accrued but unpaid interest is also
      convertible into shares of Common Stock. The original calculation of the
      beneficial conversion feature did not include accrued interest of $209,843
      that could be converted into 4,597,231 shares of Common Stock at
      maturity.




7.
            On
      July 18, 2007 the Company completed an offering of $1,025,000 of
      Subordinated Convertible Debentures (the “Subordinated Debentures”) to a
      group of institutional and accredited investors. As part of this offering
      the Company issued warrants to purchase 2,795,454 shares of Common Stock
      at a price of $0.50 per share.  The number of warrant shares in
      the original calculation was
2,159,088.




Page 27
of 65




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




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




The
analysis and results were as follows:




2001 Executive Officers
Stock Option Plan




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




Balance
Sheet




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




The
Company began the analysis for the restatement as of and for the year ended
September 30, 2007 by applying FASB 133,paragraph 6 to ascertain if
the options remained derivatives as of September 30, 2007. All of the criteria
in the original analysis were met, and the options were determined to be within
the scope and definition of a derivative. EITF 00-19, paragraph 19 was applied
next, which states that if a company is required to obtain shareholder approval
to increase the company’s authorized shares in order to net-share or physically
settle a contract, share settlement is not controlled by the company, and the
contract is required to be classified as a liability. EITF 00-19, paragraph 10
was then applied. Paragraph 10 states that if classification changes as the
result of an event, the contract should be reclassified as of the date of the
event at fair value. The event responsible for the change in classification was
the issuance of the $1,025,000 Convertible Bridge Notes on July 17,
2007.




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




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




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




The
Company began the analysis for the restatement by applying FASB 133,paragraph 6 to ascertain if
the options remained derivatives as of December 31, 2007. All of the criteria in
the original analysis were met, and the options were determined to be within the
scope and definition of a derivative. EITF 00-19, paragraph 8 was applied which
states that if share settlement is not controlled by the company, the contract
is required to be classified as a liability. Paragraph 9, which states that
contracts classified as liabilities should be measured at fair value at each
balance sheet date, with changes in fair value reported in earnings and
disclosed in the financial statements as long as the contracts remain classified
as liabilities, was also applied.




Page 28
of 65




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




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




Statement
of Operations




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




The
change in the fair value of the options for the three months ended December 31,
2007 was $703,326 and included in decrease in warrant liability in the other
income (expense) section of the statement of operations.




Statement
of Cash Flows




The
change in the statement of cash flows was the result of the change in the fair
value of the options of $703,326.




Advisory Board
Compensation




On
October 1, 2004, the Company formed an advisory board consisting of four
members. Each member was to receive $5,000 monthly from October 1, 2004 to
February 22, 2007 for a total of $576,000, convertible by the advisory board
members into 11,520,000 shares of Common Stock at a rate of $0.05 per share. The
Company determined that: the accrued expense, embedded beneficial conversion
feature, embedded beneficial conversion feature discount, and related
amortization expense were not recorded at the date of issuance, or prior to the
restatement of the financial statements as of September 30, 2007, no payments
have been made to any advisory board members; and there has been no conversion
by any Advisory Board members of the accrued liability into shares of Common
Stock.




Balance
Sheet




The
Company began the analysis for the restatement by applying paragraph 6 of
Financial Accounting Standard Board (FASB) Statement No. 133, Accounting for
Derivative Instruments and Hedging Activities, to ascertain if the embedded
beneficial conversion features were derivatives at the date of issuance. The
embedded beneficial conversion features had one or more underlings and one or
more notional amounts; required no initial investment; and required or permitted
net settlement. Therefore, the embedded beneficial conversion features were
determined to be within the scope and definition of a derivative at the date of
issuance. Next, FASB 133, paragraph 12 was applied to determine if the embedded
beneficial conversion features should be separated from the accrued expense. The
Company determined that the economic characteristics of the embedded beneficial
conversion features are not clearly and closely related to the accrued expense;
the embedded beneficial conversion features and accrued expense are not
remeasured at fair value at each balance sheet date; and a separate contract
with the same terms would be a derivative pursuant to FASB 133, paragraphs 6-11.
Therefore, the embedded beneficial conversion features were separated from the
accrued expense to determine the classification and valuation. EITF 00-19,
paragraphs 7 and 8 were applied to determine the classification. Paragraph 7
states that contracts which require net-cash settlement are liabilities, and
paragraph 8 states that contracts which give the counterparty (advisory board
members) a choice of net-cash settlement or settlement in shares are
liabilities. Therefore, the embedded conversion features were determined to be
liabilities. EITF 00-19, paragraph 9 was applied to determine the value.
Paragraph 9 of EITF 00-19 states all contracts classified as liabilities should
be measured at fair value at each balance sheet date, with changes in fair value
reported in earnings and disclosed in the financial statements as long as the
contracts remain classified as liabilities.




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




Page 29
of 65




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




During
the year ended September 30, 2007, the Company incurred and recorded to accrued
expenses $96,000 for advisory board compensation until February 22, 2007, the
date the Company’s Board of Directors renegotiated the
compensation.




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




The fair
value of the monthly embedded beneficial conversion features was calculated
using the Black Sholes valuation model with the following assumptions: risk free
rate of return of 4.94% to 5.09%; volatility of 268.59% to 277.2%; dividend
yield of 0% and an expected term of 5 years. The sum of the embedded beneficial
conversion features from October 1, 2006 to February 22, 2007 was $91,956 and
was recorded to beneficial conversion features liability and netted against
accrued expenses. Total amortization for the beneficial conversion features
discount was $106,546 ($49,192 from October 1, 2004 to September 30, 2006 and
$57,354 for the year ended September 30, 2007) as of September 30, 2007, and
recorded to accrued expenses.




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




The
Company began the analysis for the restatement as of and for the three months
ended December 31, 2007 by applying FASB 133,paragraph 6 to ascertain if
the beneficial conversion features remained derivatives subsequent to the date
of issuance. All of the criteria in the original analysis were met, and the
beneficial conversion features were determined to be within the scope and
definition of a derivative. Next, FASB 133, paragraph 12 was applied to
determine if the embedded beneficial conversion features should be separated
from the accrued expense. All of the criteria in the original analysis were met,
and the beneficial conversion features were separated from the accrued
liability. EITF 00-19, paragraphs 7 and 8 were applied to determine the
classification. Paragraph 7 states that contracts which require net-cash
settlement are liabilities, and paragraph 8 states that contracts which give the
counterparty (the advisory board members) a choice of net-cash settlement or
settlement in shares are liabilities. Therefore, the embedded conversion
features were determined to be liabilities. EITF 00-19, paragraph 9 was applied
to determine the value of the embedded beneficial conversion
features.  Paragraph 9 of EITF 00-19 states that all contracts
classified as liabilities should be measured at fair value at each balance sheet
date, with changes in fair value reported in earnings and disclosed in the
financial statements as long as the contracts remain classified as
liabilities.




Page 30
of 65




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




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




Statement
of Operations




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




There was
no increase in the fair value of the beneficial conversion features for the
three months ended December 31, 2007.




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




Statement
of Cash Flows




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




Warrants Related to 2004
Stock Purchase Agreement




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




Balance
Sheet




The
Company began the analysis by applying FASB 133, paragraph 6to determine if
the warrants were within the scope and definition of a derivative at the date of
issuance. The warrants: had one or more underlings, and one or more notional
amounts; required no initial investment; and required or permitted net
settlement. Therefore, the warrants were determined to be derivatives at the
date of issuance. EITF 00-19, paragraphs 7 and 8 were then applied to determine
classification. These paragraphs state that contractswhich
require settlement in shares are equity instruments. EITF 00-19, paragraph 9 was
applied to determine the value of the options. Paragraph 9 of EITF 00-19 states
that contracts which require the company to deliver shares as part of a physical
settlement or net-share settlement should be initially measured at fair
value.




The fair
value of the warrants was determined to be $24,367 at the date of issuance which
was calculated using the Black Sholes valuation model with the following
assumptions: risk free rate of return of 1.21% to 2.14%; volatility of 141.91%
to 170.27%; dividend yield of 0% and an expected term of 5 years. The warrants
were considered an expense prior to October 1, 2006. Therefore, $24,367 was
recorded to additional paid-in capital and deficit accumulated during
development stage.




EITF
00-19, paragraph 19 was applied next. Paragraph 19 states that if a company is
required to obtain shareholder approval to increase the company’s authorized
shares in order to net-share or physically settle a contract, share settlement
is not controlled by the company and the contract is required to be classified
as a liability. EITF 00-19, paragraph 10 was then applied. This paragraph states
that if classification changes as the result of an event, the contract should be
reclassified as of the date of the event at fair value. The event responsible
for the change in classification was the issuance of the $1,025,000 Convertible
Bridge Notes on July 17, 2007.




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




Page 31
of 65




EITF
00-19, paragraph 9 was also applied in the analysis. Paragraph 9 states that all
contracts classified as liabilities must be measured at fair value at each
balance sheet date, with changes in fair value reported in earnings and
disclosed in the financial statements as long as the contracts remain classified
as liabilities.




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




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




Statement
of Operations




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




Statement
of Cash Flows




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




Beneficial Conversion
Features




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




Balance
Sheet




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




The fair
value of the embedded beneficial conversion features was determined to be
$1,021,570 at the date of issuance and was computed using the Black Sholes
valuation model with the following assumptions: risk free rate of return of 6%;
volatility of 122.67% to 195.97%; dividend yield of 0% and an expected term of 1
to 1.5 years.  The embedded beneficial conversion features discount
was $706,186 as of September 30, 2007, net of amortization of $315,383, prior to
the restatement.




Page 32
of 65




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




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




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




The
Company began the analysis for the restatement as of and for the three months
ended December 31, 2007 by applying FASB 133, paragraph 6 to ascertain if
the embedded beneficial conversion features remained derivatives subsequent to
the date of issuance. All of the criteria in the original analysis were met, and
the embedded beneficial conversion features issued were determined to be within
the scope and definition of a derivative. FASB 133, paragraph 12 was applied to
determine if the embedded beneficial conversion features should be separated
from the convertible bridge notes. All of the criteria in the original analysis
were met, and the embedded beneficial conversion features were separated from
the convertible bridge notes. EITF 00-19, paragraphs 7 and 8 were applied to
determine the classification. Paragraph 7 states that contracts which require
net-cash settlement are liabilities, and paragraph 8 states that contracts which
give the counterparty (holders of the convertible notes) a choice of net-cash
settlement or settlement in shares are liabilities. Therefore the embedded
conversion features were determined to be liabilities. The change in the
determination of the classification from equity to a liability was based on the
rights of the holders of the convertible notes to convert the notes into shares
of Common Stock. Therefore, share settlement is not controlled by the Company.
EITF 00-19, paragraph 9 was applied to determine the value of the embedded
beneficial conversion features. Paragraph 9 states that all contracts classified
as liabilities must be measured at fair value at each balance sheet date, with
changes in fair value reported in earnings and disclosed in the financial
statements as long as the contracts remain classified as
liabilities.




The fair
value of the monthly embedded beneficial conversion features was determined to
be $1,222,663 as of December 31, 2007, which was calculated using the Black
Sholes valuation model with the following assumptions: risk free rate of return
of 3.34%; volatility of 98.01%; dividend yield of 0%; and an expected term of
..33 to 1 year.




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




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




Statement
of Operations




The
beneficial conversion features were analyzed in accordance withEITF 00-19, paragraph 9
which requires all contracts classified as liabilities to be measured at fair
value, with changes in fair value reported in earnings as long as the contracts
remain classified as liabilities.




Page 33
of 65




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




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




Statement
of Cash Flows




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




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




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




Balance
Sheet




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




The fair
value of the warrants was calculated as $340,585 ($304,259 related to the
holders of the convertible bridge notes, and $36,326 related to the placement
fee) at the date of issuance using the Black Sholes valuation model with the
following assumptions: risk free rate of return of 6%; volatility of 122.67% to
195.97%; dividend yield of 0% and an expected term of 5 years.




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




Based on
the change in the determination of the classification of the warrants, $340,585
was reclassified from additional paid-in capital to warrant
liabilities.




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




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




Page 34
of 65




The
Company began the analysis for the restatement as of December 31, 2007 by
applying FASB 133,paragraph 6 to ascertain if the warrants issued remained derivatives as
of December 31, 2007. All of the criteria in the original analysis were met, and
the warrants were determined to be within the scope and definition of a
derivative. EITF 00-19, paragraph 8, which states that if share settlement is
not controlled by the company the contract is required to be classified as a
liability, was applied. Paragraph 9 of EITF 00-19, which states that contracts
classified as liabilities should be measured at fair value at each balance sheet
date with changes in fair value reported in earnings and disclosed in the
financial statements as long as the contracts remain classified as liabilities,
was also applied.




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




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




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




Statement
of Operations




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




The
decrease in the fair value of the warrants was determined to be $178,154 for the
three months ended December 31, 2007, and recorded in decrease in warrants in
the other income (expense) section of the statement of operations.




The
increase in the amortization of the warrant discount of $30,065 is included in
interest expense in the other income (expense) section of the statement of
operations.




Statement
of Cash Flows




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




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




Warrant Issued to
Consultant




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




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




Page 35
of 65




The fair
value of the warrant was determined to be $1,448,321 at the date of issuance and
was calculated using the Black Sholes valuation model with the following
assumptions: risk free interest rate of 3.26%, expected volatility of 98.01%,
dividend yields of 0% and expected term of 5 years.




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




The
Company analyzed the warrant by applying FASB 133,paragraph 6 to ascertain if
the warrant remained a derivative as of December 31, 2007. All of the criteria
in the original analysis were met, and the warrant issued was determined to be
within the scope and definition of a derivative. EITF 00-19, paragraph 8 was
applied which states that if share settlement is not controlled by the company,
the contract is required to be classified as a liability. Paragraph 9 was also
applied, which states that contracts classified as liabilities should be
measured at fair value at each balance sheet date, with changes in fair value
reported in earnings and disclosed in the financial statements as long as the
contracts remain classified as liabilities.




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




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




Option Issued to Chief
Executive Officer




On
December 19, 2007, the Company entered into a one year Employment Agreement with
Richard H. Papalian pursuant to which Mr. Papalian had been appointed as the
Company’s Chief Executive Officer. As compensation for his services, the Company
granted to Mr. Papalian a five year option to purchase up to 8,539,312 shares of
the Company’s Common Stock at an exercise price of $0.25 per share. As per the
terms of the stock option agreement, the right to purchase 340,000 shares of
Common Stock is not exercisable until the notes dated June 6, 2007 (Convertible
Notes 2 as discussed in Note 6 to our financial statements) are eligible for
conversion into shares of Common Stock. These options were not issued from the
2001 Executive Officers Stock Option Plan.On the grant date, the
Company applied FASB 133, paragraph 6 to determine if
the option was within the scope and definition of a derivative. The option had
one or more underlings and one or more notional amounts, required no initial
investment, and required or permitted net settlement. Therefore, the option was
determined to be a derivative. In order to determine how to classify the option,
the Company followed the guidance of EITF 00-19, paragraphs 7 and 8, which state
that contractsthat require
net-cash settlement (including a requirement to net cash settle the contract if
an event occurs and if that event is outside the control of the company) are
liability instruments. In order to determine the value of the option, the
Company applied EITF 00-19, paragraph 9, which states that contracts that
require the company to deliver shares as part of a physical settlement or
net-share settlement should be initially measured at fair value.




The fair
value of the option was determined to be $1,448,321 at the date of issuance, and
was calculated using the Black Sholes valuation model with the following
assumptions: risk free rate of return of 3.26%; volatility of 98.01%; dividend
yield of 0%; and an expected term of 5 years.




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




The
Company analyzed the option as of December 31, 2007 by applying FASB 133,paragraph 6 to ascertain if
the option remained a derivative as of December 31, 2007. All of the criteria in
the original analysis were met, and the option was determined to be within the
scope and definition of a derivative. EITF 00-19, paragraph 8 was applied which
states that if share settlement is not controlled by a company, the contract is
required to be classified as a liability. Paragraph 9, which states that
contracts classified as liabilities should be measured at fair value at each
balance sheet date, with changes in fair value reported in earnings and
disclosed in the financial statements as long as the contracts remain classified
as liabilities, was also applied.




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




Page 36
of 65




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




Option Issued to
Director




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




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




The fair
value of the option was determined to be $171,520 at the date of issuance and
was calculated using the Black Sholes valuation model with the following
assumptions: risk free interest rate of 3.22%, expected volatility of 99.86%,
dividend yield of 0% and expected term of 5 years.




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




The
Company analyzed the option by applying FASB 133,paragraph 6 to ascertain if
the option remained a derivative as of December 31, 2007. All of the criteria in
the original analysis were met, and the option was determined to be within the
scope and definition of a derivative. EITF 00-19, paragraph 8 was applied which
states that if share settlement is not controlled by the company, the contract
is required to be classified as a liability. Paragraph 9, which states that
contracts classified as liabilities should be measured at fair value at each
balance sheet date, with changes in fair value reported in earnings and
disclosed in the financial statements as long as the contracts remain classified
as liabilities, was also applied.




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




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




Option Issued to Chief
Financial Officer




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




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




The fair
value of the option was 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.




Page 37
of 65




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




The
Company analyzed the option by applying FASB 133,paragraph 6 to ascertain if
the option remained a derivative as of December 31, 2007. All of the criteria in
the original analysis were met, and the option issued was determined to be
within the scope and definition of a derivative. EITF 00-19, paragraph 8 was
applied which states that if share settlement is not controlled by the company,
the contract is required to be classified as a liability. Paragraph 9, which
states that contracts classified as liabilities should be measured at fair value
at each balance sheet date, with changes in fair value reported in earnings and
disclosed in the financial statements as long as the contracts remain classified
as liabilities, was also applied.




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




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




Page 38
of 65




Table 1 -
2007




Beneficial
            
            
            WarrantConversion
            
            
            Related to
            
            
            
            
            
            Option IssuedFeatures
            
            
            $1,025,000 of
            
            
            Warrant Issued
            
            
            to Chief Executive2001
            
            
            
            
            
            Warrants
            
            
            
            
            
            and
            
            
            Convertible
            
            
            to Consultant
            
            
            Officer for theExecutive
            
            
            
            
            
            Related to
            
            
            Warrant
            
            
            Beneficial
            
            
            Bridge Notes
            
            
            for the Three
            
            
            Three MonthAs
            
            
            Officers
            
            
            Advisory
            
            
            2004 Stock
            
            
            Issued
            
            
            Conversion
            
            
            and
            
            
            Months Ended
            
            
            Period Ended
            
            
            
            
            
            Warrant IssuedPreviously
            
            
            Option
            
            
            Board
            
            
            Purchase
            
            
            for
            
            
            Features
            
            
            Warrant
            
            
            December 31,
            
            
            December 31,
            
            
            Warrant Issued
            
            
            to Chief
            
            
            
            
            
            AsStated
            
            
            Plan
            
            
            Compensation
            
            
            Agreement
            
            
            Services
            
            
            Discount
            
            
            Discount
            
            
            2007
            
            
            2007
            
            
            to Direcotr
            
            
            Financial Officer
            
            
            Reclassifications
            
            
            RestatedBalance SheetAccrued
      expenses
            
            $
            1,777,077
            
            
            
            
            
            $
            576,000
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            $
            2,353,077Convertible
      Notes, net
            
            
            1,229,817
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            (17,075
            )
            
            
            (40,691
            )
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            1,172,051Warrant
      liability
            
            
            -
            
            
            
            1,223,588
            
            
            
            1,533,300
            
            
            
            
            
            
            
            
            
            
            
            
            
            321,778
            
            
            
            1,515,432
            
            
            
            1,515,432
            
            
            
            177,465
            
            
            
            177,465
            
            
            
            
            
            
            6,464,460Beneficial
      conversion feature liability
            
            
            -
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            1,222,663
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            1,222,663Additional
      paid-in capital
            
            
            15,643,156
            
            
            
            (2,271,879
            )
            
            
            (269,848
            )
            
            
            (45,663
            )
            
            
            (100,811
            )
            
            
            (1,021,570
            )
            
            
            (340,585
            )
            
            
            (414,909
            )
            
            
            (414,909
            )
            
            
            
            
            
            
            
            
            
            
            
            
            
            10,762,982Deferred
      warrant expense
            
            
            (67,038
            )
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            67,038
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            -Deficit
      accumulated during development stage
            
            
            (19,096,592
            )
            
            
            1,048,291
            
            
            
            (1,839,452
            )
            
            
            45,663
            
            
            
            33,773
            
            
            
            (184,018
            )
            
            
            59,498
            
            
            
            (1,100,523
            )
            
            
            (1,100,523
            )
            
            
            (177,465
            )
            
            
            (177,465
            )
            
            
            
            
            
            (22,488,813
            )Statement
      of Operations (for the three months ended December 31,
    2007)General
      and administrative
            
            $
            1,367,677
            
            
            
            
            
            
            $
            1,557,705
            
            
            
            
            
            
            $
            (33,773
            )
            
            
            
            
            
            
            
            
            
            $
            1,033,412
            
            
            $
            1,033,412
            
            
            $
            171,520
            
            
            $
            171,520
            
            
            $
            (236,904
            )
            
            $
            5,064,569Research
      and development
            
            
            -
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            236,904
            
            
            
            236,904Interest
      expense
            
            
            (188,625
            )
            
            
            
            
            
            
            380,440
            
            
            
            
            
            
            
            
            
            
            
            (288,036
            )
            
            
            (30,065
            )
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            (126,286
            )Decrease
      (increase) in warrant liability
            
            
            
            
            
            
            703,326
            
            
            
            24,405
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            178,154
            
            
            
            (67,111
            )
            
            
            (67,111
            )
            
            
            (5,945
            )
            
            
            (5,945
            )
            
            
            
            
            
            
            759,773Increase
      in beneficial conversion feature liability
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            208,149
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            208,149Beneficial
      conversion feature expense
            
            
            (231,998
            )
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            231,998
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            -Basic
      and dilutive loss per s
            
            
            (0.02
            )
            
            
            
            
            
            
            (0.01
            )
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            (0.01
            )
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            (0.04
            )Statement
      of Operations (since inception)General
      and administrative
            
            $
            14,519,764
            
            
            
            
            
            
            $
            2,215,848
            
            
            $
            24,367
            
            
            $
            (33,773
            )
            
            
            
            
            
            $
            87,734
            
            
            $
            1,033,412
            
            
            $
            1,033,412
            
            
            $
            171,520
            
            
            $
            171,520
            
            
            $
            (829,730
            )
            
            $
            18,394,074Research
      and development
            
            
            1,449,474
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            763,370
            
            
            
            2,212,844Interest
      expense
            
            
            (658,869
            )
            
            
            
            
            
            
            380,440
            
            
            
            
            
            
            
            
            
            
            
            (624,165
            )
            
            
            (85,239
            )
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            (315,382
            )
            
            
            (1,303,215
            )Decrease
      in warrant liability
            
            
            
            
            
            
            1,048,291
            
            
            
            24,405
            
            
            
            70,029
            
            
            
            -
            
            
            
            
            
            
            
            232,471
            
            
            
            (67,111
            )
            
            
            (67,111
            )
            
            
            (5,945
            )
            
            
            (5,945
            )
            
            
            
            
            
            
            1,229,084Increase
      in beneficial conversion feature liability
            
            
            
            
            
            
            
            
            
            
            (4,044
            )
            
            
            
            
            
            
            
            
            
            
            208,149
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            204,105Beneficial
      conversion feature expense
            
            
            (548,858
            )
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            548,858
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            -Legal
      settlement
            
            
            434,603
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            (89,654
            )
            
            
            344,949Income
      taxes
            
            
            10,800
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            2,592
            
            
            
            13,392Statement
      of Cash Flows (for the three months ended December 31,
    2007)Net
      loss
            
            $
            (1,796,440
            )
            
            $
            703,326
            
            
            $
            (1,152,860
            )
            
            
            
            
            
            $
            33,773
            
            
            $
            152,111
            
            
            $
            148,089
            
            
            $
            (1,100,523
            )
            
            $
            (1,100,523
            )
            
            $
            (177,465
            )
            
            $
            (177,465
            )
            
            
            
            
            
            $
            (4,467,977
            )Amortization
      of beneficial conversion features discount and warr
            
            
            231,998
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            56,038
            
            
            
            30,065
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            87,550
            
            
            
            405,651Stock
      based compensation expense- employee
            
            
            414,909
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            1,033,411
            
            
            
            171,520
            
            
            
            171,520
            
            
            
            
            
            
            
            1,791,360Stock
      based compensation expense- consultant
            
            
            414,909
            
            
            
            
            
            
            
            1,557,706
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            1,033,412
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            3,006,027(Decrease)
      increase in warrant liability
            
            
            
            
            
            
            (703,326
            )
            
            
            (24,405
            )
            
            
            
            
            
            
            -
            
            
            
            
            
            
            
            (178,154
            )
            
            
            67,111
            
            
            
            67,111
            
            
            
            5,945
            
            
            
            5,945
            
            
            
            
            
            
            
            (759,773
            )Increase
      in beneficial conversion feature liaiblity
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            (208,149
            )
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            (208,149
            )Write-off
      of beneficial conversion feature
            
            
            
            
            
            
            
            
            
            
            (380,440
            )
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            (380,440
            )Accrued
      expenses
            
            
            135,529
            
            
            
            
            
            
            
            98,051
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            (46,125
            )
            
            
            187,455Accrual
      of liquidating damages
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            46,125
            
            
            
            46,125Beneficial
      conversion feature
            
            
            231,998
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            (231,998
            )
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            -Warrants
      issued for consultin
            
            
            111,255
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            (111,255
            )




Page 39
of 65


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


Table 2 -
2006


Beneficial
            
            WarrantConversion
            
            Related to
            
            
            
            Option IssuedFeatures
            
            $1,025,000 of
            
            Warrant Issued
            
            to Chief Executive2001
            
            
            
            Warrants
            
            
            
            and
            
            Convertible
            
            to Consultant
            
            Officer for theExecutive
            
            
            
            Related to
            
            Warrant
            
            Beneficial
            
            Bridge Notes
            
            for the Three
            
            Three MonthAs
            
            Officers
            
            Advisory
            
            2004 Stock
            
            Issued
            
            Conversion
            
            and
            
            Months Ended
            
            Period Ended
            
            
            
            Warrant IssuedPreviously
            
            Option
            
            Board
            
            Purchase
            
            for
            
            Features
            
            Warrant
            
            December 31,
            
            December 31,
            
            Warrant Issued
            
            to Chief
            
            
            
            AsStated
            
            Plan
            
            Compensation
            
            Agreement
            
            Services
            
            Discount
            
            Discount
            
            2007
            
            2007
            
            to Direcotr
            
            Financial Officer
            
            Reclassifications
            
            RestatedStatement
      of Operations (for the three months ended December 31,
    2006)General
      and administrative
            
            $
            202,938
            
            
            
            $
            72,304
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            $
            275,242Interest
      expense
            
            
            (19,242
            )
            
            
            
            
            
            
            
            
            
            $
            (89,686
            )
            
            
            
            
            
            
            
            
            
            
            
            (1,482
            )
            
            (110,410
            )Beneficial
      conversion feature
            
            
            (1,482
            )
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            1,482
            
            
            -Statement
      of Cash Flows (for the three months ended December 31,
    2006)Net
      loss
            
            $
            (232,249
            )
            
            
            $
            (72,304
            )
            
            
            
            
            $
            (89,686
            )
            
            
            
            
            
            
            
            
            
            
            
            
            
            $
            (394,239
            )Amortization
      of beneficial conversion features discount and warrant
      discount
            
            
            1,842
            
            
            
            
            
            
            
            
            
            
            
            89,686
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            91,528Accrued
      expenses
            
            
            87,085
            
            
            
            
            72,304
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            159,389




Page 40
of 65


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.


Page 41
of 65


ITEM
      2
            MANAGEMENT’S
      DISCUSSION AND ANALYSIS OR PLAN OF
OPERATIONS




DEVELOPMENT
STAGE COMPANY. Sionix Corporation (referred to as “the Company”, “we”, “us” or
“our”) is a development stage company as defined in Statement of Financial
Accounting Standards (“SFAS”) No. 7, “Accounting and Reporting by Development
Stage Enterprises.” The Company designs and develops turn-key stand-alone water
treatment systems for municipalities (both potable and wastewater), industry
(both make-up water and wastewater), emergency response, military and small
residential communities. To date, the Company’s efforts have been principally
devoted to research and development, organizational activities, and raising
capital. Development of our ELIXIR water treatment system was completed in 2002.
We are currently engaged in testing the product, as discussed below. We have
earned no revenues from sales of our product and we do not expect our product to
be available for sale during the next few months. Because we earn no revenues,
our operations are, and have been in the past, dependent on our ability to
borrow money or to raise capital by selling our equity or debt
securities.




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




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




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




MANAGEMENT.
On December 19, 2007, the Company entered into a one year Employment Agreement
with Richard H. Papalian and a one year Consulting Agreement with Mark Maron
pursuant to which Mr. Papalian was appointed as the Company’s Chief Executive
Officer and Mr. Maron was appointed as Special Adviser to the Company. As
compensation for these services, the Company granted each person a five year
option to purchase up to 8,539,312 shares of the Company’s common stock at an
exercise price of $0.25 per share which represented 5% of the outstanding shares
of the Company’s Common Stock on a fully diluted basis on the date the options
were issued.




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




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




RESTATEMENT
OF FINANCIAL STATEMENTS




On
December 11, 2007 the Company received a comment letter from the Securities
& Exchange Commission relating to a registration statement on Form SB-2
filed by the Company on November 14, 2007. In responding to the comment letter,
the Company recalculated the number of shares of Common Stock available for
issuance and determined that as of September 30, 2007, the number of shares of
Common Stock that would be required to be issued if all of the Company’s
convertible securities, including debt securities, options and warrants were
converted or exercised, exceeded the number of shares of authorized Common
Stock. The difference between the original calculation and the recalculation is
illustrated below.




Page 42
of 65




AsOriginally
            
            
            AsCalculated
            
            
            RecalculatedAuthorized
      shares per Articles of Incorportion
            
            
            150,000,000
            
            
            
            150,000,000Outstanding
      shares
            
            
            (106,635,201
            )
            
            
            (106,635,201
            )Available
      shares
            
            
            43,364,799
            
            
            
            43,364,799Securities
      convertible or exercisable into common stock shares:2001
      Executive Officers Stock Option Plan
            
            
            7,343,032
            
            
            
            7,034,140Advisory
      Board Compensation
            
            
            
            
            
            
            11,520,0002004
      Stock Purchase Agreement
            
            
            
            
            
            
            1,463,336Warrants
      Related to 2004 Stock Purchase Agreement
            
            
            
            
            
            
            1,463,336Warrants
      Issued for Services During the Year Ended September 30,
    2007
            
            
            
            
            
            
            1,010,000Beneficial
      Conversion Features
            
            
            32,009,087
            
            
            
            36,606,318Warrants
      Related to $1,025,000 of Subordinated Convertible
    Debentures
            
            
            2,159,088
            
            
            
            2,795,45441,511,207
            
            
            
            61,892,584




Adjustments
to the original calculation included the following:




1.
            In
      2001, the Company adopted the 2001 Executive Officers Stock Option Plan.
      The plan has issued options to purchase 7,034,140 shares of Common Stock.
      The original calculation included options to purchase 7,343,032 shares of
      Common Stock, an overstatement of 308,892 shares of Common
      Stock.




2.
            On
      October 1, 2004, the Company formed an Advisory Board consisting of four
      members. Each member was to receive $5,000 monthly from October 1, 2004,
      to February 22, 2007 (for a total of $576,000), convertible into Common
      Stock at $0.05 per share ($576,000/$.05 = 11,520,000 shares of Common
      Stock). The accrued expense related to converting the shares into Common
      Stock was not included in the original
  calculation.




3.
            Under
      the terms of a 2004 Stock Purchase Agreement, the Company was to issue
      1,463,336 shares of Common Stock to certain investors that had previously
      remitted funds to the Company from February 9, 2004 to August 25, 2004.
      The shares were not included in the original
  calculation.




4.
            Under
      the terms of the 2004 Stock Purchase Agreement, the Company issued
      warrants to purchase 1,463,336 shares of Common Stock to these investors
      at an exercise price of $0.03 per share. The warrants were not included in
      the original calculation.




5.
            On
      November 14, 2006, the Company entered into agreements for services
      pursuant to which it issued warrants to purchase a total of 1,010,000
      shares of Common Stock.  850,000 shares may be purchased at an
      exercise price of $0.05 per share and 160,000 shares may be purchased at
      an exercise price of $0.25 per share.  The warrants expire on
      November 13, 2011. The warrants were not included in the original
      calculation.




6.
              As
      of September 30, 2007, the Company had Convertible Bridge Notes
      outstanding totaling $1,861,000 that included embedded beneficial
      conversion features that allowed for the conversion of the notes into
      shares of Common Stock at rates between $0.01 and $0.22, and matured
      between June 2008 and December 2008. The Bridge Notes accrue interest at
      rates between 8% and 10%, and any accrued but unpaid interest is also
      convertible into shares of Common Stock. The original calculation of the
      beneficial conversion feature did not include accrued interest of $209,843
      that could be converted into 4,597,231 shares of Common Stock at
      maturity.




Page 43
of 65




7.
            On
      July 18, 2007 the Company completed an offering of $1,025,000 of
      Subordinated Convertible Debentures (the “Subordinated Debentures”) to a
      group of institutional and accredited investors. As part of this offering
      the Company issued warrants to purchase 2,795,454 shares of Common Stock
      at a price of $0.50 per share.  The number of warrant shares in
      the original calculation was
2,159,088.




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




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




The
analysis and results were as follows:




2001 Executive Officers
Stock Option Plan




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




Balance
Sheet




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




The
Company began the analysis for the restatement as of and for the year ended
September 30, 2007 by applying FASB 133,paragraph 6 to ascertain if
the options remained derivatives as of September 30, 2007. All of the criteria
in the original analysis were met, and the options were determined to be within
the scope and definition of a derivative. EITF 00-19, paragraph 19 was applied
next which states that if a company is required to obtain shareholder approval
to increase the company’s authorized shares in order to net-share or physically
settle a contract, share settlement is not controlled by the company, and the
contract is required to be classified as a liability. EITF 00-19, paragraph 10
was then applied. Paragraph 10 states that if classification changes as the
result of an event, the contract should be reclassified as of the date of the
event at fair value. The event responsible for the change in classification was
the issuance of the $1,025,000 Convertible Bridge Notes on July 17,
2007.




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




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




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




Page 44
of 65




The
Company began the analysis for the restatement by applying FASB 133,paragraph 6 to ascertain if
the options remained derivatives as of December 31, 2007. All of the criteria in
the original analysis were met, and the options were determined to be within the
scope and definition of a derivative. EITF 00-19, paragraph 8 was applied which
states that if share settlement is not controlled by the company, the contract
is required to be classified as a liability. Paragraph 9 also states that
contracts classified as liabilities should be measured at fair value at each
balance sheet date, with changes in fair value reported in earnings and
disclosed in the financial statements as long as the contracts remain classified
as liabilities.




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




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




Statement
of Operations




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




The
change in the fair value of the options for the three months ended December 31,
2007 was $703,326 and included in decrease in warrant liability in the other
income (expense) section of the statement of operations.




Statement
of Cash Flows




The
change in the statement of cash flows was the result of the change in the fair
value of the options of $703,326.




Advisory Board
Compensation




On
October 1, 2004, the Company formed an Advisory Board consisting of four
members. Each member was to receive $5,000 monthly from October 1, 2004 to
February 22, 2007 for a total of $576,000, convertible by the Advisory Board
members into 11,520,000 shares of Common Stock at a rate of $0.05 per share. The
Company determined that: the accrued expense, embedded beneficial conversion
feature, embedded beneficial conversion feature discount, and related
amortization expense were not recorded at the date of issuance, or prior to the
restatement of the financial statements as of September 30, 2007, as of December
31, 2007 no payments have been made to any Advisory Board members; and as of
December 31, 2007 there has been no conversion by any Advisory Board members of
the accrued liability into shares of Common Stock.




Balance
Sheet




The
Company began the analysis for the restatement by applying paragraph 6 of
Financial Accounting Standards Board (FASB) Statement No. 133, Accounting for
Derivative Instruments and Hedging Activities, to ascertain if the embedded
beneficial conversion features were derivatives at the date of issuance. The
embedded beneficial conversion features had one or more underlings, and one or
more notional amounts; required no initial investment; and required or permitted
net settlement. Therefore, the embedded beneficial conversion features were
determined to be within the scope and definition of a derivative at the date of
issuance. Next, FASB 133, paragraph 12 was applied to determine if the embedded
beneficial conversion features should be separated from the accrued expense. The
Company determined that the economic characteristics of the embedded beneficial
conversion features are not clearly and closely related to the accrued expense;
the embedded beneficial conversion features and accrued expense are not
remeasured at fair value at each balance sheet date; and a separate contract
with the same terms would be a derivative pursuant to FASB 133, paragraphs 6-11.
Therefore, the embedded beneficial conversion features were separated from the
accrued expense to determine the classification and valuation. EITF 00-19,
paragraphs 7 and 8 were applied to determine the classification. Paragraph 7
states that contracts which require net-cash settlement are liabilities, and
paragraph 8 states that contracts which give the counterparty (Advisory Board
members) a choice of net-cash settlement or settlement in shares are
liabilities. Therefore, the embedded conversion features were determined to be
liabilities. EITF 00-19, paragraph 9 was applied to determine the value.
Paragraph 9 of EITF 00-19 states all contracts classified as liabilities should
be measured at fair value at each balance sheet date, with changes in fair value
reported in earnings and disclosed in the financial statements as long as the
contracts remain classified as liabilities.




Page 45
of 65




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




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




During
the year ended September 30, 2007, the Company incurred and recorded to accrued
expenses $96,000 for Advisory Board compensation until February 22, 2007, the
date the Company’s Board of Directors renegotiated the
compensation.




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




The fair
value of the monthly embedded beneficial conversion features was calculated
using the Black Sholes valuation model with the following assumptions: risk free
rate of return of 4.94% to 5.09%; volatility of 268.59% to 277.2%; dividend
yield of 0% and an expected term of 5 years. The sum of the embedded beneficial
conversion features from October 1, 2006 to February 22, 2007 was $91,956 and
was recorded to beneficial conversion features liability and netted against
accrued expenses. Total amortization for the beneficial conversion features
discount was $106,546 ($49,192 from October 1, 2004, to September 30, 2006, and
$57,354 for the year ended September 30, 2007) as of September 30, 2007, and
recorded to accrued expenses.




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




The
Company began the analysis for the restatement as of and for the three months
ended December 31, 2007 by applying FASB 133,paragraph 6 to ascertain if
the beneficial conversion features remained derivatives subsequent to the date
of issuance. All of the criteria in the original analysis were met, and the
beneficial conversion features were determined to be within the scope and
definition of a derivative. Next, FASB 133, paragraph 12 was applied to
determine if the embedded beneficial conversion features should be separated
from the accrued expense. All of the criteria in the original analysis were met,
and the beneficial conversion features were separated from the accrued
liability. EITF 00-19, paragraphs 7 and 8 were applied to determine the
classification. Paragraph 7 states that contracts which require net-cash
settlement are liabilities, and paragraph 8 states that contracts which give the
counterparty (the Advisory Board members) a choice of net-cash settlement or
settlement in shares are liabilities. Therefore, the embedded conversion
features were determined to be liabilities. EITF 00-19, paragraph 9 was applied
to determine the value of the embedded beneficial conversion
features.  Paragraph 9 of EITF 00-19 states that all contracts
classified as liabilities should be measured at fair value at each balance sheet
date, with changes in fair value reported in earnings and disclosed in the
financial statements as long as the contracts remain classified as
liabilities.




Page 46
of 65




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




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




Statement
of Operations




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




There was
no increase in the fair value of the beneficial conversion features for the
three months ended December 31, 2007.




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




Statement
of Cash Flows




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




Warrants Related to 2004
Stock Purchase Agreement




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




Balance
Sheet




The
Company began the analysis by applying FASB 133, paragraph 6to determine if
the warrants were within the scope and definition of a derivative at the date of
issuance. The warrants: had one or more underlings, and one or more notional
amounts; required no initial investment; and required or permitted net
settlement. Therefore, the warrants were determined to be derivatives at the
date of issuance. EITF 00-19, paragraphs 7 and 8 were then applied to determine
classification. These paragraphs state that contractswhich
require settlement in shares are equity instruments. EITF 00-19, paragraph 9 was
applied to determine the value of the options. Paragraph 9 of EITF 00-19 states
that contracts which require the company to deliver shares as part of a physical
settlement or net-share settlement should be initially measured at fair
value.




The fair
value of the warrants was determined to be $24,367 at the date of issuance which
was calculated using the Black Sholes valuation model with the following
assumptions: risk free rate of return of 1.21% to 2.14%; volatility of 141.91%
to 170.27%; dividend yield of 0% and an expected term of 5 years. The warrants
were considered an expense prior to October 1, 2006. Therefore, $24,367 was
recorded to additional paid-in capital and deficit accumulated during
development stage.




EITF
00-19, paragraph 19 was applied next. Paragraph 19 states that if a company is
required to obtain shareholder approval to increase the company’s authorized
shares in order to net-share or physically settle a contract, share settlement
is not controlled by the company, and the contract is required to be classified
as a liability. EITF 00-19, paragraph 10 was then applied. This paragraph states
that if classification changes as the result of an event, the contract should be
reclassified as of the date of the event at fair value. The event responsible
for the change in classification was the issuance of the $1,025,000 Convertible
Bridge Notes on July 17, 2007.




Page 47
of 65




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 applied. Paragraph 9 states that all contracts classified
as liabilities must be measured at fair value at each balance sheet date, with
changes in fair value reported in earnings and disclosed in the financial
statements as long as the contracts remain classified as
liabilities.




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




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




Statement
of Operations




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




Statement
of Cash Flows




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




Beneficial Conversion
Features




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




Balance
Sheet




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




The fair
value of the embedded beneficial conversion features were determined to be
$1,021,5670 at the date of issuance and was computed using the Black Sholes
valuation model with the following assumptions: risk free rate of return of 6%;
volatility of 122.67% to 195.97%; dividend yield of 0% and an expected term of 1
to 1.5 years.  The embedded beneficial conversion features discount
was $706,186 as of September 30, 2007, net of amortization of $315,383, prior to
the restatement.




Page 48
of 65




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




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




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




The
Company began the analysis for the restatement as of and for the three months
ended December 31, 2007 by applying FASB 133, paragraph 6 to ascertain if
the embedded beneficial conversion features remained derivatives subsequent to
the date of issuance. All of the criteria in the original analysis were met, and
the embedded beneficial conversion features issued were determined to be within
the scope and definition of a derivative. FASB 133, paragraph 12 was applied to
determine if the embedded beneficial conversion features should be separated
from the convertible bridge notes. All of the criteria in the original analysis
were met, and the embedded beneficial conversion features were separated from
the convertible bridge notes. EITF 00-19, paragraphs 7 and 8 were applied to
determine the classification. Paragraph 7 states that contracts which require
net-cash settlement are liabilities, and paragraph 8 states that contracts which
give the counterparty (holders of the convertible notes) a choice of net-cash
settlement or settlement in shares are liabilities. Therefore the embedded
conversion features were determined to be liabilities. The change in the
determination of the classification from equity to a liability was based on the
rights of the holders of the convertible notes to convert the note. Therefore,
share settlement is not controlled by the Company. EITF 00-19, paragraph 9 was
applied to determine the value of the embedded beneficial conversion features.
Paragraph 9 states that all contracts classified as liabilities must be measured
at fair value at each balance sheet date, with changes in fair value reported in
earnings and disclosed in the financial statements as long as the contracts
remain classified as liabilities.




The fair
value of the monthly embedded beneficial conversion features was determined to
be $1,222,663 as of December 31, 2007, which was calculated using the Black
Sholes valuation model with the following assumptions: risk free rate of return
of 3.34%; volatility of 98.01%; dividend yield of 0%; and an expected term of
..33 to 1 year.




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




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




Statement
of Operations




The
beneficial conversion features were analyzed in accordance withEITF 00-19, paragraph 9
was applied which requires all contracts classified as liabilities to be
measured at fair value, with changes in fair value reported in earnings as long
as the contracts remain classified as liabilities.




Page 49
of 65




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




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




Statement
of Cash Flows




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




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




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




Balance
Sheet




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




The fair
value of the warrants was calculated as $340,585 ($304,259 related to the
holders of the convertible bridge notes, and $36,326 related to the placement
fee) at the date of issuance using the Black Sholes valuation model with the
following assumptions: risk free rate of return of 6%; volatility of 122.67% to
195.97%; dividend yield of 0% and an expected term of 5 years.




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




Based on
the change in the determination of the classification of the warrants, $340,585
was reclassified from additional paid-in capital to warrant
liabilities.




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




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




Page 50
of 65




The
Company began the analysis for the restatement as of December 31, 2007 by
applying FASB 133,paragraph 6 to ascertain if the warrants issued remained derivatives as
of December 31, 2007. All of the criteria in the original analysis were met, and
the warrants were determined to be within the scope and definition of a
derivative. EITF 00-19, paragraph 8, which states that if share settlement is
not controlled by the company the contract is required to be classified as a
liability was applied. Paragraph 9 of EITF 00-19, which states that contracts
classified as liabilities should be measured at fair value at each balance sheet
date, with changes in fair value reported in earnings and disclosed in the
financial statements as long as the contracts remain classified as liabilities
was also applied.




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




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




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




Statement
of Operations




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




The
decrease in the fair value of the warrants was $178,154 for the three months
ended December 31, 2007, and recorded in decrease in warrants in the other
income (expense) section of the statement of operations.




The
increase in the amortization of the warrant discount of $30,065 is included in
interest expense in the other income (expense) section of the statement of
operations.




Statement
of Cash Flows




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




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




Warrant Issued to
Consultant




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




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


Page 51
of 65




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




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




Option Issued to Chief
Executive Officer




On
December 19, 2007, the Company entered into a one year Employment Agreement with
Richard H. Papalian pursuant to which Mr. Papalian had been appointed as the
Company’s Chief Executive Officer. As compensation for his services, the Company
granted to Mr. Papalian a five year option to purchase up to 8,539,312 shares of
the Company’s Common Stock at an exercise price of $0.25 per share. As per the
terms of the stock option agreement, the right to purchase 340,000 shares of
Common Stock is not exercisable until the notes dated June 6, 2007 (Convertible
Note 2 as discussed in Note 6 to our financial statements) are eligible for
conversion into shares of Common Stock. These options were not issued from the
2001 Executive Officers Stock Option Plan.On the grant date, the
Company applied FASB 133, paragraph 6 to determine if
the option was within the scope and definition of a derivative. The option had
one or more underlings and one or more notional amounts, required no initial
investment, and required or permitted net settlement. Therefore, the option was
determined to be a derivative. In order to determine how to classify the option,
the Company followed the guidance of EITF 00-19, paragraphs 7 and 8, which state
that contractsthat require
net-cash settlement (including a requirement to net cash settle the contract if
an event occurs and if that event is outside the control of the company) are
liability instruments. In order to determine the value of the option, the
Company applied EITF 00-19, paragraph 9, which states that contracts that
require the company to deliver shares as part of a physical settlement or
net-share settlement should be initially measured at fair value.




The fair
value of the option was determined to be $1,448,321 at the date of issuance, and
was calculated using the Black Sholes valuation model with the following
assumptions: risk free rate of return of 3.26%; volatility of 98.01%; dividend
yield of 0%; and an expected term of 5 years.




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




The
Company analyzed the option as of December 31, 2007 by applying FASB 133,paragraph 6 to ascertain if
the option remained a derivative as of December 31, 2007. All of the criteria in
the original analysis were met, and the option was determined to be within the
scope and definition of a derivative. EITF 00-19, paragraph 8 was applied which
states that if share settlement is not controlled by a company, the contract is
required to be classified as a liability. Paragraph 9, which states that
contracts classified as liabilities should be measured at fair value at each
balance sheet date, with changes in fair value reported in earnings and
disclosed in the financial statements as long as the contracts remain classified
as liabilities was also applied.




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


Page 52
of 65




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




Option Issued to
Director




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




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




The fair
value of the option was determined to be $171,520 at the date of issuance and
was calculated using the Black Sholes valuation model with the following
assumptions: risk free interest rate of 3.22%, expected volatility of 99.86%,
dividend yield of 0% and expected term of 5 years.




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




The
Company analyzed the option by applying FASB 133,paragraph 6 to ascertain if
the option remained a derivative as of December 31, 2007. All of the criteria in
the original analysis were met, and the option was determined to be within the
scope and definition of a derivative. EITF 00-19, paragraph 8 was applied which
states that if share settlement is not controlled by the company, the contract
is required to be classified as a liability. Paragraph 9, which states that
contracts classified as liabilities should be measured at fair value at each
balance sheet date, with changes in fair value reported in earnings and
disclosed in the financial statements as long as the contracts remain classified
as liabilities was also applied.




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




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




Option Issued to Chief
Financial Officer




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




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




The fair
value of the option was 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.


Page 53
of 65




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




The
Company analyzed the option by applying FASB 133,paragraph 6 to ascertain if
the option remained a derivative as of December 31, 2007. All of the criteria in
the original analysis were met, and the option issued was determined to be
within the scope and definition of a derivative. EITF 00-19, paragraph 8 was
applied which states that if share settlement is not controlled by the company,
the contract is required to be classified as a liability. Paragraph 9, which
states that contracts classified as liabilities should be measured at fair value
at each balance sheet date, with changes in fair value reported in earnings and
disclosed in the financial statements as long as the contracts remain classified
as liabilities was also applied.




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




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




Page 54
of 65




Table 1 –
2007




Beneficial
            
            
            WarrantConversion
            
            
            Related to
            
            
            
            
            
            Option IssuedFeatures
            
            
            $1,025,000 of
            
            
            Warrant Issued
            
            
            to Chief Executive2001
            
            
            
            
            
            Warrants
            
            
            
            
            
            and
            
            
            Convertible
            
            
            to Consultant
            
            
            Officer for theExecutive
            
            
            
            
            
            Related to
            
            
            Warrant
            
            
            Beneficial
            
            
            Bridge Notes
            
            
            for the Three
            
            
            Three MonthAs
            
            
            Officers
            
            
            Advisory
            
            
            2004 Stock
            
            
            Issued
            
            
            Conversion
            
            
            and
            
            
            Months Ended
            
            
            Period Ended
            
            
            
            
            
            Warrant IssuedPreviously
            
            
            Option
            
            
            Board
            
            
            Purchase
            
            
            for
            
            
            Features
            
            
            Warrant
            
            
            December 31,
            
            
            December 31,
            
            
            Warrant Issued
            
            
            to Chief
            
            
            
            
            
            AsStated
            
            
            Plan
            
            
            Compensation
            
            
            Agreement
            
            
            Services
            
            
            Discount
            
            
            Discount
            
            
            2007
            
            
            2007
            
            
            to Direcotr
            
            
            Financial Officer
            
            
            Reclassifications
            
            
            RestatedBalance SheetAccrued
      expenses
            
            $
            1,777,077
            
            
            
            
            
            $
            576,000
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            $
            2,353,077Convertible
      Notes, net
            
            
            1,229,817
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            (17,075
            )
            
            
            (40,691
            )
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            1,172,051Warrant
      liability
            
            
            -
            
            
            
            1,223,588
            
            
            
            1,533,300
            
            
            
            
            
            
            
            
            
            
            
            
            
            321,778
            
            
            
            1,515,432
            
            
            
            1,515,432
            
            
            
            177,465
            
            
            
            177,465
            
            
            
            
            
            
            6,464,460Beneficial
      conversion feature liability
            
            
            -
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            1,222,663
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            1,222,663Additional
      paid-in capital
            
            
            15,643,156
            
            
            
            (2,271,879
            )
            
            
            (269,848
            )
            
            
            (45,663
            )
            
            
            (100,811
            )
            
            
            (1,021,570
            )
            
            
            (340,585
            )
            
            
            (414,909
            )
            
            
            (414,909
            )
            
            
            
            
            
            
            
            
            
            
            
            
            
            10,762,982Deferred
      warrant expense
            
            
            (67,038
            )
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            67,038
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            -Deficit
      accumulated during development stage
            
            
            (19,096,592
            )
            
            
            1,048,291
            
            
            
            (1,839,452
            )
            
            
            45,663
            
            
            
            33,773
            
            
            
            (184,018
            )
            
            
            59,498
            
            
            
            (1,100,523
            )
            
            
            (1,100,523
            )
            
            
            (177,465
            )
            
            
            (177,465
            )
            
            
            
            
            
            (22,488,813
            )Statement
      of Operations (for the three months ended December 31,
    2007)General
      and administrative
            
            $
            1,367,677
            
            
            
            
            
            
            $
            1,557,705
            
            
            
            
            
            
            $
            (33,773
            )
            
            
            
            
            
            
            
            
            
            $
            1,033,412
            
            
            $
            1,033,412
            
            
            $
            171,520
            
            
            $
            171,520
            
            
            $
            (236,904
            )
            
            $
            5,064,569Research
      and development
            
            
            -
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            236,904
            
            
            
            236,904Interest
      expense
            
            
            (188,625
            )
            
            
            
            
            
            
            380,440
            
            
            
            
            
            
            
            
            
            
            
            (288,036
            )
            
            
            (30,065
            )
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            (126,286
            )Decrease
      (increase) in warrant liability
            
            
            
            
            
            
            703,326
            
            
            
            24,405
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            178,154
            
            
            
            (67,111
            )
            
            
            (67,111
            )
            
            
            (5,945
            )
            
            
            (5,945
            )
            
            
            
            
            
            
            759,773Increase
      in beneficial conversion feature liability
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            208,149
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            208,149Beneficial
      conversion feature expense
            
            
            (231,998
            )
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            231,998
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            -Basic
      and dilutive loss per sh
            
            
            (0.02
            )
            
            
            
            
            
            
            (0.01
            )
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            (0.01
            )
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            (0.04
            )Statement
      of Operations (since inception)General
      and administrative
            
            $
            14,519,764
            
            
            
            
            
            
            $
            2,215,848
            
            
            $
            24,367
            
            
            $
            (33,773
            )
            
            
            
            
            
            $
            87,734
            
            
            $
            1,033,412
            
            
            $
            1,033,412
            
            
            $
            171,520
            
            
            $
            171,520
            
            
            $
            (829,730
            )
            
            $
            18,394,074Research
      and development
            
            
            1,449,474
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            763,370
            
            
            
            2,212,844Interest
      expense
            
            
            (658,869
            )
            
            
            
            
            
            
            380,440
            
            
            
            
            
            
            
            
            
            
            
            (624,165
            )
            
            
            (85,239
            )
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            (315,382
            )
            
            
            (1,303,215
            )Decrease
      in warrant liability
            
            
            
            
            
            
            1,048,291
            
            
            
            24,405
            
            
            
            70,029
            
            
            
            -
            
            
            
            
            
            
            
            232,471
            
            
            
            (67,111
            )
            
            
            (67,111
            )
            
            
            (5,945
            )
            
            
            (5,945
            )
            
            
            
            
            
            
            1,229,084Increase
      in beneficial conversion feature liability
            
            
            
            
            
            
            
            
            
            
            (4,044
            )
            
            
            
            
            
            
            
            
            
            
            208,149
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            204,105Beneficial
      conversion feature expense
            
            
            (548,858
            )
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            548,858
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            -Legal
      settlement
            
            
            434,603
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            (89,654
            )
            
            
            344,949Income
      taxes
            
            
            10,800
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            2,592
            
            
            
            13,392Statement
      of Cash Flows (for the three months ended December 31,
    2007)Net
      loss
            
            $
            (1,796,440
            )
            
            $
            703,326
            
            
            $
            (1,152,860
            )
            
            
            
            
            
            $
            33,773
            
            
            $
            152,111
            
            
            $
            148,089
            
            
            $
            (1,100,523
            )
            
            $
            (1,100,523
            )
            
            $
            (177,465
            )
            
            $
            (177,465
            )
            
            
            
            
            
            $
            (4,467,977
            )Amortization
      of beneficial conversion features discount and warr
            
            
            231,998
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            56,038
            
            
            
            30,065
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            87,550
            
            
            
            405,651Stock
      based compensation expense- employee
            
            
            414,909
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            1,033,411
            
            
            
            171,520
            
            
            
            171,520
            
            
            
            
            
            
            
            1,791,360Stock
      based compensation expense- consultant
            
            
            414,909
            
            
            
            
            
            
            
            1,557,706
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            1,033,412
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            3,006,027(Decrease)
      increase in warrant liability
            
            
            
            
            
            
            (703,326
            )
            
            
            (24,405
            )
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            (178,154
            )
            
            
            67,111
            
            
            
            67,111
            
            
            
            5,945
            
            
            
            5,945
            
            
            
            
            
            
            
            (759,773
            )Increase
      in beneficial conversion feature liaiblity
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            (208,149
            )
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            (208,149
            )Write-off
      of beneficial conversion feature
            
            
            
            
            
            
            
            
            
            
            (380,440
            )
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            (380,440
            )Accrued
      expenses
            
            
            135,529
            
            
            
            
            
            
            
            98,051
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            (46,125
            )
            
            
            187,455Accrual
      of liquidating damages
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            46,125
            
            
            
            46,125Beneficial
      conversion feature
            
            
            231,998
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            (231,998
            )
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            -Warrants
      issued for consultin
            
            
            111,255
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            (111,255
            )




Page 55
of 65


[


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








Beneficial
                                              
                                              WarrantConversion
                                              
                                              Related to
                                              
                                              
                                              
                                              Option IssuedFeatures
                                              
                                              $1,025,000 of
                                              
                                              Warrant Issued
                                              
                                              to Chief Executive2001
                                              
                                              
                                              
                                              Warrants
                                              
                                              
                                              
                                              and
                                              
                                              Convertible
                                              
                                              to Consultant
                                              
                                              Officer for theExecutive
                                              
                                              
                                              
                                              Related to
                                              
                                              Warrant
                                              
                                              Beneficial
                                              
                                              Bridge Notes
                                              
                                              for the Three
                                              
                                              Three MonthAs
                                              
                                              Officers
                                              
                                              Advisory
                                              
                                              2004 Stock
                                              
                                              Issued
                                              
                                              Conversion
                                              
                                              and
                                              
                                              Months Ended
                                              
                                              Period Ended
                                              
                                              
                                              
                                              Warrant IssuedPreviously
                                              
                                              Option
                                              
                                              Board
                                              
                                              Purchase
                                              
                                              for
                                              
                                              Features
                                              
                                              Warrant
                                              
                                              December 31,
                                              
                                              December 31,
                                              
                                              Warrant Issued
                                              
                                              to Chief
                                              
                                              
                                              
                                              AsStated
                                              
                                              Plan
                                              
                                              Compensation
                                              
                                              Agreement
                                              
                                              Services
                                              
                                              Discount
                                              
                                              Discount
                                              
                                              2007
                                              
                                              2007
                                              
                                              to Direcotr
                                              
                                              Financial Officer
                                              
                                              Reclassifications
                                              
                                              RestatedStatement
      of Operations (for the three months ended December 31,
    2006)General
      and administrative
                                              
                                              $
                                              202,938
                                              
                                              
                                              
                                              $
                                              72,304
                                              
                                              
                                              
                                              
                                              
                                              
                                              
                                              
                                              
                                              
                                              
                                              
                                              
                                              
                                              
                                              
                                              
                                              
                                              
                                              $
                                              275,242Interest
      expense
                                              
                                              
                                              (19,242
                                              )
                                              
                                              
                                              
                                              
                                              
                                              
                                              
                                              
                                              
                                              $
                                              (89,686
                                              )
                                              
                                              
                                              
                                              
                                              
                                              
                                              
                                              
                                              
                                              
                                              
                                              (1,482
                                              )
                                              
                                              (110,410
                                              )Beneficial
      conversion feature
                                              
                                              
                                              (1,482
                                              )
                                              
                                              
                                              
                                              
                                              
                                              
                                              
                                              
                                              
                                              
                                              
                                              
                                              
                                              
                                              
                                              
                                              
                                              
                                              
                                              
                                              
                                              
                                              
                                              1,482Statement
      of Cash Flows (for the three months ended December 31,
    2006)Net
      loss
                                              
                                              $
                                              (232,249
                                              )
                                              
                                              
                                              $
                                              (72,304
                                              )
                                              
                                              
                                              
                                              
                                              $
                                              (89,686
                                              )
                                              
                                              
                                              
                                              
                                              
                                              
                                              
                                              
                                              
                                              
                                              
                                              
                                              
                                              $
                                              (394,239
                                              )Amortization
      of beneficial conversion features discount and warrant
      discount
                                              
                                              
                                              1,842
                                              
                                              
                                              
                                              
                                              
                                              
                                              
                                              
                                              
                                              
                                              
                                              89,686
                                              
                                              
                                              
                                              
                                              
                                              
                                              
                                              
                                              
                                              
                                              
                                              
                                              
                                              
                                              
                                              91,528Accrued
      expenses
                                              
                                              
                                              87,085
                                              
                                              
                                              
                                              
                                              72,304
                                              
                                              
                                              
                                              
                                              
                                              
                                              
                                              
                                              
                                              
                                              
                                              
                                              
                                              
                                              
                                              
                                              
                                              
                                              
                                              
                                              
                                              
                                              159,389


SIGNIFICANT
ACCOUNTING POLICIES AND ESTIMATES.




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


Page 56
of 65




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




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




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




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




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




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




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.


Page 57
of 65




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




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




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




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




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




Contractual
                                    Obligations
                                  
                                  Payments Due by PeriodTotal
                                  
                                  
                                  Less than 1
                                    Year
                                  
                                  
                                  1 to 3
                                    Years
                                  
                                  
                                  3 to 5 Years
                                  
                                  
                                  Over 5
                                    YearsLong-Term
      Debt ObligationsCapital
      lease obligationsOperating
      lease obligations
                                  
                                  
                                  2,218,527
                                  
                                  
                                  
                                  432,525
                                  
                                  
                                  
                                  910,920
                                  
                                  
                                  
                                  875,412
                                  
                                  
                                  
                                  0Purchase
      obligationsOther
      long-term liabilities




RESULTS
OF OPERATIONS (THREE MONTHS ENDED DECEMBER 31, 2007 COMPARED TO THREE MONTHS
ENDED DECEMBER 31, 2006). We had minimal operations during the 2006 fiscal year
due to a lack of working capital. During the 2007 fiscal year, the Company began
to raise money for its operations by selling debentures. As a result of these
offerings, the Company was able to resume its operating activities, finalize the
beta unit and begin testing of the process.




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




The
Company incurred operating expenses of $5,309,630 for the three months ended
December 31, 2007, an increase of $5,026,595 or approximately 1,776%, as
compared to $283,035 for the three months ended December 31, 2006. General and
administrative expenses were $5,064,569 for the three months ended December 31,
2007, an increase of $4,789,327 or approximately 1,740%, as compared to $275,242
for the three months ended December 31, 2006. The increase in general and
administrative expenses was primarily due to the issuance of options and
warrants having a value of $4,797,385 to Richard H. Papalian as the Company’s
Chief Executive Office, Mark Maron as a Special Advisor, the Advisory Board
members, Rodney Anderson as a director, and Robert McCray as the Chief Financial
Officer. Research and development expenses incurred during the three months
ended December 31, 2007 were $236,904, and there were no research and
development expenses for the three months ended December 31,
2006.


Page 58
of 65


Other
income and (expense) was $842,553 for the three months ended December 31, 2007,
an increase of $952,857 or approximately 864%, as compared to $(110,304) for the
three months ended December 31, 2006. Decrease in warrant liability was $759,773
for the three months ended December 31, 2007 and represents the decrease in the
fair value of the option and warrant liability. The options and warrants were
required to be classified as liabilities as of July 17, 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 December 31, 2006. The decrease in beneficial
conversion feature liability of $208,149 for the three months ended December 31,
2007 represents the decrease in the fair value of the beneficial conversion
features liability. The beneficial conversion features were required to be
classified as liabilities as of July 17, 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 December 31, 2006.  Interest expense increased to
$506,726 during the three months ended December 31, 2007, an increase of
$396,316 or approximately 359%, as compared to $110,410 for the three months
ended December 31, 2006. The increase in interest expense is primarily due to
the amortization of the beneficial conversion features discount of $288,036 and
warrant discount of $107,547.




Net loss
was $4,467,977 for the three months ended December 31, 2007, an increase of
$4,073,738 or approximately 1,033%, as compared to $394,239 for the three months
ended December 31, 2006.




LIQUIDITY
AND CAPITAL RESOURCES. Net cash flows used in our operating activities was
$292,883 for the three months ended December 31, 2007, an increase of $130,707
or approximately 81%, as compared to $162,176 for the three months ended
December 31, 2006. The increase in cash flows used in operating activities, not
including the increase in net loss, is primarily attributable to the issuance of
options and warrants for $4,797,385, amortization of the beneficial conversion
features and warrant discount of $405,651, accrual of liquidating damages for
$46,125, and decrease in the beneficial conversion features and warrant
liability of $208,149 and $759,773, respectively.




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




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




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




As of
December 31, 2007, the Company had an accumulated deficit of $22,488,813. 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
December 31, 2007, the Company has incurred cumulative losses of $22,488,813
including a loss for the three months ended December 31, 2007 of $4,467,977. 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.


Page 59
of 65


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.


Page 60
of 65


ITEM
3 CONTROLS AND
PROCEDURES




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




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




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




A
material weakness is a control deficiency (within the meaning of the Public
Company Accounting Oversight Board (PCAOB) Auditing Standard No. 2) or
combination of control deficiencies, that results in more than a remote
likelihood that a material misstatement of the annual or interim financial
statements will not be prevented or detected.  Management has
identified the following three material weaknesses which have caused management
to conclude that, as of December 31, 2007, our disclosure controls and
procedures were not effective at the reasonable assurance level:




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




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




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




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


Page 61
of 65


Remediation
of Material Weaknesses




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




Changes
in Internal Control over Financial Reporting




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


Page 62
of 65


PART
II – OTHER INFORMATION




Item
      1
            Legal
      Proceedings




None




Item
      2
            Unregistered
      Sales of Equity Securities and Use of
Proceeds




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




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




Item
      3
            Defaults
      upon Senior Securities




Under the
terms of a Registration Rights Agreement executed in connection with an offering
that closed on July 18, 2007, we were required to file a registration statement
under the Securities Act of 1933 in order to register the resale of the shares
of common stock issuable upon conversion of certain units it sold consisting of
Subordinated Convertible Debentures and Warrants. The units had a value of
$1,025,000. If we did not file a registration statement with respect to the
these securities within 45 days following the closing of the offering, or if the
registration statement was not declared effective by the Securities and Exchange
Commission within 90 days of the closing, then we are required to pay to each
purchaser damages equal to 1.5% of the purchase price paid by the purchaser for
the Subordinated Convertible Debentures for each 30 days that transpires after
these deadlines. The amount of the aggregate damages payable by us is limited to
15% of the purchase price. We had until August 31, 2007 to file the registration
statement. We filed the registration statement on November 14, 2007, incurring a
penalty for 78 days which amounted to $38,437.50. The registration statement has
not been declared effective as of the date of this report, therefore we have
incurred an additional penalty for 85 days totaling $42,025




Item
      4
            Submission
      of Matters to a vote of Security
Holders




None




Item
      5
            Other
      Information




None




Item
      6
            Exhibits




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




3.2
                Bylaws,
      as amended and restated(1)




10.1
                  Employment
      Agreement dated December 19, 2007 between the registrant and Richard H.
      Papalian(2)




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




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




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




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


Page 63
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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
            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 December 20, 2007.




*
            Filed
      herewith.


Page 64
of 65


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:
February 18, 2009




SIONIX
CORPORATION




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





Page 65
of 65