UNITED STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549





FORM
10-Q/A


(Amendment
Number 1)





x
            QUARTERLY
      REPORT UNDER SECTION 13 0R 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934





For the
quarterly period ended: June
30, 2009





 ̈
            TRANSITION
      REPORT UNDER SECTION 13 0R 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934





For the
transition period from:




C ommission
file number: 002-95626-D





SIONIX
      CORPORATION(Exact name of registrant as specified in its
      charter)





Nevada
            
            87-0428526(State or other jurisdiction of incorporation or organization)
            
            (I.R.S. Employer Identification No.)2801 Ocean Park Blvd., Suite 339, Santa Monica,
      California
            
            90405(Address
      of principal executive offices)
            
            (Zip
      Code)





Issuer’s
telephone number: (847)
235-4566





3880 East Eagle Drive, Anaheim, California 92807(Former name, former address and former fiscal
      year, if changed since last
report)





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





Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this
chapter) during the preceding 12 months (or for such shorter period that the
registrant was required to submit and post such files).


 ̈ Yes    ̈ No





Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting
company.  See the definitions of “large accelerated filed,”
“accelerated filer” and “smaller reporting company” in Rule 12b-2 of the
Exchange Act.





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





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





Indicate
the number of shares outstanding of each of the issuer’s classes of common
stock, as of the latest practicable date.  As of August 19, 2009 the
number of shares of the registrant’s classes of common stock outstanding was
145,859,105.













EXPLANATORY
NOTE





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





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





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





·
            2001
      Executive Officers Stock Option
Plan


·
            Advisory
      Board Compensation


·
            Warrants
      Related to 2004 Stock Purchase
Agreement


·
            Convertible
      Notes 1


·
            Convertible
      Notes 2


·
            Subordinated
      Convertible Notes 3


·
            Warrants
      related to Subordinated Convertible Notes
3





As a
result of these transactions, we are filing this amendment number 1 (“Amendment
1”) to our Form 10-Q (the “Original Report”) that was originally filed with the
Securities and Exchange Commission (the “SEC”) on August 19, 2009 for the period
ended June 30, 2009.





The
primary purpose of this Amendment 1 is to disclose the restatement of our
financial statements for the three and nine months ended June 30, 2009 and
cumulative inception to date operations for June 30, 2009.  A complete
discussion of the restatement is included in the section of this Amendment 1
titled “Management’s Discussion and Analysis or Plan of Operation” and in Note
16 to our financial statements for the periods ended June 30, 2009.





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





The
disclosures in this Amendment 1 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 1 should be read in conjunction
with our other filings made with the SEC subsequent to the filing of the
Original Report, including any amendments to those filings.  The
filing of this Amendment 1 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.





During
the period ended June 30, 2009, certain investors converted $35,429 of
convertibles note into 885,728 common shares at $0.04 per share; however, the
conversion rate should have been $0.01.  At June 30, 2009, the Company
owes an additional 14,020,575 shares to the investors related to the $35,429
converted during the period ended June 30, 2009 and the $151,512 converted
during the period ended September 30, 2008.  The Company recorded a
liability of $2,383,498, which is recorded in accrued expenses in the
accompanying financial statements.  The change in the fair value of
the shares will be recorded as a change in fair value of beneficial conversion
liability.





The
following adjustments were made to our financial statements for the periods
ended June 30, 2009:








As
      Previously Stated
            
            
            Beneficial
      Conversion Feature
            
            
            Warrants
      and Options
            
            
            Reclassifications
            
            
            As
      Restated June 30, 2009Balance
      SheetOther
      assets
            
            $
            28,665
            
            
            $
            -
            
            
            $
            -
            
            
            $
            155,000
            
            
            $
            183,665Accrued
      expenses
            
            
            2,739,329
            
            
            
            2,383,498
            
            
            
            -
            
            
            
            155,000
            
            
            
            5,277,827Warrant
      and option liability
            
            
            5,875,700
            
            
            
            -
            
            
            
            2,724,706
            
            
            
            -
            
            
            
            8,600,406Beneficial
      conversion liability
            
            
            -
            
            
            
            10,437,445
            
            
            
            -
            
            
            
            -
            
            
            
            10,437,445Additional
      paid-in capital
            
            
            13,514,364
            
            
            
            -
            
            
            
            (1,847,488
            )
            
            
            -
            
            
            
            11,666,876Deficit
      accumulated during developmental stage
            
            
            (25,828,505
            )
            
            
            (12,820,943
            )
            
            
            (877,218
            )
            
            
            -
            
            
            
            (39,526,666
            )Statement
      of Operations (for the three months ended June 30, 2009)Gain
      (loss) on change in fair value of warrant and option
    liability
            
            $
            (3,623,669
            )
            
            $
            -
            
            
            $
            (809,220
            )
            
            $
            -
            
            
            $
            (4,432,889
            )Gain
      (loss) on change in fair value of beneficial conversion
      liability
            
            
            -
            
            
            
            (7,100,677
            )
            
            
            -
            
            
            
            -
            
            
            
            (7,100,677
            )Statement
      of Operations (for the nine months ended June 30, 2009)Gain
      (loss) on change in fair value of warrant and option
    liability
            
            $
            (1,992,282
            )
            
            $
            -
            
            
            $
            680,973
            
            
            $
            -
            
            
            $
            (1,311,309
            )Gain
      (loss) on change in fair value of beneficial conversion
      liability
            
            
            26,000
            
            
            
            (2,358,055
            )
            
            
            -
            
            
            
            -
            
            
            
            (2,332,055
            )Statement
      of Operations (since inception)Gain
      on change in fair value of warrant and option liability
            
            $
            3,225,958
            
            
            $
            -
            
            
            $
            (292,754
            )
            
            $
            -
            
            
            $
            2,933,204Gain
      on change in fair value of beneficial conversion liability
            
            
            1,426,767
            
            
            
            21,899,975
            
            
            
            -
            
            
            
            -
            
            
            
            23,326,742General
      and administrative expense
            
            
            21,919,482
            
            
            
            3,787,032
            
            
            
            83,855
            
            
            
            -
            
            
            
            25,790,369Interest
      expense and financing costs
            
            
            (2,521,065
            )
            
            
            (30,536,702
            )
            
            
            (897,793
            )
            
            
            -
            
            
            
            (33,955,560
            )Statement
      of Cash Flows (for the nine months ended June 30, 2009)Net
      income (loss)
            
            $
            (3,934,849
            )
            
            $
            (2,358,055
            )
            
            $
            680,973
            
            
            $
            -
            
            
            $
            (5,611,931
            )(Gain)
      loss on change in fair value of warrant and option
    liability
            
            
            2,000,811
            
            
            
            -
            
            
            
            (680,973
            )
            
            
            -
            
            
            
            1,319,838(Gain)
      loss on change in fair value of beneficial conversion
      liability
            
            
            (26,000
            )
            
            
            2,358,055
            
            
            
            -
            
            
            
            
            
            
            
            2,332,055Statement
      of Cash Flows (since inception)Net
      income (loss)
            
            $
            (25,828,505
            )
            
            $
            (12,423,759
            )
            
            $
            (1,274,402
            )
            
            $
            -
            
            
            $
            (39,526,666
            )(Gain)
      loss on change in fair value of warrant and option
    liability
            
            
            (3,217,429
            )
            
            
            -
            
            
            
            292,754
            
            
            
            -
            
            
            
            (2,924,675
            )Gain
      on change in fair value of beneficial conversion liability
            
            
            (1,426,768
            )
            
            
            (21,899,975
            )
            
            
            -
            
            
            
            -
            
            
            
            (23,326,743
            )Non-cash
      compensation expense
            
            
            -
            
            
            
            3,787,032
            
            
            
            83,855
            
            
            
            -
            
            
            
            3,870,887Non-cash
      financing costs
            
            
            -
            
            
            
            30,536,702
            
            
            
            897,793
            
            
            
            -
            
            
            
            31,434,495














Table
of Contents





Part
      I - Financial Information
            
            3Item
      1. Financial Statements
            
            3Balance
      Sheets as of June 30, 2009 (Unaudited) and September 30, 2008
      (Restated)
            
            3Statements
      of Operations (Unaudited) for the three and nine months ended June 30,
      2009 and June 30, 2008 and from inception (October 3, 1994) to June 30,
      2009 (Restated)
            
            4Statement
      of Stockholders Equity (Deficit) (Unaudited) from Inception (October 3,
      1994) to June 30, 2009 (Restated)
            
            5Statements
      of Cash Flows (Unaudited) for the three and nine months ended June 30,
      2009 and June 30, 2008 and from inception (October 3, 1994) to June 30,
      2009 (Restated)
            
            7Notes
      to unaudited condensed financial statements
            
            8Forward-Looking
      Statements
            
            10Item
      2. Management’s Discussion and Analysis of Financial Condition and Results
      of Operations
            
            30Item
      3. Quantitative and Qualitative Disclosures About Market
    Risk
            
            35Item
      4T. Controls and Procedures
            
            36Part
      II – Other Information
            
            36Item
      1. Legal Proceedings
            
            37Item
      1A. Risk Factors
            
            37Item
      2. Unregistered Sales of Equity Securities and Use of
    Proceeds
            
            37Item
      3. Defaults Upon Senior Securities
            
            37Item
      4. Submission of Matters to a Vote of Security Holders
            
            37Item
      5. Other Information
            
            37Item
      6. Exhibits
            
            38Signatures
            
            39











Part
I, Item 1.  Financial Statements.








SIONIX
      CORPORATIONA
      DEVELOPMENT STAGE COMPANYBALANCE
      SHEETSJune
      30,
            
            
            September
      30,2009
            
            
            2008(Unaudited)(As
      Restated)
            
            
            (As
      Restated)ASSETSCURRENT
      ASSETSCash
      and cash equivalents
            
            $
            8,582
            
            
            $
            1,220,588Inventory
            
            
            833,594
            
            
            
            -Other
      current assets
            
            
            183,665
            
            
            
            138,895TOTAL
      CURRENT ASSETS
            
            
            1,025,841
            
            
            
            1,359,483PROPERTY
      AND EQUIPMENT, net
            
            
            152,661
            
            
            
            87,101DEPOSITS
            
            
            28,495
            
            
            
            33,095TOTAL
      ASSETS
            
            
            1,206,997
            
            
            
            1,479,679LIABILITIES
      AND STOCKHOLDERS' DEFICITCURRENT
      LIABILITIESAccounts
      payable
            
            $
            317,158
            
            
            $
            259,355Accrued
      expenses
            
            
            5,277,827
            
            
            
            4,312,844Customer
      deposits
            
            
            1,620,000
            
            
            
            1,260,000Liquidated
      damages liability
            
            
            78,750
            
            
            
            153,750Notes
      payable – related parties
            
            
            107,000
            
            
            
            114,000Short-term
      promissory notes payable
            
            
            240,000
            
            
            
            -Convertible
      notes, net of debt discounts of $761,333
            
            
            1,761,333
            
            
            
            2,041,44310%
      subordinated notes payable, net
            
            
            482,492
            
            
            
            400,796Warrant
      and option liability
            
            
            8,600,406
            
            
            
            6,869,244Beneficial
      conversion liability
            
            
            10,437,445
            
            
            
            8,881,272TOTAL
      CURRENT LIABILITIES
            
            
            28,922,411
            
            
            
            24,292,704STOCKHOLDERS'
      DEFICITCommon
      stock (150,000,000 shares authorized; 144,459,104 and 143,977,204 shares
      issued and outstanding at June 30 ,2009, respectively, and 134,756,213 and
      134,274,313 shares issued and outstanding at September 30, 2008,
      respectively)
            
            
            143,976
            
            
            
            134,274Additional
      paid-in capital
            
            
            11,666,876
            
            
            
            10,841,007Shares
      to be issued
            
            
            400
            
            
            
            126,429Deficit
      accumulated during development stage
            
            
            (39,526,666
            )
            
            
            (33,914,735
            )TOTAL
      STOCKHOLDERS' DEFICIT
            
            
            (27,715,414
            )
            
            
            (22,813,025
            )TOTAL
      LIABILITIES AND STOCKHOLDERS' DEFICIT
            
            $
            1,206,997
            
            
            $
            1,479,679





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










3







SIONIX
      CORPORATIONA
      DEVELOPMENT STAGE COMPANYSTATEMENT
      OF OPERATIONS(UNAUDITED)Cumulative
      fromFor
      the three months
            
            
            For
      the nine months
            
            
            Inceptionended
      June 30,
            
            
            ended
      June 30,
            
            
            (October
      3, 1994) to2009
            
            
            2008
            
            
            2009
            
            
            2008
            
            
            June
      30, 2009(As
      Restated)
            
            
            (As
      Restated)
            
            
            (As
      Restated)
            
            
            (As
      Restated)
            
            
            (As
      Restated)Revenues
            
            $
            -
            
            
            $
            -
            
            
            $
            -
            
            
            $
            -
            
            
            $
            -Operating
      expensesGeneral
      and administrative
            
            
            179,219
            
            
            
            718,557
            
            
            
            1,144,112
            
            
            
            6,839,284
            
            
            
            25,790,279Research
      and development
            
            
            210,561
            
            
            
            280,972
            
            
            
            567,790
            
            
            
            846,904
            
            
            
            3,604,663Depreciation
      and amortization
            
            
            22,300
            
            
            
            8,157
            
            
            
            37,404
            
            
            
            24,472
            
            
            
            594,779Total
      operating expenses
            
            
            412,080
            
            
            
            1,007,686
            
            
            
            1,749,306
            
            
            
            7,710,660
            
            
            
            29,989,721Loss
      from operations
            
            
            (412,080
            )
            
            
            (1,007,686
            )
            
            
            (1,749,306
            )
            
            
            (7,710,660
            )
            
            
            (29,989,721
            )Other
      income (expense)Interest
      income
            
            
            2
            
            
            
            1,564
            
            
            
            3,870
            
            
            
            2,843
            
            
            
            70,244Interest
      expense and financing costs
            
            
            (63,423
            )
            
            
            (313,696
            )
            
            
            (221,947
            )
            
            
            (977,912
            )
            
            
            (33,955,560
            )Gain
      (loss) on change in fair value of warrant and option
    liability
            
            
            (4,432,889
            )
            
            
            (2,431,943
            )
            
            
            (1,311,309
            )
            
            
            1,497,546
            
            
            
            2,933,204Gain
      (loss) on change in fair value of beneficial conversion
      liability
            
            
            (7,100,677
            )
            
            
            (4,786,825
            )
            
            
            (2,332,055
            )
            
            
            14,136,053
            
            
            
            23,326,742Impairment
      of intangibles
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (1,267,278
            )Inventory
      obsolesence
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (365,078
            )Legal
      settlement
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            344,949Loss
      on settlement of debt
            
            
            19,800
            
            
            
            -
            
            
            
            3,616
            
            
            
            -
            
            
            
            (351,795
            )Loss
      on lease termination
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (129,166
            )Write-off
      of property and equipment
            
            
            -
            
            
            
            4,151
            
            
            
            -
            
            
            
            (125,015
            )
            
            
            (125,015
            )Total
      other income (expense)
            
            
            (11,577,187
            )
            
            
            (7,526,749
            )
            
            
            (3,857,825
            )
            
            
            14,533,515
            
            
            
            (9,518,753
            )Loss
      before income taxes
            
            
            (11,989,267
            )
            
            
            (8,534,435
            )
            
            
            (5,607,131
            )
            
            
            6,822,855
            
            
            
            (39,508,474
            )Income
      taxes
            
            
            4,800
            
            
            
            -
            
            
            
            4,800
            
            
            
            900
            
            
            
            18,192Net
      income (loss)
            
            $
            (11,994,067
            )
            
            $
            (8,534,435
            )
            
            $
            (5,611,931
            )
            
            $
            6,821,955
            
            
            $
            (39,526,666
            )Basic
      income (loss) per share
            
            $
            (0.08
            )
            
            $
            (0.07
            )
            
            $
            (0.04
            )
            
            $
            0.06Dilutive
      income (loss) per share
            
            $
            (0.08
            )
            
            $
            (0.07
            )
            
            
            (0.04
            )
            
            $
            0.06Basic
      weighted average number ofshares
      of common stock outstanding
            
            
            142,281,820
            
            
            
            113,816,474
            
            
            
            138,329,293
            
            
            
            113,816,474Dilutive
      weighted average number ofshares
      of common stock outstanding
            
            
            142,281,820
            
            
            
            113,816,474
            
            
            
            138,329,293
            
            
            
            113,816,474


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







4





SIONIX
      CORPORATIONA
      DEVELOPMENT STAGE COMPANYSTATEMENTS
      OF STOCKHOLDERS' EQUITY (DEFICIT)FOR
      THE PERIOD FROM OCTOBER 3, 1994 (INCEPTION) TO JUNE 30,
    2009(UNAUDITED)Deficit
            
            
            TotalCommon
      Stock
            
            
            Additional
            
            
            Shares
            
            
            Stock
            
            
            Shares
            
            
            Unamortized
            
            
            Accumulated
            
            
            Stockholders'Number
            
            
            
            
            
            Paid-in
            
            
            to
      be
            
            
            Subscription
            
            
            to
      be
            
            
            Consulting
            
            
            from
            
            
            Equityof
      Shares
            
            
            Amount
            
            
            Capital
            
            
            Issued
            
            
            Receivable
            
            
            Cancelled
            
            
            Fees
            
            
            Inception
            
            
            (Deficit)Stock
      issued for cash, October 3, 1994
            
            
            10,000
            
            
            $
            10
            
            
            $
            90
            
            
            $
            -
            
            
            $
            -
            
            
            $
            -
            
            
            $
            -
            
            
            $
            -
            
            
            $
            100Net
      loss
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (1,521
            )
            
            
            (1,521
            )Balance
      at December 31, 1994
            
            
            10,000
            
            
            
            10
            
            
            
            90
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (1,521
            )
            
            
            (1,421
            )Shares
      issued for assignment rights
            
            
            1,990,000
            
            
            
            1,990
            
            
            
            (1,990
            )
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Shares
      issued for services
            
            
            572,473
            
            
            
            572
            
            
            
            135,046
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            135,618Shares
      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
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (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
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (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
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (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
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (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
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (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
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (2,414,188
            )
            
            
            (2,414,188
            )Balance
      at September 30, 2000
            
            
            54,166,322
            
            
            
            54,166
            
            
            
            8,104,350
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (8,168,751
            )
            
            
            (10,235
            )Shares
      issued for services
            
            
            2,517,376
            
            
            
            2,517
            
            
            
            530,368
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (141,318
            )
            
            
            -
            
            
            
            391,567Shares
      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
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (1,353,429
            )
            
            
            (1,353,429
            )Balance
      at September 30, 2001
            
            
            62,688,698
            
            
            
            62,688
            
            
            
            9,229,213
            
            
            
            113,295
            
            
            
            -
            
            
            
            -
            
            
            
            (141,318
            )
            
            
            (9,522,180
            )
            
            
            (258,302
            )Shares
      issued for services
            
            
            1,111,710
            
            
            
            1,112
            
            
            
            361,603
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            54,400
            
            
            
            -
            
            
            
            417,115Shares
      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 related to equityfinancing
      (967,742 shares)
            
            
            -
            
            
            
            -
            
            
            
            (300,000
            )
            
            
            300,000
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Cancellation
      of shares
            
            
            (7,533,701
            )
            
            
            (7,534
            )
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (7,534
            )Net
      loss
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (1,243,309
            )
            
            
            (1,243,309
            )Balance
      at September 30, 2002
            
            
            74,540,411
            
            
            
            74,540
            
            
            
            11,074,334
            
            
            
            300,000
            
            
            
            -
            
            
            
            -
            
            
            
            (86,918
            )
            
            
            (10,765,489
            )
            
            
            596,467Shares
      issued for services
            
            
            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
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (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
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (1,593,135
            )
            
            
            (1,593,135
            )Balance
      at September 30, 2004
            
            
            102,042,286
            
            
            
            102,042
            
            
            
            13,294,405
            
            
            
            43,900
            
            
            
            -
            
            
            
            -
            
            
            
            (13,075
            )
            
            
            (14,080,615
            )
            
            
            (653,343
            )Amortization
      of consulting fees
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            13,075
            
            
            
            -
            
            
            
            13,075Net
      loss
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (722,676
            )
            
            
            (722,676
            )Balance
      at September 30, 2005
            
            
            102,042,286
            
            
            
            102,042
            
            
            
            13,294,405
            
            
            
            43,900
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (14,803,291
            )
            
            
            (1,362,944
            )Net
      loss
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (1,049,319
            )
            
            
            (1,049,319
            )Balance
      at September 30, 2006
            
            
            102,042,286
            
            
            
            102,042
            
            
            
            13,294,405
            
            
            
            43,900
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (15,852,610
            )
            
            
            (2,412,263
            )Stock
      issued for consulting
            
            
            4,592,915
            
            
            
            4,593
            
            
            
            80,336
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            84,929Reclassification
      to warrant and option liability
            
            
            -
            
            
            
            -
            
            
            
            (2,277,013
            )
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (2,277,013
            )Net
      loss
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (33,612,516
            )
            
            
            (33,612,516
            )Balance
      at September 30, 2007, restated
            
            
            106,635,201
            
            
            
            106,635
            
            
            
            11,097,728
            
            
            
            43,900
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (49,465,126
            )
            
            
            (38,216,863
            )





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


5





SIONIX
      CORPORATIONA
      DEVELOPMENT STAGE COMPANYSTATEMENTS
      OF STOCKHOLDERS' EQUITY (DEFICIT) - CONTINUEDFOR
      THE PERIOD FROM OCTOBER 3, 1994 (INCEPTION) TO JUNE 30,
    2009(UNAUDITED)Deficit
            
            
            TotalCommon
      Stock
            
            
            Additional
            
            
            Shares
            
            
            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)Conversion
      of note payable into common stock
            
            
            17,149,359
            
            
            
            17,149
            
            
            
            886,633
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            903,782Common
      stock issued for services
            
            
            1,539,750
            
            
            
            1,540
            
            
            
            254,330
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            255,870Common
      stock issued for cash
            
            
            8,950,003
            
            
            
            8,950
            
            
            
            784,550
            
            
            
            (43,500
            )
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            750,000Common
      stock to be issued for cash
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            126,029
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            126,029Issuance
      of warrants with stock
            
            
            -
            
            
            
            -
            
            
            
            (2,182,234
            )
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (2,182,234
            )Net
      income
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            15,550,391
            
            
            
            15,550,391Balance
      at September 30, 2008, restated
            
            
            134,274,313
            
            
            
            134,274
            
            
            
            10,841,007
            
            
            
            126,429
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (33,914,735
            )
            
            
            (22,813,025
            )Conversion
      of note payable into common stock
            
            
            7,169,419
            
            
            
            7,169
            
            
            
            447,173
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            454,342Common
      stock issued for services
            
            
            1,200,139
            
            
            
            1,200
            
            
            
            225,029
            
            
            
            (126,029
            )
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            100,200Common
      stock issued for property and equipment
            
            
            833,333
            
            
            
            833
            
            
            
            124,167
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            125,000Common
      stock issued for cash and debt settlement
            
            
            500,000
            
            
            
            500
            
            
            
            29,500
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            30,000Net
      loss
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (5,611,931
            )
            
            
            (5,611,931
            )Balance
      at June 30, 2009, (unaudited) restated
            
            
            143,977,204
            
            
            $
            143,976
            
            
            $
            11,666,876
            
            
            $
            400
            
            
            $
            -
            
            
            $
            -
            
            
            $
            -
            
            
            $
            (39,526,666
            )
            
            $
            (27,715,414
            )





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


6





SIONIX
      CORPORATIONA
      DEVELOPMENT STAGE COMPANYSTATEMENT
      OF CASH FLOWS(UNAUDITED)CumulativefromFor
      the Nine Months
            
            
            InceptionEnded
      June 30,
            
            
            (October
      3, 1994) to2009
            
            
            2008
            
            
            June
      30, 2009(As
      Restated)
            
            
            (As
      Restated)
            
            
            (As
      Restated)OPERATING
      ACTIVITIES:Net
      income (loss)
            
            $
            (5,611,931
            )
            
            $
            6,821,955
            
            
            $
            (39,526,666
            )Adjustments
      to reconcile net loss to net cash used inoperating
      activities:Depreciation
            
            
            37,404
            
            
            
            24,472
            
            
            
            681,696Amortization
      of beneficial conversion features discount andwarrant
      discount
            
            
            2,890
            
            
            
            1,073,445
            
            
            
            2,050,229Stock
      based compensation expense - employee
            
            
            187,844
            
            
            
            -
            
            
            
            3,866,746Stock
      based compensation expense - consultant
            
            
            238,244
            
            
            
            5,799,646
            
            
            
            6,888,835Increase
      (decrease) in fair value of warrant and option liability
            
            
            1,319,838
            
            
            
            (1,497,546
            )
            
            
            (2,924,675
            )Increase
      (decrease) in fair value of beneficial conversion
liability
            
            
            2,332,055
            
            
            
            (14,136,054
            )
            
            
            (23,326,743
            )Non-cash
      compensation costs
            
            
            -
            
            
            
            -
            
            
            
            3,870,887Non-cash
      financing costs
            
            
            -
            
            
            
            83,855
            
            
            
            31,434,495Impairment
      of assets
            
            
            -
            
            
            
            -
            
            
            
            514,755Write-down
      of obsolete assets
            
            
            -
            
            
            
            -
            
            
            
            38,862Impairment
      of intangible assets
            
            
            -
            
            
            
            -
            
            
            
            1,117,601Loss
      on settlement of debt
            
            
            (19,800
            )
            
            
            -
            
            
            
            364,777Loss
      on termination of lease
            
            
            -
            
            
            
            126,111
            
            
            
            129,166Write-off
      of beneficial conversion features
            
            
            -
            
            
            
            -
            
            
            
            (576,000
            )Stock
      issued for services and rent
            
            
            -
            
            
            
            -
            
            
            
            114,850Other
            
            
            27,582
            
            
            
            -
            
            
            
            (771,462
            )(Increase)
      decrease in assets:Inventory
            
            
            (833,594
            )
            
            
            -
            
            
            
            (833,594
            )Other
      current assets
            
            
            17,730
            
            
            
            (77,269
            )
            
            
            (28,665
            )Other
      assets
            
            
            (150,400
            )
            
            
            -
            
            
            
            (128,495
            )Increase
      (decrease) in liabilities:Accounts
      payable
            
            
            197,604
            
            
            
            409,406
            
            
            
            613,123Accrued
      expenses
            
            
            451,603
            
            
            
            (139,840
            )
            
            
            2,933,286Customer
      deposits
            
            
            360,000
            
            
            
            900,000
            
            
            
            1,620,000Net
      cash used in operating activities
            
            
            (1,451,460
            )
            
            
            (611,819
            )
            
            
            (11,876,992
            )INVESTING
      ACTIVITIES:Acquisition
      of property and equipment
            
            
            (5,546
            )
            
            
            (26,111
            )
            
            
            (473,553
            )Acquisition
      of patents
            
            
            -
            
            
            
            -
            
            
            
            (158,212
            )Net
      cash used in investing activities
            
            
            (5,546
            )
            
            
            (26,111
            )
            
            
            (631,765
            )FINANACING
      ACTIVITIES:Accrual
      of liquidated damages
            
            
            -
            
            
            
            138,375
            
            
            
            153,750Payment
      on notes payable to officer
            
            
            -
            
            
            
            (19,260
            )
            
            
            (218,502
            )Proceeds
      from notes payable, related party
            
            
            -
            
            
            
            -
            
            
            
            457,433Payments
      on notes payable to related party
            
            
            -
            
            
            
            (5,000
            )
            
            
            (15,000
            )Receipt
      from (payments to) equity line of credit
            
            
            -
            
            
            
            (27,336
            )
            
            
            428,664Receipt
      of proceeds from short term notes
            
            
            240,000
            
            
            
            -
            
            
            
            240,000Proceeds
      from convertible notes payable
            
            
            -
            
            
            
            -
            
            
            
            2,861,000Proceeds
      from 10% subordinated notes payable
            
            
            -
            
            
            
            425,000
            
            
            
            425,000Issuance
      of common stock
            
            
            5,000
            
            
            
            330,000
            
            
            
            8,184,594Receipt
      of cash for stock to be issued
            
            
            -
            
            
            
            420,000
            
            
            
            400Net
      cash provided by financing activities
            
            
            245,000
            
            
            
            1,261,779
            
            
            
            12,517,339NET
      (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS
            
            
            (1,212,006
            )
            
            
            623,849
            
            
            
            8,582CASH
      AND CASH EQUIVALENTS, BEGINNING
            
            
            1,220,588
            
            
            
            372,511
            
            
            
            -CASH
      AND CASH EQUIVALENTS, ENDING
            
            $
            8,582
            
            
            $
            996,360
            
            
            $
            8,582SUPPLEMENTAL
      INFORMATION:Cash
      and cash equivalents paid for interest
            
            $
            -
            
            
            $
            -
            
            
            $
            -Cash
      and cash equivalents paid for taxes
            
            $
            -
            
            
            $
            -
            
            
            $
            -








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


7


Sionix
Corporation


June
30, 2009


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





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 nine month period
ended June 30, 2009 are not necessarily indicative of the results to be expected
for the full year ending September 30, 2009 and should be read in conjunction
with the audited financial statements for the year ended September 30,
2008.





USE
OF ESTIMATES





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





CASH
AND CASH EQUIVALENTS





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





INVENTORY
VALUATION





Inventory
is stated at the lower of cost or market, with costs generally determined on a
first-in first-out basis. Management utilizes specific product identification,
historical product demand, and comparison of inventory costs to market value 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 are also considered by management
in determining whether an allowance for obsolete inventory is required. As of
June 30, 2009, the Company believes that no reserve is required. Inventory at
June 30, 2009, was $833,594 and consisted of work in process.





PROPERTY
AND EQUIPMENT





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





8


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





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





ACCRUED
DERIVATIVE LIABILITIES




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




ADVERTISING





The cost
of advertising is expensed as incurred, and included in general and
administrative expenses. There were no advertising costs for the three or nine
months ended June 30, 2009. Total advertising costs were $945 and $3,385 for the
three and nine months ended June 30, 2008, respectively.





REVENUE
RECOGNITION





The
Company plans to recognize revenue when there is persuasive evidence of an
arrangement, title and risk of loss has passed to the customer, delivery has
occurred or the services have been rendered, the sales price is fixed or
determinable and collection of the related receivable is reasonably assured. In
general, the Company plans to require a deposit from a customer before a unit is
fabricated and shipped.  It is the Company's policy to require an
arrangement with its customers, either in the form of a written contract or
purchase order containing all of the terms and conditions governing the
arrangement, prior to the recognition of revenue. Title and risk of loss will
generally pass to the customer at the time of delivery of the product to a
common carrier. At the time of the transaction, the Company will assess whether
the sales price is fixed or determinable and whether or not collection is
reasonably assured. If the sales price is not deemed to be fixed or
determinable, revenue will be recognized as the amounts become due from the
customer. The Company does not plan to offer a right of return on its products
and the products will generally not be subject to customer acceptance rights.
The Company plans to assess collectability based on a number of factors,
including past transaction and collection history with a customer and the
creditworthiness of the customer. The Company plans to perform ongoing credit
evaluations of its customers' financial condition. If the Company determines
that collectability of the sales price is not reasonably assured, revenue
recognition will be deferred until such time as collection becomes reasonably
assured, which is generally upon receipt of payment from the customer. The
Company plans to include shipping and handling costs in revenue and cost of
sales.
 
 The
Company's policy for shipping and handling costs, billed to customers, is to
include it in revenue in accordance with Emerging Issues Task Force ("EITF")
issue No. 00-10, "Accounting for Shipping and Handling Revenues and Costs." The
purpose of this issue was to clarify the classification of shipping and handling
revenues and costs. The consensus reached was that all shipping and handling
billed to customers should be recorded as revenue. Accordingly, the Company
records its shipping and handling amounts within net sales and operating
expenses.
 
 The
Company has not earned any revenue since its inception to the date of this
report.


RESEARCH
AND DEVELOPEMENT





The cost
of research and development is expensed as incurred. Total research and
development costs were $210,561 and $567,790 for the three and nine months ended
June 30, 2009, respectively. Total research and development costs were $280,972
and $846,904 for the three and nine months ended June 30, 2008.




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.





9


EARNINGS
PER SHARE







Net loss
per share is calculated in accordance with Statement of Financial Accounting
Standards No. 128, “Earnings Per Share,” (“SFAS 128”). Basic net loss per
share is computed by dividing the net loss available to common stock holders by
the weighted average number of common shares outstanding. Diluted net loss per
share is based on the assumption that all dilutive convertible shares and stock
options and warrants were converted or exercised. Dilution is computed by
applying the treasury stock method. Under this method, options and warrants are
assumed to be exercised at the beginning of the period (or at the time of
issuance, if later), and as if funds obtained thereby were used to purchase
common stock at the average market price during the period. During the nine
months ended June 30, 2008, the Company had net income; however, the net income
was due to the change in the fair value of the warrant and option liability and
in the change in the fair value of the beneficial conversion liability. If these
securities had been converted at the beginning of the period, then the Company
would have realized a loss for the nine month period ended June 30, 2008. 
As such, these securities are determined to be anti-dilutive and the number of
shares used to determine the basic and dilutive earnings per share is the
same.




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





For
      the Three Months Ended June 30,2009
            
            
            2008Net
            
            
            
            
            
            Per
            
            
            Net
            
            
            
            
            
            PerLoss
            
            
            Shares
            
            
            Share
            
            
            Loss
            
            
            Shares
            
            
            ShareBasic
      Earnings Per ShareNet
      Loss Available to Stockholders
            
            $
            (11,994,067
            )
            
            
            142,281,820
            
            
            $
            (0.08
            )
            
            $
            (8,534,435
            )
            
            
            113,816,474
            
            
            $
            (0.07
            )Effect
      of Dilutive Securities
            
            
            
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Diluted
      Earnings Per Share
            
            $
            (11,994,067
            )
            
            
            142,281,820
            
            
            $
            (0.08
            )
            
            $
            (8,534,435
            )
            
            
            113,816,474
            
            
            $
            (0.07
            )





For
      the Nine Months Ended June 30,2009
            
            
            2008Net
            
            
            
            
            
            Per
            
            
            Net
            
            
            
            
            
            PerLoss
            
            
            Shares
            
            
            Share
            
            
            Income
            
            
            Shares
            
            
            ShareBasic
      Earnings Per ShareNet
      Loss Available to Stockholders
            
            $
            (5,611,931
            )
            
            
            138,329,293
            
            
            $
            (0.04
            )
            
            $
            6,821,955
            
            
            
            113,816,474
            
            
            $
            0.06Effect
      of Dilutive Securities
            
            
            
            
            
            
            
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Diluted
      Earnings Per Share
            
            $
            (5,611,9341
            )
            
            
            138,329,293
            
            
            $
            (0.04
            )
            
            $
            6,821,955
            
            
            
            113,816,474
            
            
            $
            0.06





FAIR
VALUE OF FINANCIAL INSTRUMENTS





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





CONCENTRATION
OF CREDIT RISK





During
the nine months ended June 30, 2008 the Company had deposits in financial
institutions over the federally insured limits of $100,000. The Company does not
believe there is any credit risk related to these deposits due to the financial
condition of the financial institution.





RELATED
PARTY TRANSACTION





On
October 14, 2008, the Company entered into an agreement to purchase machinery
and equipment with a fair value of $125,000 from RJ Metal, Co. The Company
issued 833,333 shares of Common Stock as payment. The purchase qualified as a
related party transaction because the Company’s Chief Executive Officer and
director, is also a director, officer and significant stockholder of RJ Metal,
Co.





10


USE
OF ESTIMATES





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





RECLASSIFICATIONS





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





NOTE
3  PROPERTY AND EQUIPMENT (RESTATED)





Property
and equipment consisted of the following at:





June 30,
            
            
            September 30,2009
            
            
            2008(Unaudited)Machinery
      and equipment
            
            $
            369,391
            
            
            $
            266,425Furniture
      and fixtures
            
            
            41,176
            
            
            
            41,176Leasehold
      improvement
            
            
            1,695
            
            
            
            1,695TOTAL
      PROPERTY AND EQUIPMENT
            
            
            412,262
            
            
            
            309,296Less
      accumulated depreciation
            
            
            (259,601
            )
            
            
            (222,195
            )NET
      PROPERTY AND EQUIPMENT
            
            $
            152,661
            
            
            $
            87,101





Depreciation
expenses for the three and nine months ended June 30, 2009 were $22,600 and
$37,404, respectively. Depreciation expenses for the three and nine months ended
June 30, 2008 were $8,157 and $24,472, respectively





NOTE
4  ACCRUED EXPENSES (RESTATED)





Accrued
expenses consisted of the following at:







June 30,
            
            
            September 30,2009
            
            
            2008(Unaudited)Accrued
      salaries
            
            $
            1,641,880
            
            
            $
            1,493,444Advisory
      board compensation
            
            
            576,000
            
            
            
            576,000Auto
      allowance accruals
            
            
            104,785
            
            
            
            94,408Interest
      payable
            
            
            339,618
            
            
            
            272,016Other
      accruals
            
            
            2,615,544
            
            
            
            1,876,976TOTAL
      ACCRUED EXPENSES
            
            $
            5,277,827
            
            
            $
            4,312,844





11


NOTE
5  CUSTOMER DEPOSITS





In May
2008, the Company received an order for a water filtration system, which
required a deposit. The Company has not recognized the revenue related to the
water filtration system. As of June 30, 2009 and September 30, 2008, customer
deposits were $1,620,000 and $1,260,000, respectively.





NOTE
6  NOTES PAYABLE – RELATED PARTIES





The
Company has received advances in the form of unsecured promissory notes from
stockholders in order to pay ongoing operating expenses. These notes bear
interest at rates up to 13% and are due on demand. As of June 30, 2009 and
September 30, 2008, notes payable amounted to $107,000 and $114,000.
Accrued interest on the notes amounted to $81,494 and $74,482 at June 30,
2009 and September 30, 2008, respectively, and is included in accrued expenses.
Interest expenses on these notes for the three and nine months ended June 30,
2009 were $2,954 and $8,827, respectively. Interest expenses on these notes
for the three and nine months ended June 30, 2008 were $3,204 and $9,647,
respectively.





NOTE
7  SHORT-TERM PROMISSORY NOTES





From June
5 to June 26, 2009, the Company borrowed a total of $240,000 in principal amount
from Steel Pier Capital Advisors and Steel Pier Capital Fund, LP.  The
loans are evidenced by four promissory notes (the “Notes”) with principal
amounts ranging from $40,000 to $75,000. As consideration for the loans, the
Company issued a total of 500,000 shares of common stock to Steel Pier Capital
Fund, LP. The Notes accrue interest at the rate of 10% per annum until the
principal amount and all accrued interest is repaid.  There is no
prepayment penalty associated with the Notes.





The Notes
mature upon the earlier of: (i) two business days after the receipt of funds
from Mourant Cayman Corporate Services LTD or any other financing or investment
source to the Company; (ii) two business days after receiving funds from
Innovative Water Equipment, Inc.; or (iii) July 7, 2009.





Upon an
event of default, the holder of a Note may accelerate the Note and declare all
amounts due under the Note to be due and payable.  An event of default
is defined as (i) any failure to pay any amount of principal or interest when
due; (ii) commencement of a voluntary bankruptcy proceeding, consent to relief
in any involuntary bankruptcy proceeding, consent to the appointment of a
receiver or similar official, or making a general assignment for the benefit of
its creditors; or (iii) entrance into an order or decree under bankruptcy law
that (a) is for relief in any involuntary case or proceeding, (b) appoints a
custodian for any substantial assets or property, or (c) orders the winding up
or liquidation of the Company.





NOTE
8  CONVERTIBLE NOTES





Convertible
Notes 1





Between
October 2006 and February 2007, the Company completed an offering of $750,000 in
principal amount of convertible notes, which bear interest at 10% per annum and
mature at the earlier of (i) 18 months from the date of issuance (ii) an event
of default or (iii) the closing of any equity related financing by the Company
in which the gross proceeds are a minimum of $2,500,000. These notes are
convertible into shares of the Company’s Common Stock at $0.05 per share or
shares of any equity security issued by the Company at a conversion price equal
to the price at which such security is sold to any other party. In the event
that a registration statement covering the underlying shares was not declared
effective within 180 days after the closing, the conversion price was to be
reduced by $0.0025 per share for each 30 day period that the effectiveness of
the registration statement was delayed but in no case could the conversion price
to be reduced below $0.04 per share. As of March 31, 2009 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.


12


The first
class, as defined in paragraph 9, is financial instruments that are mandatorily
redeemable financial instruments. There are no terms or conditions that require
the Company to unconditionally redeem the convertible notes by transferring
assets at a specified or determinable date. The second class, as defined in
paragraph 11, is financial instruments that require the repurchase of shares of
Common Stock by transferring assets. There are no terms or conditions that
require the Company to repurchase shares of Common Stock. The third class, as
defined in paragraph 12, is financial instruments that require the issuance of a
variable number of shares of Common Stock. There are no terms or conditions that
require the Company to issue a variable number of shares of Common Stock.
Therefore, the Company concluded that the convertible notes were not within the
scope of SFAS 150.





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





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





As of
June 30, 2009, the outstanding principal amount of the convertible notes was
$511,333 and there was no unamortized embedded beneficial conversion feature
discount. As of August 27, 2008, the convertible notes had matured and the
outstanding principal amount of $533,333 and accrued interest of $86,981 were
due. Since the convertible notes matured, $47,639 of principal has been
converted into 1,190,972 shares of Common Stock and the Company has not repaid
the remaining outstanding amount of the convertible notes.





As of
September 30, 2008, the outstanding principal amount of the convertible notes
was $533,333 and there was no unamortized embedded beneficial conversion feature
discount.





For the
three and nine months ended June 30, 2009, interest expense was $13,090 and
$39,728, respectively, which was included in the other income (expense) section
of the statement of operations.





For the
three and nine months ended June 30, 2008, interest expense was $17,259 and
$55,593, respectively, and amortization expense for the embedded beneficial
conversion feature discount was $35,000 and $285,000, respectively, 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 are due and payable
upon the earlier of (i) the occurrence of an Event of Default or (ii) the
Maturity Date, which is defined as any business day that is not sooner than
December 31, 2008, as the holder of the notes may specify in written notice
delivered to the Company not less than 30 days prior to such specified date.
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.


13


There are
no terms or conditions that require the Company to unconditionally redeem the
convertible notes by transferring assets at a specified or determinable date.
The second class, as defined in paragraph 11, is financial instruments that
require the repurchase of shares of Common Stock by transferring assets. There
are no terms or conditions that require the Company to repurchase shares of
Common Stock. The third class, as defined in paragraph 12, is financial
instruments that require the issuance of a variable number of shares of Common
Stock. There are no terms or conditions that require the Company to issue a
variable number of shares of Common Stock. Therefore, the Company concluded that
the convertible notes were not within the scope of SFAS 150.





The fair
value of the embedded beneficial conversion features was $86,000 at the date of
issuance using the Black-Scholes 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 is amortized to interest expense
over the term of the note, which is $4,778 per month.





As of
June 30, 2009, there was no outstanding principal of the convertible notes and
there was no unamortized embedded beneficial conversion feature
discount. As of December 31, 2008, the convertible notes had matured and
the outstanding principal amount of $26,000 and accrued interest of $4,153 were
due. Since the convertible notes matured, $26,000 of principal has been
converted into 2,600,000 shares of Common Stock.





As of
September 30, 2008, the outstanding principal amount of the convertible notes
was $26,000 and unamortized embedded beneficial conversion feature discount was
$2,890.





For the
three and nine months ended June 30, 2009, interest expense was $160 and $1,445,
and amortization expense for the embedded beneficial conversion feature discount
was $2,890, which was included in interest expense in the other income (expense)
section of the statement of income (operations).





For the
three and nine months ended June 31, 2008, interest expense was $2,191 and
$6,526, respectively, and amortization expense for the embedded beneficial
conversion feature discount was $16,556 and $43,000, which was included in
interest expense in the other income (expense) section of the statement of
income (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. An amendment dated March 13, 2008 reduces the
conversion rate of the notes to $0.15 per share and the exercise price of the
warrants to $0.30 per share.





Under the
terms of a Registration Rights Agreement signed in conjunction with this
offering, the Company is required to file a registration statement under the
Securities Act of 1933 in order to register the resale of the shares of Common
Stock issuable upon conversion of the Convertible Notes 3 and the warrant
shares (collectively, the "Registrable Securities"). If the Company did not file
a registration statement with respect to the Registrable Securities within 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,
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 and
has accrued $153,750 of expenses as liquidated damages as of September
30, 2008. During the nine months ended June 30, 2009, $75,000 of the liquidated
damages were converted into 937,500 shares of Common Stock. As of June 30, 2009,
the Company has accrued $78,750 as liquidated damages. No derivative liability
is recorded as the amount of liquidated damage is fixed with a maximum
ceiling.


14


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




The fair value of the warrants was $741,341 at the date of
issuance calculated using the Black-Scholes 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 expected term of 5 years.  As a result, the
relative fair value of the warrants was $430,189.





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





The fair
value of the embedded beneficial conversion features was $594,811 at the date of
issuance using the Black-Scholes 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 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
June 30, 2009, the outstanding principal amount of the convertible notes was
$250,000, there was no unamortized warrant discount or embedded beneficial
conversion feature discount, and the number of outstanding warrants was
2,329,546. As of July 16, 2008, the convertible notes had matured and the
outstanding principal amount of $485,000 and accrued interest of $67,417 were
due. Since the convertible notes matured, $235,000 of principal has been
converted into 1,566,667 shares of Common Stock and the Company has not repaid
the remaining outstanding principal amount or accrued interest of the
convertible notes.





As of
September 30, 2008, the outstanding principal amount of the convertible notes
was $485,000, there was no unamortized warrant discount or embedded beneficial
conversion feature discount, and the number of outstanding warrants was
2,329,546.





For the
three and nine months ended June 30, 2009, interest expense was $4,984 and
$21,582, respectively, which was included in the other income (expense) section
of the statement of operations.





For the
three and nine months ended June 30, 2008, interest expense was $16,306 and
$59,972, amortization expense for the warrant discount was $84,909 and $298,262,
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 $117,174 and $412,154, which was also included
in interest expense in the other income (expense) section of the statement
of operations.





12%
SUBORDINATED CONVERTIBLE NOTES





On July
29, 2008, the Company completed an offering of $1,000,000 in principal amount of
Subordinated Debentures to a group of institutional and accredited investors.
 The 12% Subordinated Convertible Notes mature on July 29, 2009 or  
sooner if declared due and payable by the holder upon the occurrence of an event
of default, and bear interest at the rate of 12% per annum. The
Debentures


15


will be
convertible into Common Stock at a conversion price of $0.25 per share (the
“Conversion Price”) from and after such time as the authorized Common Stock is
increased in accordance with applicable federal and state laws. In the event of
an offering of Common Stock, or securities convertible into Common Stock, at a
price, conversion price or exercise price less than the conversion price (a
“dilutive issuance”), then the conversion price of any then outstanding
subordinated convertible notes will be reduced to equal such lower price, except
in connection with certain exempt issuances.  In an event of default,
the conversion price will be reduced to $0.15 per share. As part of the above
offering, the Company issued warrants to purchase 3,333,333 shares of Common
Stock, which expire five years from the date of grant, are exercisable at an
exercise price of $0.30 per share from and after such time as the authorized
Common Stock is increased in accordance with applicable federal and state laws,
and may be exercised on a cashless basis at the election of the
holder.  In the event of a dilutive issuance, the exercise price of
the warrants will be reduced to equal the price of the securities issued in the
dilutive issuance, except in connection with certain exempt
issuances.





The
requirement to increase the number of authorized shares of Common Stock is a
condition that has not occurred, is not certain to occur, and is outside the
control of the Company. Therefore, the Company has not recognized the related
beneficial conversion feature or the warrants related to these notes. If and
when this condition does occur, the Company will recognize the beneficial
conversion feature and warrants at fair value on the date the number of
authorized shares is increased. The note will be converted into 4,000,000 shares
of Common Stock at a conversion price of $0.25 per share. These shares were
excluded from the earnings per share calculation as the effect of dilutive
securities is anti-dilutive.





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





As of
June 30, 2009 and September 30, 2008, the principal outstanding totaled
$1,000,000.





For the
three and nine months ended June 30, 2009, interest expense was $29,918 and
$89,754, respectively.





Note
9 10% SUBORDINATED NOTES PAYABLE (RESTATED)





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





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





The grant
date fair value of the warrants was determined to be $125,462 which was
calculated using the Black-Sholes valuation model, using the following
assumptions: risk free rate of return of 2.64% to 3.26%, volatility of
97.08% to 98.27%, dividend yield of 0% and expected life of 6 years. As a
result, the relative fair value of the warrants was determined to be
$96,814.





On May
22, 2009, the Company entered into an amendment, exchange and waiver agreement
with each holder of the subordinated debentures. The terms of the agreement
included the waiver of any claim for default under Section 3.01(a) under the
original debentures, an exchange of the original debenture for a new debenture
equal to the outstanding principal and accrued interest through May 22, 2009,
and the amendment of the exercise price of all outstanding warrants from $0.40
to $0.175.





As of
June 30, 2009, the principal outstanding totaled $482,493, and there
was no unamortized warrant discount.





As of
September 30, 2008, the principal outstanding totaled $425,000, and
unamortized warrant discount was $24,204.





For the
three and nine months ended June 30, 2009, interest expense was $11,170 and
$32,370, respectively.





For the
three and nine months ended June 30, 2008, interest expense was $5,856 and
$14,795, respectively, and amortization expense for the warrant discount was
$24,204 and $48,408, respectively, which was included in interest expense in the
other income (expense) section of the statement of operations.





16


NOTE
10 WARRANT LIABILITY (RESTATED)





2001
Executive Officers Stock Option Plan





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





The fair value of the options was $789,912 as of June 30, 2009,
calculated using the Black-Scholes valuation model with the following
assumptions: risk free rate of return of 0.56%; volatility of 130.03%; dividend
yield of 0%; and expected term of 1.75 years.





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





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 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-Scholes 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 expected term of 5 years.





The fair
value of the warrants was determined to be $267,636 ($213,924 attributable to
the holders of the Convertible Notes 3 and $53,712 attributable to the placement
fee) as of June 30, 2009, which was calculated using the Black-Scholes
valuation model with the following assumptions: risk free rate of return of
0.56%; volatility of 130.03%; dividend yield of 0%; and expected term of
2.92 to 3.00 years.





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





Warrant
Issued to Legal Counsel





On
October 25, 2007, the Company entered into an agreement with its legal counsel
to issue 150,000 shares of Common Stock and 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.





The fair
value of the warrant was $32,394 at the date of issuance and was calculated
using the Black-Scholes valuation model with the following assumptions: risk
free interest rate of 3.93%, volatility of 116.99%, dividend yield of 0% and
expected term of 5 years.





17


The fair value of the warrant was determined to be $18,797 as of
June 30, 2009, using the Black-Scholes valuation model with the following
assumptions: risk free rate of return of 0.56%; volatility of 130.03%; dividend
yield of 0%; and expected term of 3.25 years.





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 fair
value of the warrants was $1,557,705 at the date of issuance and was calculated
using the Black-Scholes option valuation model with the following assumptions:
risk free interest rate of 3.22%, expected volatility of 99.86%, dividend yields
of 0% and expected term of 5 years.





The fair
value of the warrants was determined to be $1,103,629 as of June 30, 2009, using
the Black-Scholes valuation model with the following assumptions: risk free
rate of return of 0.56%; volatility of 130.03%; dividend yield of 0%;
and expected term of 3.42 years.





The fair
value of the warrants was determined to be $620,453 as of September 30, 2008,
using the Black-Scholes model with the following assumptions: risk free
rate of return of 1.78%; volatility of 84.94%; dividend yield of 0%;
and expected term of 4.17 years.





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





The fair
value of the option was determined to be $127,735 as of June 30, 2009, using the
Black-Scholes valuation model with the following assumptions: risk free
rate of return of 0.56%; volatility of 130.03%; dividend yield of 0%;
and expected term of 3.42 years.





The fair
value of the option was determined to be $71,812 as of September 30, 2008, using
the Black-Scholes model with the following assumptions: risk free rate of
return of 1.78%; volatility of 84.94%; dividend yield of 0%; and expected
term of 4.17 years.




18


Option Issued to Former 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 fair
value of the option was $171,520 at the date of issuance and was calculated
using the Black-Scholes option 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 fair
value of the option was determined to be $127,735 as of June 30, 2009, using the
Black-Scholes valuation model with the following assumptions: risk free
rate of return of 0.56%; volatility of 130.03%; dividend yield of 0%; and
expected term of 3.42 years.





The fair
value of the option was determined to be $71,812 as of September 30, 2008, using
the Black-Scholes model with the following assumptions: risk free rate of
return of 1.78%; volatility of 84.94%; dividend yield of 0%; and expected
term of 4.17 years.





Option
Issued to Former Chief Executive Officer





On
December 19, 2007, the Company entered into a one year Employment Agreement with
Richard H. Papalian pursuant to which Mr. Papalian had been appointed as the
Company’s Chief Executive Officer. As compensation for his services, the Company
granted Mr. Papalian a five year option to purchase up to 8,539,312 shares of
the Company’s Common Stock at an exercise price of $0.25 per share. As per the
terms of the stock option agreement, the right to purchase 340,000 shares of
Common Stock is not exercisable until the notes dated June 6, 2007 (Convertible
Notes 2 as discussed in Note 7 above) are eligible for conversion into shares of
Common Stock. These options were not issued from the 2001 Executive Officers
Stock Option Plan.   On August 14, 2008, Mr. Papalian resigned as the
Company’s Chief Executive Officer





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





The fair
value of the option was determined to be $374,713 as of June 30, 2009, using the
Black-Scholes valuation model with the following assumptions: risk free
rate of return of 0.56%; volatility of 130.03%; dividend yield of 0%; and
expected term of 3.42 years.





The fair
value of the option was determined to be $613,223 as of September 30, 2008,
using the Black-Scholes model with the following assumptions: risk free
rate of return of 1.78%; volatility of 84.94%; dividend yield of 0%; and
expected term of 4.17 years.





Warrant
Issued to Consultant





On
December 19, 2007, the Company entered into a one year Consulting Agreement with
Mark Maron pursuant to which Mr. Maron has been appointed as Special Adviser to
the Company. As compensation for his services, the Company granted Mr. Maron a
five year warrant to purchase up to 8,539,312 shares of the Company’s Common
Stock at an exercise price of $0.25 per share. As per the terms of the warrant
agreement, the right to purchase 340,000 shares of Common Stock is not
exercisable until the notes dated June 6, 2007 (Convertible Notes 2 as discussed
in Note 7 above) are eligible for conversion into shares of Common
Stock.  The warrant was not issued from the 2001 Executive
Officers Stock Option Plan.





19


The fair value of the warrant was $1,448,321 at the date of
issuance and was calculated using the Black-Scholes option 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 warrant was determined to be $1,090,768 as of June 30, 2009, using
the Black-Scholes valuation model with the following assumptions: risk free
rate of return of 0.56%; volatility of 130.03%; dividend yield of 0%;
and expected term of 3.42 years.





The fair
value of the warrant was determined to be $613,223 as of September 30, 2008,
using the Black-Scholes model with the following assumptions: risk free
rate of return of 1.78%; volatility of 84.94%; dividend yield of 0%;
and expected term of 4.17 years.





Warrants
Related to 10% Subordinated Debentures





In
January 2008, the Company completed an offering of $425,000 in principal amount
of Subordinated Debentures to a group of institutional and accredited
investors. As part of the above offering, the Company issued warrants to
purchase 850,000 shares of Common Stock at an exercise price of $0.40 per
share.





The fair
value of the warrants was determined to be $96,814 at the date of issuance,
which 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 life of six
years.





On May
22, 2009, the Company entered into an amendment, exchange and waiver agreement
with the holders of the warrants. Terms of the agreement included an amendment
of the exercise price to $0.175 per share.





The fair
value of the warrants was determined to be $96,395 as of June 30, 2009, using
the Black-Scholes valuation model with the following assumptions: risk free
rate of return of 0.56%; volatility of 130.03%; dividend yield of 0%;
and expected term of 4.58 years.





The fair
value of the warrants was determined to be $52,609 as of September 30, 2008,
using the Black-Scholes model with the following assumptions: risk free
rate of return of 1.78%; volatility of 84.94%; dividend yield of 0%;
and expected term of 5.33 years.





Warrants
Related to $750,000 Stock Issuance





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





The fair value of the warrants was determined to be $483,476 at
the date of issuance, which was calculated using the Black-Scholes valuation
model, using the following assumptions: risk free rate of return of 1.32% to
2.17%, volatility of 72.4% to 77.86%, dividend yield of 0%, and expected term of
3 years.





The fair
value of the warrants was determined to be $536,066 as of June 30, 2009, using
the Black-Scholes valuation model with the following assumptions: risk free
rate of return of 0.56%; volatility of 130.03%; dividend yield of 0%;
and expected term of 1.67 to 1.83 years.





20


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.





The fair
value of the warrant was $60,645 at the date of issuance and was calculated
using the Black-Scholes valuation model with the following assumptions: risk
free interest rate of 2.36%, expected volatility of 74.90%, dividend yields of
0% and expected term of 6 years.





The fair
value of the warrant was determined to be $60,461 as of June 30, 2009, using the
Black-Scholes valuation model with the following assumptions: risk free
rate of return of 0.56%; volatility of 130.03%; dividend yield of 0%;
and expected term of 4.92 years.





The fair
value of the warrant was determined to be $38,802 as of September 30, 2008,
using the Black-Scholes model with the following assumptions: risk free
rate of return of 1.78%; volatility of 84.94%; dividend yield of 0%;
and expected term of 5.75 years.





Warrant
Issued to Director (John Pavia)





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





The fair
value of the warrant was $51,582 at the date of issuance and was calculated
using the Black-Scholes valuation model with the following assumptions: risk
free interest rate of 2.30%, expected volatility of 71.69%, dividend yield of 0%
and expected term of 5 years.





The fair
value of the warrant was determined to be $67,589 as of June 30, 2009, using the
Black-Scholes valuation model with the following assumptions: risk free
rate of return of 0.56%; volatility of 130.03%; dividend yield of 0%; and
expected term of 4.00 years.





The fair
value of the warrant was determined to be $38,759 as of September 30, 2008,
using the Black-Scholes model with the following assumptions: risk free
rate of 1.78%; volatility of 84.94%; dividend yield of 0%; and expected term
of 4.75 years.





Warrant Issued to Director (Marcus Woods)





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





The fair
value of the warrant was $51,582 at the date of issuance and was calculated
using the Black-Scholes valuation model with the following assumptions: risk
free interest rate of 2.30%, expected volatility of 71.69%, dividend yield of 0%
and expected term of 5 years.





The fair
value of the warrant was determined to be $67,589 as of June 30, 2009, using the
Black-Scholes valuation model with the following assumptions: risk free
rate of return of 0.56%; volatility of 130.03%; dividend yield of 0%;
and expected term of 4.00 years.


21





The fair
value of the warrant was determined to be $38,759 as of September 30, 2008,
using the Black-Scholes model with the following assumptions: risk free
rate of return of 1.78%; volatility of 84.94%; dividend yield of 0%;
and expected term of 4.75 years.





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.





The fair
value of the warrant was $82,779 at the date of issuance and was calculated
using the Black-Scholes valuation model with the following assumptions: risk
free interest rate of 2.27%, expected volatility of 70.18%, dividend yield of 0%
and expected term of 6 years.





The fair
value of the warrant was determined to be $97,241 as of June 30, 2009, using the
Black-Scholes valuation model with the following assumptions: risk free
rate of return of 0.56%; volatility of 130.03%; dividend yield of 0%; and
expected term of 5.00 years.





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





Warrant
Issued to Advisory Board Member





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





The fair
value of the warrant was $144,641 at the date of issuance and was calculated
using the Black-Scholes valuation model with the following assumptions: risk
free interest rate of 2.01%, expected volatility of 78.92%, dividend yield of 0%
and expected term of 5 years.





The fair
value of the warrant was determined to be $205,571 as of June 30, 2009, using
the Black-Scholes valuation model with the following assumptions: risk free
rate of return of 0.56%; volatility of 130.03%; dividend yield of 0%; and
expected term of 4.17 years.





The fair
value of the warrant was determined to be $118,551 as of September 30, 2008,
using the Black-Scholes model with the following assumptions: risk free
rate of return of 1.78%; volatility of 84.94%; dividend yield of 0%;
and expected term of 4.83 years.





Option Issued to Former Chief Executive Officer





On
November 11, 2008 the Company’s Board of Directors approved the issuance to the
Chief Executive Officer of a five year option to purchase a total of 3,500,000
shares of the Company’s common stock at an exercise price of $0.15 per
share.





The fair
value of the option was $238,244 at the date of issuance, which was calculated
using the Black-Scholes valuation model with the following assumptions:
risk free rate of return of 1.16%; volatility of 89.31%; dividend yield of 0%;
and expected term of 5 years.





22


The fair
value of the option was determined to be $485,854 as of June 30, 2009, using the
Black-Scholes valuation model with the following assumptions: risk free
rate of return of 0.56%; volatility of 130.03%; dividend yield of 0%; and
expected term of 4.33 years.





Option
Issued to Director (Rodney Anderson)





On March
30, 2009 the Company issued an option to a director to purchase a total of
1,380,114 shares of the Company’s common stock at an exercise price of $0.15 per
share. The right to purchase 690,057 shares of Common Stock vested on the date
of grant and the right to purchase 172,514 shares of Common Stock vests on June
30, September 30, December 31, 2009 and March 31, 2010,
respectively.





The fair
value of the vested options was $41,847 at the date of issuance, which was
calculated using the Black-Scholes valuation model with the following
assumptions: risk free rate of return of 0.58%; volatility of 109.22%; dividend
yield of 0%; and expected term of 5 years.





The fair
value of the vested options was determined to be $128,884 as of June 30, 2009,
using the Black-Scholes valuation model with the following assumptions:
risk free rate of return of 0.56%; volatility of 130.03%; dividend yield of 0%;
and expected term of 4.67 years.





Option
Issued to interim Chief Financial Officer (Robert Hasson)





On March
30, 2009 the Company issued an option to the interim Chief Financial Officer to
purchase a total of 958,412 shares of the Company’s common stock at an exercise
price of $0.15 per share. The right to purchase 479,206 shares of Common Stock
vested on the date of grant and the right to purchase 119,802 shares of Common
Stock vests on June 30, September 30, December 31, 2009 and March 31, 2010,
respectively.





The fair
value of the vested options was $29,060 at the date of issuance, which was
calculated using the Black-Scholes valuation model with the following
assumptions: risk free rate of return of 0.58%; volatility of 109.22%; dividend
yield of 0%; and expected term of 5 years.





The fair
value of the vested options was determined to be $89,503 as of June 30, 2009,
using the Black-Scholes valuation model with the following assumptions:
risk free rate of return of 0.56%; volatility of 130.03%; dividend yield of 0%;
and expected term of 4.67 years.





Option
Issued to Employee





On March
30, 2009 the Company issued an option to an employee to purchase a total of
1,495,124 shares of the Company’s common stock at an exercise price of $0.15 per
share. The right to purchase 747,562 shares of Common Stock vested on the date
of grant and the right to purchase 186,891 shares of Common Stock vests on June
30, September 30, December 31, 2009 and March 31, 2010,
respectively.





The fair value of the vested options was $45,334 at the date of
issuance, which was calculated using the Black-Scholes valuation model with
the following assumptions: risk free rate of return of 0.58%; volatility of
109.22%; dividend yield of 0%; and expected term of 5
years.





The fair
value of the vested options was determined to be $139,624 as of June 30, 2009,
using the Black-Scholes valuation model with the following assumptions:
risk free rate of return of 0.56%; volatility of 130.03%; dividend yield of 0%;
and expected term of 4.67 years.





23


NOTE
10 BENEFICIAL CONVERSION FEATURES LIABILITY





The
Company issued convertible notes between October 17, 2006 and July 17, 2007 that
matured 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 fair
value of the embedded beneficial conversion features was $1,430,811 at the date
of issuance using the Black-Scholes 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.





The fair
value of the embedded beneficial conversion features was $26,000 as of September
30, 2008, which was calculated using the Black-Scholes model with the following
assumptions: risk free rate of return of 1.78%; volatility of 84.94%; dividend
yield of 0% and expected term of .25.





NOTE
11 STOCKHOLDERS’ EQUITY (RESTATED)





COMMON
STOCK





The
Company has 150,000,000 authorized shares of Common Stock, par value $0.001 per
share.  As of June 30, 2009 the Company had 144,459,104 and
143,977,204 shares issued and outstanding, respectively. At September 30, 2008,
the Company had 134,756,213 and 134,274,313 shares issued and outstanding,
respectively. As of June 30, 2009 and September 30, 2009, there are 481,900
shares of Common Stock subject to cancellation. Subsequent to cancellation, the
total issued and outstanding shares of Common Stock would be 143,977,204 and
134,274,313 as of June 30, 2009 and September 30, 2008,
respectively.





During
the nine months ended June 30, 2009 the Company issued 7,169,419 shares of
Common Stock for the payment of $283,000 of debt, $67,942 of accrued interest,
$28,400 of late fees and penalties and $75,000 of liquidated damages at
conversion prices between $0.04 and $0.15. The Company received $5,000 in cash
from a related party note holder and also settled his debt of $7,000 and accrued
interest of $1,816 by issuing him 500,000 shares. Additionally, the Company
issued 833,333 shares of common stock for $125,000 for machinery and equipment
from RJ Metal Co. Lastly, the Company issued 1,200,139 shares of Common Stock to
legal counsel for services having a value of $180,014.  The fair value
of the Common Stock on the date of issuance was $226,229.





The
Company has not issued 13,333 shares of Common Stock representing $400 to
certain investors pursuant to the terms of an offering undertaken by the Company
in 2004. The investment was made and funds deposited into the Company’s bank
accounts between February 9, 2004, and August 25, 2004.  The
investment has been recorded on the Company’s balance sheet in the Stockholders’
Deficit section as “Shares to be Issued.”





24


STOCK
OPTIONS





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







WeightedAverage
            
            
            
            
            
            AggregateExercise
            
            
            Number
            
            
            IntrinsicPrice
            
            
            of
      Options
            
            
            ValueOutstanding
      at October 1, 2008
            
            $
            0.19
            
            
            
            17,573,452
            
            
            $
            -Granted
            
            
            0.15
            
            
            
            7,333,650
            
            
            
            -Expired
            
            
            0.25
            
            
            
            (5,605,786)
            
            
            
            -Forfeited
            
            
            -
            
            
            
            -
            
            
            
            -Exercised
            
            
            -
            
            
            
            -
            
            
            
            -Outstanding
      at June 30, 2009
            
            $
            0.19
            
            
            
            19,301,316
            
            
            $
            271,695


Options
outstanding as of June 30, 2009:





WeightedAverageRemaining
            Weighted
      AverageExercise
            Options
            Options
            Contractual
            Exercise
      PricePrice
            Outstanding
            Exercisable
            Life
            Outstanding Exercisable$0.15
      - $0.25
            19,301,316
            17,863,698
            3.85
            $0.18
            
            $0.18





STOCK
WARRANTS





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








WeightedAverage
            
            
            
            
            
            AggregateExercise
            
            
            Number
            
            
            IntrinsicPrice
            
            
            of
      Options
            
            
            ValueOutstanding
      at October 1, 2008
            
            $
            0.20
            
            
            
            42,849,099
            
            
            $
            -Granted
            
            
            -
            
            
            
            -
            
            
            
            -Expired
            
            
            -
            
            
            
            -
            
            
            
            -Forfeited
            
            
            -
            
            
            
            -
            
            
            
            -Exercised
            
            
            -
            
            
            
            -
            
            
            
            -Outstanding
      at June 30, 2009
            
            $
            0.20
            
            
            
            42,849,099
            
            
            $
            -





Warrants
outstanding as of June 30, 2009:





WeightedAverageRemaining
            Weighted
      AverageExercise
            Warrants
            Options
            Contractual
            Exercise
      PricePrice
            Outstanding
            Exercisable
            Life
            Outstanding
      Exercisable$0.10
      - $0.30
            42,849,099
            39,515,766
            3.78
            $0.20
            
            $0.19





25





NOTE
12 GOING CONCERN





The
accompanying financial statements have been prepared assuming that the Company
will continue as a going concern. This basis of accounting contemplates the
recovery of the Company’s assets and the satisfaction of its liabilities in the
normal course of business. Through June 30, 2009, the Company has incurred
cumulative losses of $39,526,666 including net loss for the nine months ended
June 30, 2009 of $5,611,931. As the Company has no cash flow from
operations, its ability to transition from a development stage company
to an operating company is entirely dependent upon obtaining adequate cash to
finance its overhead, research and development activities, and acquisition of
production equipment. It is unknown when, if ever, the Company will achieve a
level of revenues adequate to support its costs and expenses. In order for the
Company to meet its basic financial obligations, including rent, salaries, debt
service and operations, it plans to seek additional equity or debt financing.
Because of the Company’s history and current debt levels, there is considerable
doubt that the Company will be able to obtain financing. The Company’s ability
to meet its cash requirements for the next twelve months depends on its ability
to obtain such financing. Even if financing is obtained, any such financing will
likely involve additional fees and debt service requirements which may
significantly reduce the amount of cash we will have for our operations.
Accordingly, there is no assurance that the Company will be able to implement
its plans.





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





As
mentioned in Notes 7 and 8, the Company has convertible notes and subordinated
notes payable that have matured. The Company is in the process of renegotiating
the terms of the notes with the note holders to extend the maturity date. If the
Company is unsuccessful in extending the maturity date, the Company may not be
able to continue as a going concern.





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





NOTE
13 COMMITMENTS





Operating
Lease





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





For
      the Fiscal Year Ended September 30,2009
            
            $
            52,5902010
            
            
            108,6602011
            
            
            93,550





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





Issuance of Shares of Common
Stock for Services





On June
10, 2009, the Company entered into an agreement to convert $120,000 of
outstanding legal fees into a total of 600,000 shares of Common Stock. However,
if the average closing price of the Common Stock is $0.15 or less for the 10
trading days preceding December 10, 2009, the Company is required to issue an
additional 200,000 shares of Common Stock.


26





NOTE
14 SUPPLEMENTAL CASH FLOW INFORMATION





The
Company had the following noncash transactions.
 
 The
Company issued 7,169,419 shares of Common Stock for the payment of $283,000 of
debt, $67,942 of accrued interest, $28,400 of late fees and penalties and
$75,000 of liquidated damages at conversion prices between $0.04 and
$0.15.
 
 The
Company issued 500,000 shares for the settlement of outstanding debt due to a
related party of $7,000 in principal and accrued interest of $1,816 and received
$5,000 in cash.
 
 The
Company issued 833,333 shares of Common Stock for the purchase of machinery and
equipment from RJ Metal, Co. having a value of $125,000.
 
 The
Company issued 1,200,139 shares of Common Stock for legal services having a
value of $180,014.  The fair value of the Common Stock on the date of
issuance was $226,229.
  NOTE
15 SUBSEQUENT EVENT





The
Company considered all subsequent events through August 14, 2009, and the date
of issuance is August 17, 2009.





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





On July
22, 2009, the Company received $65,000 for the issuance of a total of 650,000
shares of Common Stock as a result of a warrant that was exercised at $0.10 per
share.





NOTE
16 RESTATEMENT





The
Company restated its September 30, 2007 financial statements in response to a
comment letter from the Securities and Exchange Commission.  However,
the restatement did not properly account for certain derivative transactions
and, as discussed below, the Company restated its September 30, 2007 financial
statements for a third time, restated its September 30, 2008 financial
statements, and restated financial statements for the interim periods that
followed September 30, 2007 and September 30, 2008, through June 30,
2009.


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


On June
6, 2007, the Company issued 5 convertible promissory notes for a total of
$86,000 (“Convertible Notes 2”).  No warrants were issued in
connection with Convertible Notes 2. Convertible Notes 2 mature on June 30,
2009, and are convertible into common stock at $0.01 per share.





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





·
            Warrants
      and Options


·
            Beneficial
      Conversion Features





The
Company analyzed the effect of the recalculation on the balance sheet and the
statements of operations and cash flows as of June 30, 2009. The analysis and
results were as follows:





Warrants and Options
Liability





As of
June 30, 2009, the Company had 39,515,766 warrants and 17,863,698 options
outstanding that vested at that date.





27


Balance
Sheet





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





At June
30, 2009, the Company determined the fair value of all warrants and options to
be $5,945,787 and $2,654,619, respectively, using the Black-Scholes model with
the following assumptions:





·
            risk
      free rate of return between 0.56% and
2.54%;


·
            volatility
      between 154% and 240%;


·
            dividend
      yield of 0%; and


·
            expected
      term between 1.81 years and 4.99
years.





Statement
of Operations





For the
three months ended June 30, 2009, the Company recorded a loss on change in fair
value of warrant and option liability of $809,220 and for the nine months ended
June 30, 2009, the Company recorded $680,973 as a gain on change in fair value
of warrant and option liability.





Statement
of Cash Flows





Changes
in the statement of cash flows were the result of the decrease in fair value of
the warrant and option liability of $680,973.





Beneficial Conversion
Liability





As of
September 30, 2007, the Company had $761,333 in convertible notes that could be
converted into 65,905,310 shares. During the period ended June 30, 2009, certain
investors converted $35,429 of convertibles note into 885,728 common shares at
$0.04 per share; however, the conversion rate should have been
$0.01.  At June 30, 2009, the Company owes an additional 14,020,575
shares to the investors related to the $35,429 converted during the period ended
June 30, 2009 and the $151,512 converted during the period ended September 30,
2008.  The Company recorded a liability of $2,383,498, which is
recorded in accrued expenses in the accompanying financial
statements.  The change in the fair value of the shares was recorded
as a change in fair value of beneficial conversion liability.





Balance
Sheet





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





At June
30, 2009, the Company determined the fair value of the embedded conversion
options to be $10,437,445 using the Black-Scholes model with the following
assumptions:





·
            risk
      free rate of return of 0.35%;


·
            volatility
      between of 168%;


·
            dividend
      yield of 0%; and


·
            expected
      term of 0.50 years.





Statement
of Operations





For the
three and six months ended June 30, 2009, the Company recorded $7,110,677 and
$2,358,055, respectively, as a loss on change in fair value of warrant and
option liability.





Statement
of Cash Flows





Changes
in the statement of cash flows were the result of the $2,358,055 change in fair
value of the beneficial conversion liability.


28


The
following table shows the effect of each of the changes discussed above on the
Company’s balance sheet, statement of operation, and statement of cash flows for
the three and nine months ended June 30, 2009.





As
      Previously Stated
            
            
            Beneficial
      Conversion Feature
            
            
            Warrants
      and Options
            
            
            Reclassifications
            
            
            As
      Restated June 30, 2009Balance
      SheetOther
      assets
            
            $
            28,665
            
            
            $
            -
            
            
            $
            -
            
            
            $
            155,000
            
            
            $
            183,665Accrued
      expenses
            
            
            2,739,329
            
            
            
            2,383,498
            
            
            
            -
            
            
            
            155,000
            
            
            
            5,277,827Warrant
      and option liability
            
            
            5,875,700
            
            
            
            -
            
            
            
            2,724,706
            
            
            
            -
            
            
            
            8,600,406Beneficial
      conversion liability
            
            
            -
            
            
            
            10,437,445
            
            
            
            -
            
            
            
            -
            
            
            
            10,437,445Additional
      paid-in capital
            
            
            13,514,364
            
            
            
            -
            
            
            
            (1,847,488
            )
            
            
            -
            
            
            
            11,666,876Deficit
      accumulated during developmental stage
            
            
            (25,828,505
            )
            
            
            (12,820,943
            )
            
            
            (877,218
            )
            
            
            -
            
            
            
            (39,526,666
            )Statement
      of Operations (for the three months ended June 30, 2009)Gain
      (loss) on change in fair value of warrant and option
    liability
            
            $
            (3,623,669
            )
            
            $
            -
            
            
            $
            (809,220
            )
            
            $
            -
            
            
            $
            (4,432,889
            )Gain
      (loss) on change in fair value of beneficial conversion
      liability
            
            
            -
            
            
            
            (7,100,677
            )
            
            
            -
            
            
            
            -
            
            
            
            (7,100,677
            )Statement
      of Operations (for the nine months ended June 30, 2009)Gain
      (loss) on change in fair value of warrant and option
    liability
            
            $
            (1,992,282
            )
            
            $
            -
            
            
            $
            680,973
            
            
            $
            -
            
            
            $
            (1,311,309
            )Gain
      (loss) on change in fair value of beneficial conversion
      liability
            
            
            26,000
            
            
            
            (2,358,055
            )
            
            
            -
            
            
            
            -
            
            
            
            (2,332,055
            )Statement
      of Operations (since inception)Gain
      on change in fair value of warrant and option liability
            
            $
            3,225,958
            
            
            $
            -
            
            
            $
            (292,754
            )
            
            $
            -
            
            
            $
            2,933,204Gain
      on change in fair value of beneficial conversion liability
            
            
            1,426,767
            
            
            
            21,899,975
            
            
            
            -
            
            
            
            -
            
            
            
            23,326,742General
      and administrative expense
            
            
            21,919,482
            
            
            
            3,787,032
            
            
            
            83,855
            
            
            
            -
            
            
            
            25,790,369Interest
      expense and financing costs
            
            
            (2,521,065
            )
            
            
            (30,536,702
            )
            
            
            (897,793
            )
            
            
            -
            
            
            
            (33,955,560
            )Statement
      of Cash Flows (for the nine months ended June 30, 2009)Net
      income (loss)
            
            $
            (3,934,849
            )
            
            $
            (2,358,055
            )
            
            $
            680,973
            
            
            $
            -
            
            
            $
            (5,611,931
            )(Gain)
      loss on change in fair value of warrant and option
    liability
            
            
            2,000,811
            
            
            
            -
            
            
            
            (680,973
            )
            
            
            -
            
            
            
            1,319,838(Gain)
      loss on change in fair value of beneficial conversion
      liability
            
            
            (26,000
            )
            
            
            2,358,055
            
            
            
            -
            
            
            
            
            
            
            
            2,332,055Statement
      of Cash Flows (since inception)Net
      income (loss)
            
            $
            (25,828,505
            )
            
            $
            (12,423,759
            )
            
            $
            (1,274,402
            )
            
            $
            -
            
            
            $
            (39,526,666
            )(Gain)
      loss on change in fair value of warrant and option
    liability
            
            
            (3,217,429
            )
            
            
            -
            
            
            
            292,754
            
            
            
            -
            
            
            
            (2,924,675
            )Gain
      on change in fair value of beneficial conversion liability
            
            
            (1,426,768
            )
            
            
            (21,899,975
            )
            
            
            -
            
            
            
            -
            
            
            
            (23,326,743
            )Non-cash
      compensation expense
            
            
            -
            
            
            
            3,787,032
            
            
            
            83,855
            
            
            
            -
            
            
            
            3,870,887Non-cash
      financing costs
            
            
            -
            
            
            
            30,536,702
            
            
            
            897,793
            
            
            
            -
            
            
            
            31,434,495

















29


Part
I, Item 2.  Management’s Discussion and Analysis of Financial
Condition and Results of Operations.





The
information in this quarterly report on Form 10-Q contains forward-looking
statements.  These forward-looking statements involve risks and
uncertainties, including statements regarding our capital needs, business
strategy and expectations.  Any statements contained in this report
that are not statements of historical facts may be deemed to be forward-looking
statements.  In some cases, you can identify forward-looking
statements by terminology such as may, will, should, expect, plan, intend,
anticipate, believe, estimate, predict, potential or continue, the negative of
such terms or other comparable terminology.  Actual events or results
may differ materially from those events or results included in the
forward-looking statements.  In evaluating these statements, you
should consider various factors, including the risks outlined from time to time
in the reports we file with the Securities and Exchange
Commission.  Some, but not all, of these risks include, among other
things:





·
            our
      inability to obtain the financing we need to continue our
      operations;


·
            changes
      in regulatory requirements that adversely affect our
    business;


·
            loss
      of our key personnel; and


·
            risks
      over which we have no control, such as the general global downturn in the
      economy which may adversely affect spending by government
      agencies.





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


30








Overview





The
Company is based in Anaheim, California.  Its business is the design,
development and marketing of automatic water filtration systems primarily for
small water districts.  The Company received an order for two water
filtration systems in June, 2008.  The Company anticipates that the
water treatment systems will be manufactured and delivered within the next few
months. Subsequent to the delivery of the water treatment systems, revenue will
be recognized and the Company will no longer meet the definition of a
development stage company.





Until
additional orders and customer deposits are received, we anticipate that most of
our capital needs will need to be funded by debt or equity
financing.  To date we have not earned revenue.





Application
of Critical Accounting Policies and Estimates





The
preparation of our financial statements in accordance with U.S. GAAP requires
management to make judgments, assumptions and estimates that affect the amounts
reported. A critical accounting estimate is an assumption about highly uncertain
matters and could have a material effect on the consolidated financial
statements if another, also reasonable, amount were used or a change in the
estimate is reasonably likely from period to period. We base our assumptions on
historical experience and on other estimates that we believe are reasonable
under the circumstances. Actual results could differ significantly from these
estimates. There were no changes in accounting policies or significant changes
in accounting estimates during the three and nine months ended June 30
2009. Management believes the following critical accounting policies reflect its
more significant estimates and assumptions.





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


31





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





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





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







Restatement
for the Three and Nine Months Ended June 30, 2009





The
Company restated its September 30, 2007 financial statements in response to a
comment letter from the Securities and Exchange Commission.  However,
the restatement did not properly account for certain derivative transactions
and, as discussed below, the Company restated its September 30, 2007 financial
statements for a third time, restated its September 30, 2008 financial
statements and restated the interim periods following September 30, 2007 and
September 30, 2008, through June 30, 2009.
  The
Company issued 25 secured convertible promissory notes between October 17, 2006
and February 27, 2007 for total proceeds to the Company of $750,000
(“Convertible Notes 1”). Convertible Notes 1 could be converted into shares of
the Company’s common stock at a conversion price of $0.05 per share. Convertible
Notes 1 contained a provision that would automatically adjust the conversion
price if equity securities or instruments convertible into equity securities
were issued at a conversion price less than $0.05.


On June
6, 2007, the Company issued 5 convertible promissory notes for a total of
$86,000 (“Convertible Notes 2”).  No warrants were issued in
connection with Convertible Notes 2. Convertible Notes 2 mature on June 30,
2009, and are convertible into common stock at $0.01 per
share.





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





·
            Warrants
      and Options


·
            Beneficial
      Conversion Features





The
Company analyzed the effect of the recalculation on the balance sheet and the
statements of operations and cash flows as of June 30, 2009. The analysis and
results were as follows:





Warrants and Options
Liability





As of
June 30, 2009, the Company had 39,515,766 warrants and 17,863,698 options
outstanding that vested at that date.





Balance
Sheet


32


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





At June
30, 2009, the Company determined the fair value of all warrants and options to
be $5,945,787 and $2,654,619, respectively, using the Black-Scholes model with
the following assumptions:





·
            risk
      free rate of return between 0.56% and
2.54%;


·
            volatility
      between 154% and 240%;


·
            dividend
      yield of 0%; and


·
            expected
      term between 1.81 years and 4.99
years.





Statement
of Operations





For the
three months ended June 30, 2009, the Company recorded a loss on change in fair
value of warrant and option liability of $809,220 and for the nine months ended
June 30, 2009, the Company recorded $680,973 as a gain on change in fair value
of warrant and option liability.





Statement
of Cash Flows





Changes
in the statement of cash flows were the result of the decrease in fair value of
the warrant and option liability of $680,973.





Beneficial Conversion
Liability





As of
September 30, 2007, the Company had $761,333 in convertible notes that could be
converted into 65,905,310 shares. During the period ended June 30, 2009, certain
investors converted $35,429 of convertibles note into 885,728 common shares at
$0.04 per share; however, the conversion rate should have been
$0.01.  At June 30, 2009, the Company owes an additional 14,020,575
shares to the investors related to the $35,429 converted during the period ended
June 30, 2009 and the $151,512 converted during the period ended September 30,
2008.  The Company recorded a liability of $2,383,498, which is
recorded in accrued expenses in the accompanying financial
statements.  The change in the fair value of the shares will be
recorded as a change in fair value of beneficial conversion
liability.





Balance
Sheet





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





At June
30, 2009, the Company determined the fair value of the embedded conversion
options to be $10,437,445 using the Black-Scholes model with the following
assumptions:





·
            risk
      free rate of return of 0.35%;


·
            volatility
      between of 168%;


·
            dividend
      yield of 0%; and


·
            expected
      term of 0.50 years.





Statement
of Operations





For the
three and six months ended June 30, 2009, the Company recorded $7,110,677 and
$2,358,055, respectively, as a loss on change in fair value of warrant and
option liability.





Statement
of Cash Flows





Changes
in the statement of cash flows were the result of the $2,358,055 change in fair
value of the beneficial conversion liability.


33


The
following table shows the effect of each of the changes discussed above on the
Company’s balance sheet, statement of operation, and statement of cash flows for
the three and nine months ended June 30, 2009.





As
      Previously Stated
            
            
            Beneficial
      Conversion Feature
            
            
            Warrants
      and Options
            
            
            Reclassifications
            
            
            As
      Restated June 30, 2009Balance
      SheetOther
      assets
            
            $
            28,665
            
            
            $
            -
            
            
            $
            -
            
            
            $
            155,000
            
            
            $
            183,665Accrued
      expenses
            
            
            2,739,329
            
            
            
            2,383,498
            
            
            
            -
            
            
            
            155,000
            
            
            
            5,277,827Warrant
      and option liability
            
            
            5,875,700
            
            
            
            -
            
            
            
            2,724,706
            
            
            
            -
            
            
            
            8,600,406Beneficial
      conversion liability
            
            
            -
            
            
            
            10,437,445
            
            
            
            -
            
            
            
            -
            
            
            
            10,437,445Additional
      paid-in capital
            
            
            13,514,364
            
            
            
            -
            
            
            
            (1,847,488
            )
            
            
            -
            
            
            
            11,666,876Deficit
      accumulated during developmental stage
            
            
            (25,828,505
            )
            
            
            (12,820,943
            )
            
            
            (877,218
            )
            
            
            -
            
            
            
            (39,526,666
            )Statement
      of Operations (for the three months ended June 30, 2009)Gain
      (loss) on change in fair value of warrant and option
    liability
            
            $
            (3,623,669
            )
            
            $
            -
            
            
            $
            (809,220
            )
            
            $
            -
            
            
            $
            (4,432,889
            )Gain
      (loss) on change in fair value of beneficial conversion
      liability
            
            
            -
            
            
            
            (7,100,677
            )
            
            
            -
            
            
            
            -
            
            
            
            (7,100,677
            )Statement
      of Operations (for the nine months ended June 30, 2009)Gain
      (loss) on change in fair value of warrant and option
    liability
            
            $
            (1,992,282
            )
            
            $
            -
            
            
            $
            680,973
            
            
            $
            -
            
            
            $
            (1,311,309
            )Gain
      (loss) on change in fair value of beneficial conversion
      liability
            
            
            26,000
            
            
            
            (2,358,055
            )
            
            
            -
            
            
            
            -
            
            
            
            (2,332,055
            )Statement
      of Operations (since inception)Gain
      on change in fair value of warrant and option liability
            
            $
            3,225,958
            
            
            $
            -
            
            
            $
            (292,754
            )
            
            $
            -
            
            
            $
            2,933,204Gain
      on change in fair value of beneficial conversion liability
            
            
            1,426,767
            
            
            
            21,899,975
            
            
            
            -
            
            
            
            -
            
            
            
            23,326,742General
      and administrative expense
            
            
            21,919,482
            
            
            
            3,787,032
            
            
            
            83,855
            
            
            
            -
            
            
            
            25,790,369Interest
      expense and financing costs
            
            
            (2,521,065
            )
            
            
            (30,536,702
            )
            
            
            (897,793
            )
            
            
            -
            
            
            
            (33,955,560
            )Statement
      of Cash Flows (for the nine months ended June 30, 2009)Net
      income (loss)
            
            $
            (3,934,849
            )
            
            $
            (2,358,055
            )
            
            $
            680,973
            
            
            $
            -
            
            
            $
            (5,611,931
            )(Gain)
      loss on change in fair value of warrant and option
    liability
            
            
            2,000,811
            
            
            
            -
            
            
            
            (680,973
            )
            
            
            -
            
            
            
            1,319,838(Gain)
      loss on change in fair value of beneficial conversion
      liability
            
            
            (26,000
            )
            
            
            2,358,055
            
            
            
            -
            
            
            
            
            
            
            
            2,332,055Statement
      of Cash Flows (since inception)Net
      income (loss)
            
            $
            (25,828,505
            )
            
            $
            (12,423,759
            )
            
            $
            (1,274,402
            )
            
            $
            -
            
            
            $
            (39,526,666
            )(Gain)
      loss on change in fair value of warrant and option
    liability
            
            
            (3,217,429
            )
            
            
            -
            
            
            
            292,754
            
            
            
            -
            
            
            
            (2,924,675
            )Gain
      on change in fair value of beneficial conversion liability
            
            
            (1,426,768
            )
            
            
            (21,899,975
            )
            
            
            -
            
            
            
            -
            
            
            
            (23,326,743
            )Non-cash
      compensation expense
            
            
            -
            
            
            
            3,787,032
            
            
            
            83,855
            
            
            
            -
            
            
            
            3,870,887Non-cash
      financing costs
            
            
            -
            
            
            
            30,536,702
            
            
            
            897,793
            
            
            
            -
            
            
            
            31,434,495








Results
of Operations





Three
Months Ended June 30, 2009 Compared To Three Months Ended June 30,
2008





Revenues
for the three months ended June 30, 2009 and 2008 were zero.  Although
we received an order and deposit for two water treatment systems during the 2009
fiscal year, revenue from this order has not been recognized because the units
have not been completed and delivered. The Company incurred operating expenses
of $412,080 during the three months ended June 30, 2009, a decrease of $595,606
or approximately 59%, as compared to $1,007,686 for the three months ended June
30, 2008.  General and administrative expenses were $179,219 during
the three months ended June 30, 2009, a decrease of $539,338 or approximately
75%, as compared to $718,557 for the three months ended June 30,
2008.  The decrease in general and administrative expenses contributed
to the significant decrease in operating expenses. Research and development
expenses were $210,561 during the three months ended June 30, 2009, a decrease
of $70,411 or approximately 25%, as compared to $280,972 for the three months
ended June 30, 2008.  The decrease in research and development
expenses resulted primarily from the reallocation of personnel for the design of
the two water treatment systems ordered during the 2009 fiscal
year.


34





Other
income (expense) totaled ($11,577,187) during the three months ended June 30,
2009, an increase of $4,050,438 or approximately 54%, as compared to $7,526,749
for the three months ended June 30, 2008. The Company earned interest income of
$2 during the three months ended June 30, 2009, a decrease of $1,562 or 100%, as
compared to $1,564 during the three months ended June 30, 2008.  The
Company incurred interest expense of $63,423 during the three months ended June
30, 2009, a decrease of $250,273 or approximately 80%, as compared to $313,696
for the three months ended June 30, 2008. The significant interest expense we
incurred during the three months ended June 30, 2008 was due primarily to the
amortization of the beneficial conversion features discount and warrant discount
of the convertible debt securities, while during the three months ended June 30,
2009 there was a decrease in outstanding debt principal, which resulted in lower
interest expenses. The gain (loss) in fair value of warrant and option liability
was ($4,432,889) during the three months ended June 30, 2009, an increase of
$2,000,946 or approximately 82%, as compared to ($2,431,943) during the three
months ended June 30, 2008. The increase in the loss in fair value of
warrant and option liability was due to the increase in the trading price of our
Common Stock, resulting in a higher Black-Scholes valuation model valuation
calculation of the warrant liability.  The gain (loss) in fair value
of beneficial conversion liability was ($7,100,677) during the three months
ended June 30, 2009, an increase of $2,313,852 or approximately 48%, as compared
to ($4,786,825) for the three months ended June 30, 2008. The increase in the
loss in fair value of beneficial conversion liability was due to the increase in
the trading price of our Common Stock, resulting in a higher Black-Scholes
valuation model valuation calculation of the warrant liability.





As a
result of these items, net loss for the three months ended June 30, 2009 was
$11,994,067, an increase of $3,459,632 or approximately 41% over the net
loss of $8,534,435 for the three months ended June 30, 2008.





Nine
Months Ended June 30, 2009 Compared To Nine Months Ended June 30,
2008





Revenues
for the nine months ended June 30, 2009 and 2008 were zero.  Although
we received an order and deposit for two water treatment systems during the 2008
fiscal year, revenue from this order has not been recognized because the units
have not been completed and delivered. The Company incurred operating expenses
of $1,749,306 during the nine months ended June 30, 2009, a decrease of
$5,961,354 or approximately 77%, as compared to $7,710,660 for the nine months
ended June 30, 2008.  General and administrative expenses were
$1,144,112 during the nine months ended June 30, 2009, a decrease of $5,695,172
or approximately 83%, as compared to $6,839,284 for the nine months ended June
30, 2008.  The decrease in general and administrative expenses
contributed to the significant decrease in operating expenses. The significant
general and administrative expenses incurred during the nine months ended June
30, 2008 were primarily due to the issuance of options. Research and development
expenses were $567,790 during the nine months ended June 30, 2009, a decrease of
$279,114 or approximately 33%, as compared to $846,904 for the nine months ended
June 30, 2008.  The decrease in research and development expenses
resulted primarily from the reallocation of personnel for the design of the two
water treatment systems ordered during the 2009 fiscal year.





Other
income (expense) totaled ($3,857,825) during the nine months ended June 30,
2009, an increase of $18,391,340 or approximately 127%, as compared to other
income of $14,533,515 for the nine months ended June 30, 2008. The Company
earned interest income of $3,870 during the nine months ended June 30, 2009,
an increase of $1,027 or 36%, as compared to $2,843 during the nine months
ended June 30, 2008.  The Company incurred interest expense of
$221,947 during the nine months ended June 30, 2009, a decrease of $755,965 or
approximately 77%, as compared to $977,912 for the nine months ended June 30,
2008. The significant interest expense we incurred during the nine months ended
June 30, 2008 was due primarily to the amortization of the beneficial conversion
features discount and warrant discount of the convertible debt securities, while
during the nine months ended June 30, 2009 there was a decrease in outstanding
debt principal, which resulted in lower interest.





The gain
(loss) in fair value of warrant and option liability was ($1,311,309) during the
nine months ended June 30, 2009, an increase of $2,808,855 or approximately
188%, as compared to $1,497,546 during the nine months ended June 30,
2008. The increase in the loss in fair value of warrant and option
liability was due to the increase in the trading price of our Common Stock,
resulting in a higher Black-Scholes valuation model valuation calculation of the
warrant liability.  The gain (loss) in fair value of beneficial
conversion liability was ($2,332,055) during the nine months ended June 30,
2009, an increase of $16,468,108, or approximately 116%, as compared to
$14,136,053 for the nine months ended June 30, 2008. The increase in the loss in
fair value of beneficial conversion liability was due to the increase in the
trading price of our Common Stock, resulting in a higher Black-Scholes valuation
model valuation calculation of the warrant liability.  During the nine
months ended June 30, 2009 the Company recorded a loss on settlement of debt of
$3,616 related to the conversion of notes payable and accrued interest into
Common Stock. During the nine months ended June 30, 2008 the Company recorded a
loss on lease termination for $125,015 related to the termination of
lease. During the nine months ended June 30, 2008 the Company recorded a
write-off of beneficial conversion feature and discount of $380,440 related to
the advisory board compensation.  There were no comparable expenses
recorded during the nine months ended June 30, 2009.





As a result of these items, net loss for the nine months ended
June 30, 2009 was ($5,611,931), a decrease of $12,433,886 or approximately 182%
over the net income of $6,821,955 for the nine months ended June 30,
2008.





Liquidity
and Capital Resources


35





The
Company had cash and cash equivalents of $8,582 at June 30, 2009. The Company’s
source of liquidity has been the sale of its securities and deposits received
from orders for two water treatment systems. The Company expects to receive
additional orders for water treatment systems but if it does not receive
additional orders or if these orders do not satisfy its capital needs, the
Company expects to sell its securities or obtain loans to meet its capital
requirements. There can be no assurance that sales of the Company’s securities
or the sale of its water treatment systems, if such sales occur, will provide
sufficient capital for its operations or that the Company will not encounter
unforeseen difficulties that may deplete its capital resources more rapidly than
anticipated.





Operating
Activities





During
the nine months ended June 30, 2009, the Company used $1,451,460 of cash in
operating activities.  Non-cash adjustments included $37,404 for
depreciation, $2,890 for amortization of warrant and beneficial conversion
feature, $1,311,309 as an increase in fair value of warrant and option
liability, $2,332,055 as an increase in fair value of beneficial conversion
liability, and $19,800 for loss on settlement of debt. Cash provided by
operating activities included $17,730 in other current assets, $197,604 in
accounts payable, $451,603 in accrued liabilities, and $360,000 in customer
deposits. Cash used in operating activities included $833,594 for inventory and
$150,400 for other assets. Stock based compensation to employees and consultants
was $187,844 and $238,244, respectively.





During
the nine months ended June 30, 2008, the Company used $611,819 of cash in
operating activities. Non-cash adjustments included $24,472 for depreciation,
$1,073,445 for amortization of warrant and beneficial conversion
feature, $126,111 for loss on termination of lease. Cash provided by
operating activities included $409,406 in accounts payable. Cash used in
operating activities included $77,269 for other current assets, $1,497,546 for
warrant liability, and $14,136,054 for beneficial conversion features liability.
Stock based compensation to nonemployees was $5,799,646.





Investing
Activities





During
the nine months ended June 30, 2009, the Company acquired $5,546 of property and
equipment. During the nine months ended June 30, 2008, the
Company acquired $26,111 of property and equipment.





Financing
Activities





During
the nine months ended June 30, 2009, the Company received $5,000 for the
purchase of common stock, and $240,000 from short term notes.





During
the nine months ended June 30, 2008 the Company received $1,261,779 in financing
activities. Cash provided from financing activities for the nine months
ended June30, 2008 consisted proceeds of $425,000 from the issuance of 10%
subordinated notes payable and $330,000 for the purchase of Common Stock. Cash
used in financing activities for the nine months ended June 30, 2008 included a
payment of $5,000 toward a note payable, payments of $27,336 toward notes
payable under an equity line of credit, and payments totaling $19,260 to
officers for loans made to us.





On June
30, 2009, the Company had cash and cash equivalents of $8,582. The sole source
of liquidity has been borrowings from affiliates and the sales of our
securities. There is no certainty that the Company will be able to generate
revenues from operations during the fiscal year. As of June 30, 2009, the
Company had an accumulated deficit of $39,526,666. We expect that our future
operating results will continue to be subject to many of the problems, expenses,
delays and risks, which we often cannot control, inherent in the establishment
of a developmental business enterprise.





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





We are
not certain how the current economic downturn may affect our
business.  Because of the global recession, government agencies and
private industry may not have the funds to purchase our water treatment
systems.  It may also be more difficult for us to raise capital in the
current economic environment. 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.





36


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 June 30, 2009, the Company has incurred
cumulative losses of $39,526,666 including net loss for the nine months ended
June 30, 2009 of $5,611,931. As the Company has limited cash flow from
operations, its ability to transition from a development stage company to an
operating company is entirely dependent upon obtaining adequate financing to pay
for its overhead, research and development activities, and acquisition of
production equipment. It is unknown when, if ever, the Company will achieve a
level of revenues adequate to support its costs and expenses. In order for the
Company to meet its basic financial obligations, including rent, salaries, debt
service and operations, it plans to undertake additional equity or debt
financing. Because of the Company’s history and current debt levels, there is
considerable doubt that the Company will be able to obtain financing. The
Company’s ability to meet its cash requirements for the next twelve months
depends on its ability to obtain such financing. Even if financing is obtained,
any such financing will likely involve additional fees and debt service
requirements, which may significantly reduce the amount of cash the Company will
have for its operations. Accordingly, there is no assurance that the Company
will be able to implement its plans.





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





As
mentioned in Notes 7 and 8, the Company has convertible notes and subordinated
notes payable that have matured. The Company is in the process of renegotiating
the terms of the notes with the note holders to extend the maturity date. If the
Company is unsuccessful in extending the maturity date, the Company may not be
able to continue as a going concern.





Part
I, Item 3.  Quantitative and Qualitative Disclosures about Market
Risk





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





Part
I, Item 4T.  Controls and Procedures





(a)
Disclosure Controls and Procedures





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





We
conducted an evaluation, with the participation of our Chief Executive Officer
and Chief Financial Officer, of the effectiveness of the design and operation of
our disclosure controls and procedures as of the period covered by this
report.  Based on that evaluation, our Chief Executive Officer and
Chief Financial Officer have concluded that as of March 31, 2009, our disclosure
controls and procedures were not effective at the reasonable assurance level due
to the material weaknesses described below.





A
material weakness is a control deficiency (within the meaning of the Public
Company Accounting Oversight Board (PCAOB) Auditing Standard No. 2) or
combination of control deficiencies that result in more than a remote likelihood
that a material misstatement of the annual or interim financial statements will
not be prevented or detected.  Management has identified the following
three material weaknesses in our disclosure controls and
procedures:





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





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


37








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





(b)
Changes in internal control over financial reporting





During
the quarter covered by this report, there was no change in our internal control
over financial reporting that has materially affected, or is reasonably likely
to materially affect, our internal control over financial
reporting.





Part
II, Item 1.  Legal Proceedings





Not
applicable.





Part
II, Item 1A.  Risk Factors





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





Part
II, Item 2.  Unregistered Sales of Equity Securities and Use of
Proceeds





On May
11, 2009, the Company issued 290,798 shares of common stock in exchange for
$11,632 in accrued interest owed to holders of our convertible notes. We relied
on section 3(9) of the Securities Act of 1933 to issue the securities inasmuch
as the notes were exchanged by us with our existing security holders
exclusively, and no commission or other remuneration was paid or given directly
or indirectly for soliciting the exchange.





On May
20, 2009, the Company issued 300,000 shares of common stock in exchange for
$12,000 in principal owed to holders of our convertible notes. We relied on
section 3(9) of the Securities Act of 1933 to issue the securities inasmuch as
the notes were exchanged by us with our existing security holders exclusively,
and no commission or other remuneration was paid or given directly or indirectly
for soliciting the exchange.





On June
10, 2009, the Company issued 600,000 shares of common stock in exchange for
$120,000 of services previously rendered.  We relied on section 4(2)
of the Securities Act of 1933 to issue the common stock in exchange for cash, as
the common stock was issued without any form of general solicitation or general
advertising and the acquirers were accredited investors.





On June15
20, 2009, the Company issued 964,400 shares of common stock in exchange for
$8,000 in principal and $1,638 in accrued interest owed to holders of our
convertible notes. We relied on section 3(9) of the Securities Act of 1933 to
issue the securities inasmuch as the notes were exchanged by us with our
existing security holders exclusively, and no commission or other remuneration
was paid or given directly or indirectly for soliciting the
exchange.





Part
II, Item 3.  Defaults upon Senior Securities.





Between
October 2006 and February 2007 we issued Secured Convertible Promissory Notes in
the aggregate principal amount of $750,000.  These notes were due to
be paid on the earlier of the first anniversary of the date of issuance, an
Event of Default (as defined in the note) or on the closing of any equity
financing in which we received gross proceeds of at least $2.5
million.  Payment of these notes became due on the first anniversary
of the date of issuance.  We have not paid the notes and, as of August
15, 2009, we owed a total of $511,333 in principal and approximately $101,000 in
accrued interest.


38


On July
17, 2007 we issued Subordinated Notes Payable in the aggregate principal amount
of $1,025,000.  We were required to pay the principal and accrued
interest monthly in cash or in shares of our common stock.  We have
not paid these notes in accordance with their terms and, as of August 15, 2009,
we owed a total of $250,000 in principal and approximately $39,000 in accrued
interest.





Part
II, Item 4.  Submission of Matters to a Vote of Security
Holders





During
the quarter ended June 30, 2009, no matters were submitted to a vote of security
holders.





Part
II, Item 5.  Other Information


None.




Part II, Item
6.  Exhibits





Exhibit
      No.
            
            Description
      of Exhibit3.1
            
            Articles
      of Incorporation (1)3.2
            
            Bylaws
      (1)10.1
            
            Promissory
      note dated June 5, 2009 for $75,00010.2
            
            Promissory
      note dated June 11, 2009 for $50,00010.3
            
            Promissory
      note dated June 18, 2009 for $75,00010.4
            
            Promissory
      note dated June 26, 2009 for $40,00031.1
            
            Certification
      pursuant to Section 302 of the Sarbanes-Oxley Act of
  2002*31.2
            
            Certification
      pursuant to Section 302 of the Sarbanes-Oxley Act of
  2002*32
            
            Certification
      pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of
      the Sarbanes-Oxley Act of 2002*





* Filed
herewith.


(1)
Incorporated by reference from our Current Report on Form 8-K filed with the
Securities and Exchange Commission on July 15, 2003 as file number
002-95626-D.





39


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.





SIONIX CORPORATIONJanuary
      13, 2010
              By:
              /s/ David
      R. WellsDavid
      R. WellsPresident,
      Chief Financial Officer, and Principal Financial and Accounting
      Officer