** **

**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

**AmendmentNo. 1To**

**FORM 10-Q**

**( Mark One )**

**x**                              QUARTERLYREPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

**Forthe quarterly period ended March 31, 2006**

**o**                                 TRANSITIONREPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT

**Forthe transition period from                       to                              **

**Commissionfile number 00-32019**

**TASKER CAPITAL CORP.**

(Exact name of registrantas specified in its charter)

| **Nevada**                                                      | ** ** | **88-0426048**                     |
|-----------------------------------------------------------------|------------|------------------------------------|
| (State or other  jurisdiction of incorporation or organization) |       | (IRS Employer  Identification No.) |

 

**39 Old RidgeburyRoad-Suite 14, Danbury, CT 06810-5116**

(Address of principalexecutive offices)

**(203) 730-4350**

(Registrant’s telephonenumber)

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

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

Indicate by check mark whether the registrant is alarge accelerated filer, an accelerated filer, or a non-accelerated filer. See

definition of “accelerated filer and large acceleratedfiler” in Rule 12b-2 of the Exchange Act.
| Large accelerated filer o | Accelerated filer o | Non-accelerated filer x |
|---------------------------|---------------------|-------------------------|

 

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

The number ofshares outstanding of the registrant’s common stock as of May 5, 2006 was104,921,861.

 

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**ExplanatoryNote**

**Tasker Capital Corp. hereby amends its QuarterlyReport on Form 10-Q for the quarterly period ended March 31, 2006,filed on May 15, 2006, as set forth in this Quarterly Report on Form 10-Q/A(Amendment No. 1), in response to comments from the Securities andExchange Commission****related to ourRegistration Statement on Form S-1, as amended, filed on April 26, 2006 .**

**TASKERCAPITAL CORP.**

**INDEX**
| **PART I. FINANCIAL INFORMATION** |                                                                                                           |
|-----------------------------------|----------------------------------------------------------------------------------------------------------------|
|                              |                                                                                                           |   |
| **Item 1.**                       | **Financial  Statements**                                                                                      |   |
|                              | Unaudited  Condensed Consolidated Balance Sheets as of March 31, 2006 and December 31,  2005                   |   |
|                              | Unaudited  Condensed Consolidated Statements of Operations for the three months ended  March 31, 2006 and 2005 |   |
|                              | Unaudited  Condensed Consolidated Statements of Cash Flow for the three months ended  March 31, 2006 and 2005  |   |
|                              | Notes to  Unaudited Condensed Consolidated Financial Statements                                                |   |
|                              |                                                                                                           |   |
| **Item 2.**                       | **Management’s  Discussion And Analysis Of Financial Condition And Results Of Operations**                |   |
|                              |                                                                                                           |   |
| **Item 3.**                       | **Quantitative  And Qualitative Disclosures About Market Risk**                                                |   |
|                              |                                                                                                           |   |
| **Item 4.**                       | **Controls And  Procedures**                                                                                   |   |
|                              |                                                                                                           |   |
| **PART II. OTHER  INFORMATION**   |                                                                                                           |
|                              |                                                                                                           |   |
| **Ite m 1.**                      | **Legal Proceedings**                                                                                          |   |
|                              |                                                                                                           |   |
| **Item 1A.**                      | **Risk Factors**                                                                                               |   |
|                              |                                                                                                           |   |
| **Item 2.**                       | **Unregistered  Sales Of Equity Securities And Use Of Proceeds**                                               |   |
|                              |                                                                                                           |   |
| **Item 6.**                       | **Exhibits**                                                                                                   |   |
|                              |                                                                                                           |   |
| **SIGNATURES**                    |                                                                                                           |

 

2

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** **

**PARTI — FINANCIAL INFORMATION**

**Item 1. Financial Statements**

**TASKER CAPITAL CORP. AND SUBSIDIARIES**

**UNAUDITED CONDENSED CONSOLIDATEDBALANCE SHEETS**
| ** **                                                                                                                                                                          | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                          | ** ** | **2006**           | ** ** | **2005**              | ** ** |
| **ASSETS**                                                                                                                                                                          |       |               | ** ** | ** **            |       |
|                                                                                                                                                                                |       |               |       |                  |       |
| Current assets:                                                                                                                                                                     |       |               |       |                  |       |
| Cash and cash  equivalents                                                                                                                                                          |       | $                  | 3,531,409  |                  | $          | 1,037,250 |   |
| Marketable  securities                                                                                                                                                              |       | 3,450,000          |       | —                |       |
| Accounts  receivable, net of allowance for doubtful accounts of $50,518 and $79,500 as  of March 31, 2006 and December 31, 2005, respectively                                       |       | 78,963             |       | 155,189               |       |
| Notes receivable                                                                                                                                                                    |       | 663,333            |       | 653,958               |       |
| Inventories, net  of reserve of $20,666 and $74,675 as of March 31, 2006 and December 31, 2005,  respectively                                                                       |       | 1,327,212          |       | 1,350,963             |       |
| Prepaid expenses  & other current assets                                                                                                                                        |       | 184,591            |       | 191,227               |       |
| Total current  assets                                                                                                                                                               |       | 9,235,508          |       | 3,388,587             |       |
|                                                                                                                                                                                |       |               |       |                  |       |
| Property and equipment,  net                                                                                                                                                        |       | 1,444,670          |       | 1,525,142             |       |
| Investment in equity  investee                                                                                                                                                      |       | 659,700            |       | 664,737               |       |
| Intangible assets, net                                                                                                                                                              |       | 21,050,814         |       | 21,562,292            |       |
| Goodwill                                                                                                                                                                            |       | 41,677,180         |       | 41,677,180            |       |
| Deposit, net                                                                                                                                                                        |       | 36,081             |       | 36,081                |       |
| Total assets                                                                                                                                                                        |       | $                  | 74,103,954 |                  | $          | 68,854,019 |   |
|                                                                                                                                                                                |       |               |       |                  |       |
| **LIABILITIES AND STOCKHOLDERS’  EQUITY**                                                                                                                                      |       |               |       |                  |       |
| Current liabilities:                                                                                                                                                                |       |               |       |                  |       |
| Convertible  debentures                                                                                                                                                             |       | $                  | —     |                  | $          | 194,000 |   |
| Accounts payable                                                                                                                                                                    |       | 1,527,111          |       | 1,740,245             |       |
| Notes payable -  acquisition of IRL                                                                                                                                                 |       | 445,840            |       | 445,840               |       |
| Other accrued  liabilities                                                                                                                                                          |       | 1,752,007          |       | 1,611,587             |       |
| Total current  liabilities                                                                                                                                                          |       | 3,724,958          |       | 3,991,672             |       |
|                                                                                                                                                                                |       |               |       |                  |       |
| Long-term liabilities:                                                                                                                                                              |       |               |       |                  |       |
| Notes payable -  shareholders                                                                                                                                                       |       | 451,104            |       | 443,790               |       |
| Notes payable -  acquisition of IRL                                                                                                                                                 |       | 817,373            |       | 1,077,447             |       |
| Other long term  liabilities                                                                                                                                                        |       | 50,053             |       | 52,686                |       |
| Total long-term  liabilities                                                                                                                                                        |       | 1,318,530          |       | 1,573,923             |       |
|                                                                                                                                                                                |       |               |       |                  |       |
| Stockholders’ equity:                                                                                                                                                          |       |               |       |                  |       |
| Common stock,  $0.001 par value; 300,000,000 shares authorized; 104,773,020 and 89,167,095  shares issued and outstanding as of March 31, 2006 and December 31, 2005,  respectively |       | 104,773            |       | 89,167                |       |
| Additional  paid-in capital                                                                                                                                                         |       | 99,946,927         |       | 89,265,154            |       |
| Accumulated  deficit                                                                                                                                                                |       | (30,991,235        | )          | (26,065,897           | )          |
| Total  stockholders’ equity                                                                                                                                                    |       | 69,060,465         |       | 63,288,424            |       |
| Total liabilities and  stockholders’ equity                                                                                                                                    |       | $                  | 74,103,954 |                  | $          | 68,854,019 |   |

 

See accompanying notes

3

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**TASKER CAPITAL CORP. AND SUBSIDIARIES**

**UNAUDITED CONDENSED CONSOLIDATEDSTATEMENTS OF OPERATIONS**
| ** **                                        | ** ** | **THREE MONTHS ENDED  MARCH 31,** | ** **     |
|---------------------------------------------------|------------|--------------------------------------------------|----------------|
| ** **                                        | ** ** | **2006**                                         | ** **     | **2005** | ** ** |
|                                              |       |                                             |           |   |   |
| **Revenues**                                      |       | $                                                | 220,636        |   | $ | 60,875 |   |
| **Cost of  goods sold**                           |       | 67,690                                           |           | 25,162 |   |
| **Gross  margin**                                 |       | 152,946                                          |           | 35,713 |   |
|                                              |       |                                             |           |   |   |
| **Expenses**                                      |       |                                             |           |   |   |
| Selling, general & administrative             |       | 4,082,153                                        |           | 2,899,716 |   |
| Product development                               |       | 375,318                                          |           | 340,505 |   |
| Depreciation and amortization                     |       | 574,399                                          |           | 12,034 |   |
| **Total  expenses**                               | ** ** | **5,031,870**                                    | ** **     | **3,252,255** | ** ** |
|                                              |       |                                             |           |   |   |
| **Loss  from operations**                         | ** ** | **(4,878,924**                                   | **)**          | **(3,216,542** | **)** |
|                                              |       |                                             |           |   |   |
| Other income (expense):                           |       |                                             |           |   |   |
| Interest income                                   |       | 38,609                                           |           | 46,251 |   |
| Interest expense                                  |       | (27,169                                          | )              | (113,608 | ) |
| Liquidated damages                                |       | (86,954                                          | )              | — |   |
| Loss on disposal of vehicle                       |       | (50,387                                          | )              | — |   |
| Other                                             |       | 79,487                                           |           | — |   |
| **Total  other expense, net**                     | ** ** | **(46,414**                                      | **)**          | **(67,357** | **)** |
|                                              |       |                                             |           |   |   |
| **Net  loss**                                     | ** ** | **$**                                            | **(4,925,338** | **)** | **$** | **(3,283,899** | **)** |
|                                              |       |                                             |           |   |   |
| **Net loss per common share,  basic and diluted** | ** ** | **$**                                            | **(0.05**      | **)** | **$** | **(0.06** | **)** |

 

See accompanying notes

4

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**TASKER CAPITAL CORP. AND SUBSIDIARIES**

**UNAUDITED CONDENSED CONSOLIDATEDSTATEMENTS OF CASH FLOWS**
| ** **                                                                   | ** ** | **Three Months Ended March 31,** | ** ** |
|------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                                   | ** ** | **2006**                                             | ** ** | **2005** | ** ** |
|                                                                         |       |                                                 |       |   |   |
| **Cash  flows from operating activities:**                                   |       |                                                 |       |   |   |
| Net loss                                                                     |       | $                                                    | (4,925,338 | ) | $ | (3,283,899 | ) |
| Adjustments to reconcile net loss to net cash used  in operating activities: |       |                                                 |       |   |   |
| Depreciation and amortization                                                |       | 574,399                                              |       | 12,034 |   |
| Noncash interest- liquidating damages                                        |       | 86,954                                               |       | — |   |
| Noncash interest- interest payable on convertible  debentures                |       | 13,696                                               |       | — |   |
| Noncash- loss on disposal of vehicle                                         |       | 50,037                                               |       | — |   |
| Noncash interest -note payable and note receivable                           |       | (2,061                                               | )          | 14,717 |   |
| Stock option compensation expense                                            |       | 1,723,334                                            |       | 484,000 |   |
| Loss on equity investee                                                      |       | 5,037                                                |       |   |   |
| Common stock, warrants and options for services                              |       | —                                               |       | 1,324,225 |   |
| Changes in operating assets and liabilities:                                 |       |                                                 |       |   |   |
| Accounts receivable                                                          |       | 76,226                                               |       | (34,132 | ) |
| Inventories                                                                  |       | 23,751                                               |       | (474,755 | ) |
| Prepaid expenses                                                             |       | 16,636                                               |       | (79,268 | ) |
| Prepaid commissions                                                          |       | (10,000                                              | )          | (15,000 | ) |
| Accounts payable                                                             |       | (213,134                                             | )          | 319,061 |   |
| Other accrued liabilities                                                    |       | 37,137                                               |       | (176,510 | ) |
| Net cash used in operating activities                                        |       | (2,543,326                                           | )          | (1,909,528 | ) |
|                                                                         |       |                                                 |       |   |   |
| **Cash  flows from investing activities:**                                   |       |                                                 |       |   |   |
| Purchases of available for sale securities                                   |       | (3,450,000                                           | )          | — |   |
| Purchases of property and equipment                                          |       | (32,487                                              | )          | (106,751 | ) |
| Advances pursuant to notes                                                   |       | —                                               |       | (2,606,001 | ) |
| Acquisition costs paid                                                       |       | —                                               |       | (314,689 | ) |
| Payments for deposits and other                                              |       | —                                               |       | (1,688 | ) |
| Net cash used in investing activities                                        |       | (3,482,487                                           | )          | (3,029,129 | ) |
|                                                                         |       |                                                 |       |   |   |
| **Cash  flows from financing activities:**                                   |       |                                                 |       |   |   |
| Proceeds from private placement                                              |       | 9,335,151                                            |       | — |   |
| Payment of private placement broker fee                                      |       | (592,609                                             | )          | — |   |
| Exercise of warrants/options                                                 |       | 37,503                                               |       | 128,024 |   |
| Repayments on note payable - IRL                                             |       | (260,074                                             | )          | — |   |
| Net cash provided by financing activities                                    |       | 8,519,971                                            |       | 128,024 |   |
|                                                                         |       |                                                 |       |   |   |
| **Net  increase (decrease) in cash and cash equivalents**                    |       | 2,494,158                                            |       | (4,810,633 | ) |
| **Cash  and cash equivalents, beginning of period**                          |       | 1,037,250                                            |       | 14,225,305 |   |
|                                                                         |       |                                                 |       |   |   |
| **Cash  and cash equivalents, end of period**                                |       | $                                                    | 3,531,408  |   | $ | 9,414,672 |   |
|                                                                         |       |                                                 |       |   |   |
| **Supplemental  disclosures of cash flow information:**                      |       |                                                 |       |   |   |
| Interest paid                                                                |       | $                                                    | 13,246     |   | $ | 16,275 |   |
| **Supplemental  disclosures of noncash investing and financing activities:** |       |                                                 |       |   |   |
| Fair value of warrants issued as private placement  fees                     |       | $                                                    | 593,555    |   | $ | — |   |
| Conversion of  debt and accrued interest into common stock                   |       | $                                                    | 194,000    |   | $ | 99,930 |   |

 

See accompanying notes

5

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**TASKER CAPITAL CORP. AND SUBSIDIARIES**

**NOTESTO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**1.**   **Basis of Presentation**

Tasker Capital Corp. was formed on May 13,1996 and was in the development stage through December 31, 2005. Thequarterly period ended March 31, 2006 is the first period duringwhich it is considered an operating company.

The accompanyingunaudited condensed consolidated financial statements of Tasker Capital Corp.and its subsidiaries (collectively, “the Company “) as of March 31, 2006 andDecember 31, 2005 and for the three month periods ended March 31, 2006 and 2005reflect all adjustments of a normal and recurring nature to present fairly theconsolidated financial position, results of operations and cash flows for theinterim periods.  These unaudited condensed, consolidated financialstatements have been prepared by the Company pursuant to the instructions toForm 10-Q, and Article 10 of Regulation S-X.  Pursuant to suchinstructions, certain financial information and footnote disclosures normallyincluded in such financial statements have been condensed or omitted.

These unaudited condensedconsolidated financial statements should be read in conjunction with theaudited consolidated financial statements of the Company and notes thereto,together with management’s discussion and analysis or plan of operations,contained in the Company’s Annual Report on Form 10-KSB for the year endedDecember 31, 2005. The results of operations for the three month periodended March 31, 2006 are not necessarily indicative of the results that mayoccur for the year ending December 31, 2006.

Certain prior period amounts have been reclassified toconform to the current year presentation.

**2. Liquidity**

The Company had continuedto sustain losses from operations and for the three months ended March 31, 2006and 2005 it has incurred a net loss of approximately $4,925,000 and $3,284,000respectively. In addition the Company has not generated positive cash flow fromoperations for the three months ended March 31, 2006 and 2005. The Companyexpects to continue to incur losses for at least the short term. TheCompany expects to increase operating expenses as it attempts to build itsbrands, expand its customer base and develop new products. To become profitable,the Company must increase revenue substantially and achieve and maintainpositive gross margins. The Company may not be able to increase revenue andgross margins sufficiently to achieve profitability. Consequently the resultsof operations and financial condition will be materially and adverselyaffected.

At March 31, 2006, theCompany had a total of approximately $7 million of cash, cash equivalents andmarketable securities as a result of the January 2006 private placement.

Since the Company’sinception, the Company has funded operations and investing activities throughthe issuance of common stock and convertible debt under several privateplacements. Requirements for liquidated damages under some of its privateplacements may have an impact on the Company’s future liquidity. To date theCompany has satisfied and/or received waivers for the provisions of a majorityof the agreements that would have otherwise required the Company to payliquidated damages. The Company does not expect, although certain of theconditions that may result in liquidated damages are not in itscontrol, that any liquidated damage amounts it may be required to pay will bematerial. At March 31, 2006, the Company’s derivative liability balance,related to the April 2004 and July 2004 registration rights agreements, wasapproximately $150,000. Additionally, included in the other accrued liabilitiesat March 31, 2006 is approximately $373,000 of incurred liquidated damagesassociated with the April 2004 and the July 2004 convertible debentures.The Company has not incurred any liquidated damages liabilities related to anyof its other registration rights agreements.

The Company may be unableto meet its future capital requirements. The Company may require additionalfinancing in the future in order to continue to implement its product andservices development, marketing and other corporate programs. The Company maynot be able to obtain such financing or obtain it on acceptable terms. Withoutadditional financing, the Company may be forced to delay, scale back oreliminate some or all of its product and services development, marketing andother corporate programs. If the Company is able to obtain such financing, thefinancing agreement may contain restrictive covenants that might negativelyaffect the Company’s common stock, such as limitations on payments ofdividends, or, in the case of a debt financing, the Company may have reducedearnings due to interest expenses. Any further issuance of equity securitieswould likely have a dilutive effect on the holders of the Company’s commonstock. The Company’s business, operating results and financial condition may bematerially harmed if revenues from certain products do not materialize orgrow slower, than the Company anticipates, or if operating expenses exceed theCompany’s expectations or cannot be reduced timely.

6

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Based upon the Company’sforecast of future revenues from its products in conjunction with the cash andmarketable securities on hand, cash expected to be generated from operationswill provide adequate funding for the Company’s working capital over the nexttwelve months.  As with all business forecasts, management’s currentassessment of future revenues is based upon its assumptions andexpectations.  Future market trends for its products may not develop asmanagement has predicted, and regulatory approvals required to market productsas the Company currently plans may not be obtained, and, in the future, theCompany may find that its cash on hand and cash from operations is notsufficient to fund existing operations or new opportunities may presentthemselves over the course of the next twelve months, in which case the Companymay find that its cash on hand and cash from operations is not sufficient. Suchchanges may, or may not, require it to seek additional outside funding and, ifrequired, there can be no assurance that suitable outside financing will beavailable to the Company.

**3. Share-Based Payments**

Effective January 1,2006, the Company adopted Statement of Financial Accounting StandardNo. 123 (revised 2004), “Share-Based Payment” (SFAS 123R). Under SFAS123(R), the Company is required to recognize, as expense, the estimated fairvalue of all share-based payments to employees. For the three months endedMarch 31, 2006, the Company recorded expense of approximately $1.7 million inconnection with its share-based payment awards to its employees. Compensationexpense increased by approximately $1.6 million during the three months endedMarch 31, 2006 as result of implementing 123(R).

The Company adopted SFAS123R under the modified prospective method. Under this method, the Companyrecognized compensation expense for stock options awarded prior to January 1,2006, but vested in the quarter ended March 31, 2006 and stock options awardedin the three months ended March 31, 2006, based on the grant date estimate offair value for those awards. Prior period financial information has not beenrestated.

For periods prior to theadoption of SFAS 123R, the Company had elected to follow Accounting PrinciplesBoard Opinion No. 25 “Accounting for Stock Issued to Employees,” (APB 25)and related Interpretations in accounting for its share based payment awards.

The followingtable illustrates the effect on net loss and loss per share as if the Companyhad applied the fair value recognition provisions of FASB StatementNo. 123, “Accounting for Stock Based Compensation,” to its share basedpayment arrangements for the three months ended March 31, 2005.

|                                                                                                                                               | ** ** | **Three Months Ended  March 31, 2005** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------|------------|
| Net loss, as  reported                                                                                                                        |       | $                                                          | (3,283,899 | ) |
| Add: Stock-based  employee compensation expense included in reported net loss                                                                 |       | $                                                          | 484,000    |   |
| Deduct: Total  stock-based employee compensation expense determined under fair value based  method for all awards, net of related tax effects |       | $                                                          | (3,665,000 | ) |
| Pro forma net  loss                                                                                                                           |       | $                                                          | (6,464,899 | ) |
|                                                                                                                                          |       |                                                       |       |
| Basic and  diluted net loss per share, as reported:                                                                                           |       | $                                                          | (0.06      | ) |
| Pro forma basic and  diluted net loss per share                                                                                               |       | $                                                          | (0.11      | ) |

 

7

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Compensation costassociated with employee stock options represented approximately $1.7 millionfor the three months ended March 31, 2006. The compensation costassociated with these awards is recorded as expense within the same functionalexpense category as cash compensation for the respective employee is recorded.No tax benefit has been recognized with respect to this expense as we havedetermined in our evaluation of our tax assets that it is more likely thannot that we will not realize any benefit and have provided full valuationallowances.

The stock optionswere valued taking into consideration a forfeiture rate of 6.7% based onhistorical experience and using a straight-line pro-rated method of valuation.The resulting fair value is recorded as compensation cost on a straight linebasis over the option vesting period. The assumptions made for purposes ofestimating fair value under the Black-Scholes model for options granted duringthe three months ended March 31, 2006 were as follows:

| Dividend yield:                    |   | 0         | %      |
|------------------------------------|--------|-----------|--------|
| Expected term of  options (years): |   | 6.1 years |   |
| Risk free  interest rate:          |   | 4.88      | %      |
| Volatility:                        |   | 135       | %      |

 

The Company’s estimate ofan expected option term was derived based on the average of the sum of thevesting term and the original contract term. The estimated stock pricevolatility was derived based on a review of the Company’s actual historicvolatility for a period equal to the expected term of its stock options awardedin the first fiscal quarter ended March 31, 2006, by reference to actual stockprices during this period historic stock prices over the past five years. Therisk free interest rate was based on the five year Treasury note. The specificstock option valuation assumptions used for awards granted prior toJanuary 1, 2006 are as disclosed in the Company’s prior annual reports onForm 10-KSB, as filed with the SEC.

A summary of stock option activity for the threemonths ended March 31, 2006 is as follows: 

|                                        | ** ** | **Number of  shares** | ** ** | **Weighted  average  exercise price  per share** | ** ** | **Weighted average  remaining  contractual term  in years** | ** ** | **Aggregate  Intrinsic  Value** | ** ** |
|----------------------------------------|------------|----------------------------|------------|------------------------------------------------------------|------------|----------------------------------------------------------------------------|------------|---------------------------------|------------|
|                                   |       |                       |       |                                                       |       |                                                                       |       |                            |       |
| Outstanding,  December 31, 2005        |       | 16,540,777                 |       | $                                                          | 0.91       |                                                                       |       |                            |       |   |
| Granted                                |       | 5,645,000                  |       | $                                                          | 1.00       |                                                                       |       |                            |       |   |
| Exercised                              |       | 175,000                    |       | $                                                          | 0.25       |                                                                       |       |                            |       |   |
|                                   |       |                       |       |                                                       |       |                                                                       |       |                            |       |
| Outstanding,  March 31, 2006           |       | 22,010,777                 |       | $                                                          | 0.94       |                                                                       | 8.7        |                            | $          | 4,328,000 |   |
|                                   |       |                       |       |                                                       |       |                                                                       |       |                            |       |
| Options exercisable at  March 31, 2006 |       | 15,987,070                 |       | $                                                          | 0.86       |                                                                       | 8.4        |                            | $          | 3,881,000 |   |

 

The weighted averagegrant date fair value of options granted during the three months ended March31, 2006 and 2005 was $0.67 and $3.18, respectively. The total intrinsic valueof options exercised during the three months ended March 31, 2006 and 2005 wasapproximately $82,000 and $1.4 million, respectively. As of March 31, 2006there was approximately $4.3 million of unrecognized compensation cost relatedto stock option awards that is expected to be recognized as expense over aweighted average period of 2 years. The total fair value of stock options thatvested during the three months ended March 31, 2006 and 2005 was approximately $3.9million and $27.1 million, respectively.

8

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**4. Net Loss Per Common Share**

The followingtable sets forth the computation of basic and diluted net loss per common sharefor the three months ended March 31, 2006 and 2005.

|                                                                                   | ** ** | **Three Months Ended** | ** ** |
|-----------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                        | ** ** | **March 31,**               | ** ** |
| ** **                                                                        | ** ** | **2006**                         | ** ** | **2005** | ** ** |
| **Numerator  for basic & diluted net loss per share**                         |       |                             |       |   |   |
| Net loss                                                                          |       | $                                | (4,925,338 | ) | $ | (3,283,899 | ) |
| Net loss available to common stockholders                                         |       | $                                | (4,925,338 | ) | $ | (3,283,899 | ) |
|                                                                              |       |                             |       |   |   |
| **Denominator:**                                                                  |       |                             |       |   |   |
| Denominator for basic & diluted net loss per  share - weighted-average shares |       | 100,526,919                      |       | 59,663,000 |   |
|                                                                              |       |                             |       |   |   |
| **Basic  & diluted earnings net loss per share:**                             |       |                             |       |   |   |
| Net loss                                                                          |       | $                                | (0.05      | ) | $ | (0.06 | ) |
|                                                                              |       |                             |       |   |   |
| **Diluted  earnings net loss per share:**                                         |       |                             |       |   |   |
| Net loss                                                                          |       | $                                | (0.05      | ) | $ | (0.06 | ) |

 

As of March 31, 2006,22,010,777 options and 21,497,200 warrants were excluded from the computationof net loss per share because the effect would be antidilutive. As of March 31,2005 17,550,000 options, 7,980,575 warrants, and 5,940,000 of convertibledebentures were excluded from the computation of net loss per share because theeffect would be antidilutive.

**5. Marketable Securities**

The Company accounts formarketable securities in accordance with Statement of Financial AccountingStandards No. 115 “Accounting for Certain Investments in Debt and EquitySecurities” (SFAS 115). SFAS 115 establishes the accounting and reportingrequirements for all debt securities and for investments in equity securitiesthat have determinable fair values. All marketable securities must beclassified as one of the following: held-to-maturity, available-for-sale, ortrading.

The Company’s marketablesecurities consist of auction rate securities which are invested in agenciesand institutions affiliated with U.S. states. The Company’s auction rateinvestments are classified as available-for-sale and are recorded at fairvalue. Interest income on the Company’s marketable securities is recognized inthe statement of operations when earned. The cost of securities sold is determinedbased on the specific identification method.

The Company’savailable-for-sale investments may be offered for sale at auction every 28 or35 days, depending on the individual security. The auction rate securities havestated contractual maturities, which represents the date they will be redeemedby the issuer, ranging from 22 to 32 years, and may, at the option ofthe issuer, be redeemed prior to the stated maturity date. As of March 31,2006, the Company had invested $3,450,000 in marketable securities.

**6. Inventories**

Inventories consisted ofthe following:
| ** **         | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|--------------------|------------|--------------------|------------|-----------------------|------------|
| ** **         | ** ** | **2006**           | ** ** | **2005**              | ** ** |
|               |       |               |       |                  |       |
| Raw Materials      |       | $                  | 968,411    |                  | $          | 955,701 |   |
| Finished Goods     |       | 379,468            |       | 469,937               |       |
| Inventory  Reserve |       | (20,666            | )          | (74,675               | )          |
|               |       | $                  | 1,327,213  |                  | $          | 1,350,963 |   |

 

9

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Inventories are stated at the lower of cost or market.Cost is determined using the first-in, first-out (FIFO) method.

**7. Goodwill and Other IntangibleAssets**

The Company accounts forgoodwill and other intangible assets at their estimated fair values in accordancewith SFAS No. 142, “Goodwill and Other Intangible Assets”. In connection withthe July 2005 asset acquisition, the Company recorded goodwill based on theexcess of the purchase price over the identifiable tangible and intangibleassets acquired and liabilities assumed. Goodwill is tested annually, everyDecember, for impairment.

The Company’sspecifically identifiable intangible assets, which consist of utility patents,are reported at cost, net of accumulated amortization. These intangible assetsare being amortized over their estimated useful lives, which is 11.5 years, atamortization rates that are proportional to each asset’s estimated economicbenefit to the Company.

The carrying value ofthese intangible assets is reviewed annually by the Company, or more frequentlywhen indicators of impairment are present, in accordance with the provisions ofSFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets”which requires impairment losses to be recorded on long-lived assets used in operationswhen indicators of impairment are present and undiscounted cash flows estimatedto be generated by these assets are less than the assets’ carrying amount.

In performing its reviewof the recoverability of goodwill and other intangible assets, the Companyconsiders several factors. These factors include the expected cash flows thatan asset is expected to generate over its estimated economic life. The Companyalso considers whether there have been significant changes in legal factors orthe overall business climate that could affect the underlying value of an assetor whether there is an expectation that the asset will be sold or disposed ofbefore the end of its originally estimated useful life. In the case ofgoodwill, the Company must also consider, and estimate, the fair value of thereporting unit to which the goodwill is assigned. If, as a result of examiningany of these factors, the Company concludes that the carrying value of itsgoodwill or other intangible assets exceeds its estimated fair value, theCompany will record an impairment charge and reduce the carrying value of theasset to its estimated fair value.  Thisimpairment charge may be material to the Company’s results of operations.

The approximatenet carrying value of the goodwill and other intangible assets at March 31,2006 and December 31, 2005 are as follows:

|                            | ** ** | **March 31, 2006** | ** ** |
|----------------------------|------------|------------------------------|------------|
| ** **                 | ** ** | **Gross  carrying  amount**  | ** ** | **Accumulated  amortization** | ** ** | **Net  carrying value** | ** ** |
| Amortized  utility patents |       | $                            | 22,500,000 |   | $ | 1,400,000 |   | $ | 21,100,000 |   |
| Unamortized  goodwill      |       | $                            | 41,700,000 |   | $ | — |   | $ | 41,700,000 |   |
| Total intangible assets    |       | $                            | 64,200,000 |   | $ | 1,400,000 |   | $ | 62,800,000 |   |

 

10

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|                            | ** ** | **December 31, 2005** | ** ** |
|----------------------------|------------|---------------------------------|------------|
| ** **                 | ** ** | **Gross  carrying  amount**     | ** ** | **Accumulated  amortization** | ** ** | **Net  carrying value** | ** ** |
| Amortized  utility patents |       | $                               | 22,500,000 |   | $ | 938,000 |   | $ | 21,562,000 |   |
| Unamortized  goodwill      |       | $                               | 41,700,000 |   | $ | — |   | $ | 41,700,000 |   |
| Total intangible assets    |       | $                               | 64,200,000 |   | $ | 938,000 |   | $ | 63,262,000 |   |

 

For the three months ended March 31, 2006, the Companyrecorded amortization expense of approximately $511,000 related to theintangible assets.

Estimated amortizationexpense for the remaining three quarters of the current fiscal year, andsubsequent fiscal years, is as follows :

| 2006                |   | $ | 1,534,000  |   |
|---------------------|--------|---|------------|--------|
| 2007                |   | $ | 2,046,000  |   |
| 2008                |   | $ | 2,046,000  |   |
| 2009                |   | $ | 2,046,000  |   |
| 2010                |   | $ | 2,046,000  |   |
| 2011 and thereafter |   | $ | 11,382,000 |   |

 

**8. Derivative Instruments**

The Company hasissued and outstanding severalfinancial instruments with embedded derivative features consisting of convertible debt and warrants. The Company analyzesthese financial instruments in accordance with Statement of FinancialAccounting Standards (“SFAS”) No. 133 and Emerging Issues task Force (“EITF”)Issue Nos. 00-19 and 05-02 to determine if these hybrid contractshave embedded derivatives that must be bifurcated. In addition, free standingwarrants are accounted for as either equity or liabilities in accordance withthe provisions of EITF Issue No. 00-19.

EITF Issue No.05-4 “The Effect of aLiquidated Damages Clause on a Freestanding Financial Instrument Subject toEITF Issue No. 00-19, ‘Accountingfor Derivative Financial Instruments Indexed to, and Potentially Settled in, aCompany’s Own Stock’” addresses financial instruments,such as convertible notes and stock purchase warrants, which are accounted forunder EITF 00-19, that are issued with a corresponding right to havethese securities registered pursuant to a registration rights agreement that includesa liquidated damages clause.  Alternative accounting treatmentsof registration rights are discussed in EITF Issue No. 05-4.  One alternative treatment discussed in EITFIssue No. 05-4 could require the warrants, the convertible debt and theregistration rights agreement to be treated as a single financial instrument.If the EITF implements this approach, the convertible debt and the warrants the Company has issued would need tobe recorded as a liability at fair value and changes in the fair value of theliability would need to be recorded in the statement of operations each period.Implementation of this approach may have a material non-cash impact to the Company’s consolidated financialstatement. Since no consensus on EITF Issue No. 05-4 has been reached, the Company has adopted View C as describedin the EITF Issue No. 05-4 Issue Summary No. 1. Under View C,registration rights agreements and the associated financial instruments areaccounted for as separate instruments. Accordingly, the Company hasgiven only prospective application to this guidance.  Further impact on its consolidated financial statementsof adopting the standard, if any, will follow the transition guidance whenreleased.

In April and July2004, the Company entered intoprivate placement agreements for convertible debentures, registration rightsagreements and warrants (see Note 6).  Based on theinterpretive guidance in EITF Issue No. 05-4 due to an uncappedliquidated damages provision in the registration rights agreements, the Company determined that theregistration rights are derivative liabilities that should be bifurcated from therelated financial instruments.  Accordingly, the estimated fair value of theregistration rights derivative of approximately $244,000 was recorded as aliability as of October 1, 2005, the beginning of the first fiscal period afterSeptember 15, 2005, the date that EITF postponed further deliberations.

In connection with the Company’s December 2004 and January 2006 privateplacements, the Company’s estimated fair value of the related registrationrights derivative was immaterial at the inception and at each reporting datesince and the Company has not recorded a liability. At each reporting period,the Company calculate the estimated fair value of the registration rightsderivatives. If the underlying assumptions of the calculation change such thatthe estimated fair value is not immaterial, the Company will record a liabilityat that time. In connection with the Company’s September 2005 privateplacement, the Company’s estimated fair value of the related registrationrights derivative at its inception was immaterial and the Company did notrecord a liability. Subsequently, in connection with the January 2006 privateplacement, the Company amended its September 2005 agreement with the rightsholder to waive the liquidated damages relating to its inability to have suchregistration statement declared effective by May 23, 2006. On April 26, 2006,the Company filed a registration statement registering resale of securitiespurchased in the September 2005 and January 2006 private placements. As itrelates to the September 2005 private placement, the Company believes that ithas used its best efforts to cause the registration statement to be declaredeffective and, therefore, pursuant to the terms of the September 2005registration rights agreement, the Company believes that it is not currentlyliable for liquidated damages as a result of the registration statement it isnot likely that will be declared effective by May 23, 2006. Should the rightsholders dispute that the Company’s best efforts were used, and the Companyeither accedes to their assertion or is found to not have used its bestefforts, the estimated maximum amount of liquidated damages for which theCompany would be liable, assuming (i) ineffectiveness from May 23, 2006 to theend of the period covered by the registration agreement and (ii) a stock priceof $0.37 for periods subsequent to July 26, 2006, is approximately $270,000.Also, the Company believes that as it relates to the January 2006 privateplacement, the Company has used its best efforts to respond to the SEC commentswithin fifteen days from the date of the receipt of those comments. As of March31, 2006, no shares were issuable as liquidated damages under the terms of theJanuary 2006 registration rights agreement. However, if the Company fails tomeet certain conditions of the January 2006 registration rights agreement, itwill be required to issue to each holder in the January 2006 private placement,shares and warrants equal to one percent, or 266,718 of the respective numberof shares and warrants purchased by each holder, for each 30 days of failure tomeet any one of these conditions. The Company may be required to issue amaximum aggregate of 4 million shares and warrants.

Changes in the estimatedfair value of the registration rights derivative liability are recorded in theconsolidated statement of operations. In the quarter ended March 31, 2006, theCompany recorded under the Other Income line of the condensed consolidatedstatement of operations a gain on the reduction of the derivative liability ofapproximately $87,000. At March 31, 2006, the derivative liability wasapproximately $150,000 and was reported under other accrued liabilities.

            In connection with the Company’s examination of past transactions for application ofEITF Issue No. 05-4, the Companynoted that for the period from entering into the April 2004 Securities PurchaseAgreement until the Companyincreased its authorized sharesin August 2004, the Company hadinsufficient shares to meet all potential obligations to issue shares under its convertible notes and exercisablewarrants and options.  Under EITF IssueNo. 00-19, a liability should be recognized for those financial instruments forthat period, with any changes in the fair value of such liabilities recognized inits consolidated statement ofoperations.  Based on the Company’s analysis of suchliabilities, it determined theeffect of any such amounts to be immaterial.

11

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**9. Contractual Obligations andCommitments**

The Company hasthe following commitments as of March 31, 2006, which are comprised primarilyof a research and development fee contract, consulting and employmentcontracts, a vendor agreement, notes payable, as well as numerous operatingleases.
| ** **                                                 | ** ** | **Payments**    | ** **    | ** **         | ** ** | ** **    | ** ** | ** ** | ** **    | ** **         | ** ** |
|------------------------------------------------------------|------------|-----------------|---------------|--------------------|------------|---------------|------------|------------|---------------|--------------------|------------|
| ** **                                                 | ** ** | **Due by** | ** **    | ** **         | ** ** | ** **    | ** ** | ** ** | ** **    | ** **         | ** ** |
| ** **                                                 | ** ** | **Period**      | ** **    | **Less Than** | ** ** | **1-3**       | ** ** | **3-5**    | ** **    | **More Than** | ** ** |
| **Contractual Obligations**                           | ** ** | **Total**       | ** **    | **1 Year**    | ** ** | **Years**     | ** ** | **Years**  | ** **    | **5 Years**   | ** ** |
| Research &  development (“R&D”) fees (1) |       | $               | 150,000       |               | $          | 150,000       |       | $          | —        |               | $          | — |   | $ | — |   |
| Consulting  agreements                                     |       | 194,267         |          | 194,267            |       | —        |       | —     |          | —             |       |
| Employment  agreements (2)                                 |       | 2,295,433       |          | 970,850            |       | 1,324,583     |       | —     |          | —             |       |
| Vendor  agreements                                         |       | 150,000         |          | 150,000            |       | —        |       | —     |          | —             |       |
| Operating leases                                           |       | 1,345,252       |          | 295,395            |       | 987,628       |       | 62,228     |          | —             |       |
| Note(s) payable                                            |       | 1,741,699       |          | 691,266            |       | 1,042,198     |       | 8,235      |          | —             |       |
| **Total**                                                  | ** ** | **$**           | **5,876,651** | ** **         | **$**      | **2,451,778** | ** ** | **$**      | **3,354,409** | ** **         | **$**      | **70,463** | ** ** | **$** | **—** | ** ** |

 

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(1) On January 26, 2006,R&D fees payable under the Sub-License Agreement with pHarlo IP wereamended so that these fees are (i) payable on a quarterly basis within 30 daysafter the end of each calendar quarter and (ii) are based on gross sales of theCompany (or its affiliates) of products using the pHarlo technology. For fiscalyear 2006, the R&D Fees must not be less than $150,000 and are capped at$500,000. The R&D Fees have no minimum amounts payable after 2006; however,they are capped at $2,000,000 for 2007, $4,000,000 for 2008, $8,000,000 for2009 and $10,000,000 for 2010 and beyond.

(2) Subsequent toDecember 31, 2005, the Company terminated several of its existing employmentagreements with some of its senior management and entered into new employmentagreements with its current executive management. As of March 31, 2006 therevised estimated future minimum annual compensation under these employmentagreements, including the new and terminated agreements for 2006, 2007, 2008and 2009 is approximately $970,850, $687,800, $587,800 and $49,000,respectively.

12

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**10. Employment and ConsultingAgreements**

On January 26, 2006,effective on the closing of the January 2006 private placement, the Board ofDirectors of the Company appointed Richard D. Falcone as President and ChiefExecutive Officer of the Company. On February 9, 2006, the Company entered intoan employment agreement with Mr. Falcone. The principal terms of the employmentagreement are as follows: (i) Mr. Falcone’s base salary is $275,000 per year;(ii) any bonus payments made to Mr. Falcone will be at the discretion of theBoard; (iii) Mr. Falcone is eligible to participate in the Company’s existingbenefit plans; and (iv) Mr. Falcone has use of a Company car. In addition, theCompany has agreed to provide Mr. Falcone with disability benefits, and hasagreed to reimburse Mr. Falcone for health insurance coverage if the Companyterminates its group health insurance plan. The employment agreement has a termof three years, with provision for automatic renewal for successive three yearterms. If Mr. Falcone is terminated by the Company for any reason other thancause, as defined in his employment agreement, if he should resign for a goodreason, as defined in his employment agreement and which includes a change incontrol of the Company, or if the Company should not renew his employmentagreement after the expiration of the term, Mr. Falcone is entitled toseverance. The severance payable to Mr. Falcone is dependant on how long he hasbeen employed at the Company, beginning with twenty-four months of base salary(and any bonus to which he would have been entitled during such period) payableupon termination immediately after execution of his employment agreement,decreasing by one month for each month he remains employed at the Company, butsubject to a minimum severance of twelve months of base salary. The obligationto pay severance is conditioned upon Mr. Falcone’s execution of a mutuallyagreeable release of claims against the Company. The Board also granted Mr.Falcone 2,200,000 stock options with an exercise price of $1.00 per share. Theoptions have a ten year term, less one day. Twenty-five percent (25%) of theoptions vested immediately, and the remainder vest in equal monthlyinstallments over the two-year period from the date of grant. If Mr. Falcone isterminated by the Company other than for cause, if Mr. Falcone resigns for goodreason, or if termination is caused by Mr. Falcone’s death, the options willcontinue to vest; otherwise, vesting of the options ceases upon Mr. Falcone’stermination. In addition, if the Company undergoes a change in control, asdefined in his employment agreement, the stock options granted above will fullyvest upon the change in control.

On January 26, 2006, theCompany approved a new consulting arrangement with Mr. Gordon Davis, theCompany’s former Chairman of the Board of Directors. On February 9, 2006, theCompany entered into a consulting agreement with Mr. Davis with an effectivedate of February 2, 2006. This consulting agreement was not affected by Mr.Davis’s resignation as Chairman of the Board of Directors on May 11, 2006. Theprincipal terms of the consulting agreement are as follows: (i) Mr. Davis’sconsulting fee is $120,000 per year; and (ii) Mr. Davis has use of a companycar for company business. The consulting agreement has a term of three years,with provision for automatic renewal for successive one year terms. If Mr.Davis is terminated for any reason other than by the Company for cause, as definedin his consulting agreement, including if the consulting agreement is notrenewed by the Company, he will be entitled to termination payments. If Mr.Davis’s termination is caused by his death or disability, then the terminationfee is equal to $120,000. If the Company terminates Mr. Davis for any reasonother than for cause, if Mr. Davis terminates the agreement for good reason, orif the Company does not renew the consulting agreement, then Mr. Davis’stermination fee is dependant on when the termination takes place. If thetermination occurs prior to the one year anniversary of the effective date,then Mr. Davis is entitled to the $120,000 annual consulting fee for theremainder of the term of the consulting agreement. If the termination occursafter the one year anniversary of the effective date, Mr. Davis is entitled tothe consulting fee then in effect for a period of one year followingtermination. The obligation to pay the termination fee is conditioned upon Mr.Davis’s execution of a release of claims against the Company. Mr. Davis willcontinue to receive remuneration for service on the Board of Directors. TheBoard also granted Mr. Davis 1,750,000 stock options with an exercise price of$1.00 per share. The options have a ten year term, less one day. Twenty-fivepercent (25%) of the options vested immediately, and the remainder vest inequal monthly installments over the two-year period from the date of grant. IfMr. Davis is terminated by the Company other than for cause, if Mr. Davisterminates for good reason, or if termination is caused by Mr. Davis’s death ordisability, or non-renewal of the agreement by the Company, the options willcontinue to vest, otherwise, vesting of the options ceases upon Mr. Davis’stermination as a consultant. In addition, if the Company undergoes a change incontrol, as defined in the consulting agreement, the stock options grantedabove will fully vest upon the change in control.

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On February 8, 2006, theCompany appointed Stathis Kouninis as Chief Financial Officer. On February 13,2006 the Company entered into an employment agreement with Mr. Kouninis. Theprincipal terms of the employment agreement are as follows: (i) Mr. Kouniniswill be paid a base salary of $165,000 per year; (ii) any bonus payment made toMr. Kouninis will be at the discretion of the Board; and (iii) Mr. Kouniniswill be eligible to participate in the Company’s existing benefit plans. Inaddition, the employment agreement will have a term of three years withprovision for automatic renewal for successive one year terms. If Mr. Kouninisis terminated by the Company for any reason other than cause, as defined in hisemployment agreement, or if he should resign for good reason, as defined in hisemployment agreement, Mr. Kouninis will be entitled to receive, for a period ofsix months following termination, his base salary at the rate in effect on thedate of termination. The obligation to pay severance is conditioned upon Mr.Kouninis’ execution of a mutually agreeable release of claims against theCompany. The Company also granted Mr. Kouninis stock options to purchase450,000 shares of the Company’s common stock at an exercise price of $1.00 pershare. The options have a ten year term, less one day. Twenty five percent(25%) of the options vested on the date of grant, and the remainder will vestin equal monthly installments over the two-year period from the date of grant,provided that Mr. Kouninis remains employed by the Company. If the Companyundergoes a change in control, as defined in his employment agreement, thestock options granted above will fully vest upon the change in control.

On February 8, 2006, theCompany entered into an employment agreement with Michael Bradley to serve asits Controller. The principal terms of the employment agreement are as follows:(i) Mr. Bradley will be paid a base salary of $140,000 per year; (ii) any bonuspayment made to Mr. Bradley will be at the discretion of the CEO; (iii) anautomobile allowance in the amount of $7,800 per annum and (iv) Mr. Bradleywill be eligible to participate in the Company’s existing benefit plans. Inaddition, the employment agreement will have a term of three years withprovision for automatic renewal for successive one year terms. If Mr. Bradleyis terminated by the Company for any reason other than cause, as defined in hisemployment agreement, or if he should resign for good reason, as defined in hisemployment agreement, Mr. Bradley will be entitled to receive, for a period ofsix months following termination, his base salary at the rate in effect on thedate of termination. The obligation to pay severance is conditioned upon Mr.Bradley’s execution of a mutually agreeable release of claims against theCompany. The Company also granted Mr. Bradley stock options to purchase 350,000shares of the Company’s common stock at an exercise price of $1.00 per share.The options have a ten year term, less one day. Twenty five percent (25%) ofthe options vested on the date of grant, and the remainder will vest in equalmonthly installments over the two-year period from the date of grant, providedthat Mr. Bradley remains employed by the Company. If the Company undergoes achange in control, as defined in his employment agreement, the stock optionsgranted above will fully vest upon the change in control.

**11. Related Party Transactions**

In 2004, we entered intoan Exclusive Field of Use License Agreement and Product Sale Agreement withWynn Starr Special Products, LLC. Under the terms of this agreement and itssubsequent amendments, we granted Wynn Starr the exclusive, worldwide right tomarket and distribute products used as post-harvesting processing aids, orchemicals that assist with microbial reduction and shelf life extension withoutchanging food characteristics, for the poultry industry based on the pHarlotechnology. In return for this license, Wynn Starr has agreed to pay us aroyalty of $70.00 per gallon on all net sales (as defined in the ExclusiveField of Use License Agreement and Product Sale Agreement) sold by Wynn Starrfor which payment is received from customers. As of June 30, 2006 no royaltieswere due and none had been paid to us under this royalty arrangement. TheCompany is currently renegotiating an amendment to this royalty arrangement toalign its terms to the current market demand for the product. Steven B.Zavagli, one of the Companys’s directors, is the founder, Chairman and theChief Executive Officer of Wynn Starr and Wynn Starr’s ultimate parent company,Wynn Starr Flavors, Inc.

14

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TheCompany paid Mr. Gordon O. Davis, the former Chairman of the board ofdirectors, approximately $20,000 for consulting services during the quarterended March 31, 2006.

**12. Sale of Equity Securities**

On January 26, 2006, theCompany, entered into a Securities Purchase Agreement (the “Purchase Agreement”)with accredited investors pursuant to which the Company sold 13,335,925 unitsconsisting of one share of common stock and a warrant to purchase one share ofcommon stock at an exercise price of $1.00 per share for $0.70 per unit. TheCompany also entered into a Registration Rights Agreement with such accreditedinvestors pursuant to which the Company agreed to file a registration statementwith the SEC covering the resale of the shares of common stock purchasedpursuant to the Purchase Agreement and the shares of common stock receivableupon exercise of the warrants.  On April26, 2006, the Company filed with the SEC a Registration Statement on Form S-1to register these shares for resale. This registration statement is currentlyunder review by the SEC. If such registration statement is not declaredeffective within six months after the filing of the registration statement, theCompany will be required under the terms of the registration rights agreementto pay liquidated damages in the form of additional common stock and warrants.

Emerging Growth Equities,Ltd., a Pennsylvania limited partnership, served as placement agent for thetransaction. The net proceeds to the Company at the closing of this privateplacement, exclusive of the exercise price of the warrants, were approximately$8.7 million.

As compensation foracting as placement agent, Emerging Growth Equities, Ltd. received a cashpayment equal to 6% of the gross proceeds from the private placement, and alsoreceived a warrant exercisable for shares of the Company’s common stock in anamount equal to 6% of the gross proceeds from the sale of the shares andwarrants divided by $0.70. The warrant to Emerging Growth Equities has anexercise price equal to $1.00 and is exercisable immediately for a term of fiveyears.

*Registration Right Agreement:*

In connection withthe January 2006 private placement, the Company also obtained waivers of allclaims for liquidated damages relating to the inability of the Company to havethe registration statement registering resale of securities purchased in theSeptember 2005 private placement declared effective by the deadline specifiedin the Registration Rights Agreement. The Company received these waivers fromshareholders representing more than a majority of all outstanding securitiesissued in connection with the September 2005 private placement. Inconsideration for obtaining the waiver, the Company repriced the warrantsissued to shareholders providing the waiver such that the exercise price of thewarrants issued in connection with the September 2005 private placement wasreduced from $3.00 to $1.00.  Under the waiver, the date by which theregistration statement covering resale of the securities purchased in theSeptember 2005 private placement was required to be declared effective wasextended to May 23, 2006.  While the Company filed a registrationstatement with the SEC on April 26, 2006, the Company believes it is unlikelythat such registration statement will be declared effective by May 23,2006.  The Company believes, however, that it has used its best efforts tocause the registration statement to be declared effective and that, therefore,pursuant to the terms of the applicable registration rights agreement, it willnot be liable for liquidated damages. Should the rights holders dispute that the Company’s best efforts wereused, and the Company either accedes to their assertion or is found to not haveused its best efforts, the estimated maximum amount of liquidated damages forwhich the Company would be liable, assuming (i) ineffectiveness from May 23,2006 to the end of the period covered by the registration agreement and (ii) astock price of $0.37 for periods subsequent to July 26, 2006, is approximately$270,000. Also, the Company believes that as it relates to the January 2006private placement, the Company has used its best efforts to respond to the SECcomments within fifteen days from the date of the receipt of those comments. Asof March 31, 2006, no shares were issuable as liquidated damages under theterms of the January 2006 registration rights agreement. However, if theCompany fails to meet certain conditions of the January 2006 registrationrights agreement, it will be required to issue to each holder in the January2006 private placement, shares and warrants equal to one percent, or 266,718 ofthe respective number of shares and warrants purchased by each holder, for each30 days of failure to meet any one of these conditions. The Company may berequired to issue a maximum aggregate of 4 million shares and warrants.

##  **13. Restructuring Charges**

During the fourth quarter of fiscal year 2005 theCompany recorded and paid approximately $29,000 of severance to one executiveand five staff members. Seven more staff members were terminated but noseverance was paid to them during this time period. Additionally, in a separatecost reduction action during the first quarter of fiscal year 2006, the Companyrecorded severance costs of approximately $224,000 for one executive and fouradministrative staff members whose employment was terminated as a result of theCompany’s effort to reduce operating costs. In the first fiscal quarter of2006, the Company paid $117,000 of the $224,000 severance obligation itrecorded in the same quarter. Consequently, the severance obligation accrualbalance as of March 31, 2006 was $107,000.

**14.  Segments — Enterprise Wide Disclosures**

The Company owns severalutility patents that allow it to produce, market and distribute certain productapplications related to these utility patents. In 2005, the Company beganselling two product applications, Unifresh® Footbath and Close CallTM. The ChiefOperating Decision Maker (CODM) of the Company is the President and CEO. Theoperating results of each product application, other than for revenue, are notseparately tracked or reported. Operating results by product application arenot reviewed by the CODM because discrete financial information is notavailable. Consequently, as permitted by the provisions of SFAS No. 131, “DisclosureAbout Segments of an Enterprise and Related Information,” the Company has onereportable segment for financial statement purposes.

*Revenueby Product*

The Company’srevenue by product is as follows:

|                          | ** ** | **Three Months Ended March 31,** | ** ** |
|--------------------------|------------|------------------------------------------------------|------------|
| ** **               | ** ** | **2006**                                             | ** ** | **2005** | ** ** |
| ** **               | ** ** | **(in thousands)**                              | ** ** |
| Unifresh®  Footbath |       | $                                                    | 129        |   | $ | — |   |
| Close CallTM         |       | 92                                                   |       | 61 |   |
|                     |       | $                                                    | 221        |   | $ | 61 |   |

 

## *Dependenceon Certain Customers*

The Company’sdependence on certain customers as a percentage of total revenue is as follows:
|            | ** ** | **Three Months Ended  March 31,** | ** ** |
|------------|------------|--------------------------------------------------|------------|
| ** ** | ** ** | **2006**                                         | ** ** | **2005** | ** ** |
| Customer A |       | 36.5                                             | %          | — | % |
| Customer B |       | —                                           | %          | 14.1 | % |

 

**Item 2. Management’s Discussion AndAnalysis of Financial Condition And Results Of Operations**

This Form 10-Q, as wellas our other reports filed with the SEC, and our press releases and othercommunications, contain forward-looking statements. Forward-looking statementsinclude all statements regarding our expected financial position, results ofoperations, cash flows, dividends, financing plans, strategy, budgets, capitaland other expenditures, competitive positions, growth opportunities, benefitsfrom new technology, plans and objectives of management, and markets for stock.These forward-looking statements are based largely on our expectations and,like any other business, are subject to a number of risks and uncertainties,many of which are beyond our control. In some cases, you can identifyforward-looking statements by words such as *“may,”“should,” “expect,” “plan,” “could,” “anticipate,” “intend,” “believe,” “estimate,”“predict,” “potential,” “goal,”* or *“continue”*or similar terminology.

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Forward-looking statements are not guarantees ofperformance. They involve risks, uncertainties and assumptions. Future resultsmay differ materially from those expressed in the forward-looking statements.Many of the factors that will determine these results are beyond our ability tocontrol or predict. Current and potential investors are cautioned not to putundue reliance on any forward-looking statements, which speak only to the datemade.

For a discussion of someof the factors that may cause actual results to differ materially from thosesuggested by the forward-looking statements, please read carefully theinformation under “Risk Factors” in our annual report of Form 10-KSB for theyear ended December 31, 2005 and in our other filings with the SEC. Some of therisks that current and potential investors should be aware of include, but arenot limited to, the following:

·                           Ourlimited operating history in our present markets;

·                           Ourlimited experience in marketing our products;

·                           Ourneed to obtain regulatory approval for the manufacturing of some of our currentproducts and products under development;

·                           Ourability to protect our intellectual property rights;

·                           Intensecompetition in our current markets;

·                           Ourproducts, like most regulated products, may be subject to various enforcementactions, which could require, among other things, the relabeling, reformulationor recall of products and/or the submission of additional information insupport of product claims or safety, or punitive actions, any of which couldharm our reputation and business; and

·                           We do not maintain effectivecontrols and procedures and we consistently had material weaknesses in ourinternal controls over financial reporting.

The identification inthis document of factors that may affect future performance and the accuracy offorward-looking statements is meant to be illustrative and by no meansexhaustive. All forward-looking statements should be evaluated with theunderstanding of their inherent uncertainty.

**Company Overview**

We are a manufacturer, distributor and marketer ofproducts using a patented process, which we refer to as the “pHarlo technology,”that utilizes a highly charged and acidified, yet stable and safe, solutionthat enables copper sulfate, a compound with bacteriostatic properties, toremain active throughout a wide range of pH values. We currently market:

·                           CloseCall TM , an oral hygiene breath drink;

·                           UnifreshTM Footbath, a grooming aid for dairy cows; and

·                           Tasker Pacific Blue SeafoodWash

The Company is also inthe process of conducting tests of the pHarlo technology for other pre- andpost-harvest food processing applications.

  On December 7,2005 we announced that we intended to concentrate our efforts on thedevelopment and commercialization of our poultry processing products, seafoodprocessing applications, and Unifresh® Footbath and Unifresh® Pen Spray products.We also announced that we intended to seek to license and/or sell the CloseCall TM brand and derivative applications.

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In August 2005, we began the in-plant commercialverification process for USDA approval to use the pHarlo technology in thescalder process of poultry processing. In January 2006 we received initialapproval from the USDA to continue in-plant testing in two additional plantsand we expect to complete these tests in the second quarter of 2006, at whichtime we will seek further USDA approval for full commercialization of theproduct.

Initial tests of ourpoultry pen spray application began during the fourth quarter of 2005 atpoultry farms in France. This application was created to reduce or neutralizethe ammonia byproduct generated by the birds’ natural waste during their growthphase. During the first quarter of 2006, we began a second phase of testingdesigned to attain a statistically acceptable measure of the product’seffectiveness under varying conditions. The second phase of tests is expectedto be completed during the second quarter of 2006. Upon the successful completionof these tests, we intend to apply for regulatory approval in the US tocommercialize the product. Additionally, we began testing our poultry pen sprayin the United States early in the second quarter of 2006. We believe that useof our poultry pen spray in the United States is approved under the existinggenerally recognized as safe (GRAS) determination by the Food and DrugAdministration (FDA). Consequently when the tests are completed to oursatisfaction and to the satisfaction of our advisors we will start marketingthe product in the United States.

**Financial Overview**

As a result of anacquisition in July 2005, we now own certain utility patent applications andprovisional patent applications associated with the pHarlo technology includingfor pre-harvest and post-harvest food processing, skin care, pet products,hangover remedy, alcohol abatement and water purification applications.

For the first threemonths of fiscal 2006, our revenue increased to approximately $221,000 fromapproximately $61,000 in the same period of the prior year. This increase wasprimarily attributable to sales of our Unifresh TM Footbath concentrate, a grooming aid for dairycows, a product acquired in the July 2005 acquisition. We expect to continue togrow revenue during fiscal 2006 as a result of our increased sales andmarketing efforts.

We had a net loss ofapproximately $4,925,000 in the three months ended March 31, 2006 compared to anet loss of $3,284,000 in the three months ended March 31, 2005. Excluding thestock compensation expense of $1,720,000 our net loss for the three monthsended March 31, 2006 decreased by approximately $80,000 as compared to the netloss for the same period in 2005. The stock compensation expense is due to theadoption of SFAS 123R “Share Based Payment”. As a result of the adoption ofSFAS 123(R), the fair value of all stock-based compensation is now recorded asexpense in our financial statements, rather than as a footnote disclosure.

There is no guaranteethat we can achieve profitability on a quarterly or annual basis in the future.If revenues grow slower than anticipated, or if operating expenses exceedexpectations, or cannot be reduced timely, we will continue to experiencelosses and the results of operations and financial condition will be materiallyand adversely affected.

**Related Party Transactions**

In 2004, we entered intoan Exclusive Field of Use License Agreement and Product Sale Agreement withWynn Star Specialty Flavors LLC (“Wynn Starr”). Under the terms of thisagreement and its subsequent amendments, we granted Wynn Starr the exclusive,worldwide right to market and distribute products used as post-harvestingprocessing aids for the poultry industry based on the pHarlo technology. Inreturn for this license, Wynn Starr has agreed to pay us a royalty of $70.00per gallon on all net sales (as defined in the Exclusive Field of Use LicenseAgreement and Product Sale Agreement) sold by Wynn Starr for which payment isreceived from customers. No such royalties have accrued or paid to date and weare currently renegotiating the royalty payments associated with the ExclusiveField of Use License Agreement and Product Sale Agreement. Steven Zavagli, oneof our directors, is the founder, Chairman and the Chief Executive Officer ofWynn Starr and Wynn Starr’s ultimate parent company, Wynn Starr Flavors.

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We paid Mr. Gordon O. Davis, the former Chairman ofour board of directors, approximately $20,000 for consulting services duringthe quarter ended March 31, 2006.

**Critical Accounting Policies andEstimates**

We believe that severalaccounting policies are important to understanding our historical and futureperformance. We refer to these policies as “critical” because these specificareas generally require us to make judgments and estimates about matters thatare uncertain at the time we make the estimate, and different estimates—whichalso would have been reasonable—could have been used, which would have resultedin different financial results.

The critical accountingpolicies we identified in our most recent Annual Report on Form 10-KSB for thefiscal year ended December 31, 2005 related to goodwill and intangible assets,valuation of acquired intangible assets, derivative liabilities and inventoryvaluation and classification. With the adoption of SFAS 123(R) on January 1,2006, we have identified the estimates and assumptions that accompany the fairvalue determination of our stock option awards as critical, as discussed below.It is important that the discussion of our operating results that follows beread in conjunction with the critical accounting policies discussed below aswell as those disclosed in our Annual Report on Form 10-KSB, as filed with theSEC on March 31, 2006.

**Stock-Based Compensation**

Effective January 1,2006, we adopted accounting rules (SFAS 123(R), “Share-Based Payment”)requiring the expense recognition of the estimated fair value of allshare-based payments issued to employees. Prior to this, the estimated fairvalue associated with such awards was not recorded as an expense, but ratherwas disclosed in a footnote to our financial statements. For the quarter endedMarch 31, 2006, we recorded approximately $1.72 million of expense associated withshare-based payments, with the majority of this expense, approximately $1.68million, attributable to employee stock options.

The valuation of employeestock options is an inherently subjective process, since market values aregenerally not available for long-term, non-transferable employee stock options.Accordingly, an option pricing model is utilized to derive an estimated fairvalue. In calculating the estimated fair value of our stock options, we used aBlack-Scholes pricing model which requires the consideration of the followingsix variables for purposes of estimating fair value:

·                    the stock option exercise price,

·                    the expected term of the option,

·                    the grant date price of our commonstock, which is issuable upon exercise of the option,

·                    the expected volatility of ourcommon stock,

·                    expected dividends on our commonstock (we do not anticipate paying dividends for the foreseeable future), and

·                    the risk free interest rate for theexpected option term.

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Of the variables above, the selection of an expectedterm and expected stock price volatility are the most subjective. Our estimateof the expected option term was 6.1 years and was derived based on the averageof the sum of the vesting term and the original contract term. In estimatingour stock price volatility, we analyzed our historic volatility for a periodequal to the expected term of our stock options awarded in the first fiscalquarter ended March 31, 2006, by reference to actual stock prices during thisperiod and calculated an estimated volatility of 135%. We believe that each ofthese estimates, both expected term and volatility, is reasonable in light ofthe data we analyzed. However, as with any estimate, the ultimate accuracy ofthese estimates is only verifiable over time.

The specific valuationassumptions noted above were applied to stock options that we grantedsubsequent to our adoption of SFAS 123(R). The majority of the stock optionexpense recorded in the quarter ended March 31, 2006 relates to options grantedin the quarter ended March 31, 2006. We expect that stock compensation expensewill continue to have a material impact on our financial results for theremainder of the fiscal year. For the remainder of fiscal 2006 we expect toincur stock compensation expenses of approximately $825,000 per quarter.

**Three Months Ended March 31, 2006Compared to Three Months Ended March 31, 2005**

**Revenues**

Revenues for the threemonths ended March 31, 2006 were approximately $221,000 compared withapproximately $61,000 for the corresponding period in 2005. This increase inrevenue was due primarily to revenue associated with sales of Unifresh®Footbath. The revenue for the three months ended March 31, 2005, was entirelydue to sales of Close Call TM . We expect that revenue will continue to increasethroughout fiscal year 2006 upon the successful marketing of existing productsand the securing of regulatory approvals for certain applications that itintends to market. While waiting for regulatory approvals, we are aggressivelymarketing our existing products, building our network of distributors and weare identifying prospective customers.

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**Product Development**

Product developmentconsists primarily of personnel costs to support product development whichcontinued to be a major focus of our company for the first quarter of 2006.Product development and research costs for the three months ended March 31,2006 increased by approximately $34,000 or 10% to approximately $375,000 fromapproximately $341,000 for the three months ended March 31, 2005. The increasewas primarily due to a $74,000 increase in compensation costs, due to increasedstaffing, and an increase in stock based compensation of approximately $40,000,which was partially offset by a decrease of consulting expenses ofapproximately $100,000. We expect that in fiscal 2006 product developmentexpense will increase as a percentage of revenue as new product lines aretested and developed.

**Selling, General and Administrative**

Selling, General, andAdministrative (“SGA”) expenses are primarily comprised of sales and marketingcosts, compensation, professional fees, and general administrative costs. SGAcosts for the three months ended March 31, 2006 increased by approximately $1.2million from $2.9 million for the three months ended March 31, 2005, to $4.1million for the three months ended March 31, 2006. We anticipate that SGA costswill continue to decrease, as a percentage of revenues, in fiscal year 2006.

Sales and marketingexpenses consist primarily of salaries and other related costs for sales andmarketing personnel, sales commissions, promotional expenses, advertising,public relations and trade shows. Sales and marketing costs increased byapproximately $52,000 due to marketing research, branding and promotion for ourUnifresh ® Footbath product line roll-out, as well asincreased compensation expense for an increase in sales force personnel.

Compensation expenseconsists primarily of salaries and other related costs for senior management,finance and administrative employees of our company. Compensation expenseincreased by approximately $416,000 primarily due to an increase in severancecosts associated with a reduction in administrative and warehouse personnel ofapproximately $224,000, and to a lesser extent due to salaries for personnelfrom the July 2005 acquisition of approximately $192,000.

Professional fees for thethree months ended March 31, 2006 decreased by $1.1 million primarily due to anon-cash charge decrease of approximately $1.2 million for stock options issuedto an investor relations consultant for services provided in the three monthsended March 31, 2005.

General andadministrative expenses consist primarily of rent, insurance and travel andentertainment expenses. The increase in general administrative costs for the threemonths ended March 31, 2006 by approximately $658,000 was primarilyattributable to an accrual for a settlement fee of approximately $369,000 forthe termination of minimum purchase commitments obligations for Close Callbottles which was settled for $249,000, an increase in rent and associatedutility expenses for the Texas facility, acquired in the July 2005 acquisition,of approximately $72,000, an increase in travel and entertainment expenses ofapproximately $50,000, an increase in insurance cost of approximately $50,000, anincrease in rent expense for the corporate office of approximately $48,000, an increasein telecommunication cost of approximately $45,000, an increase of $50,000 dueto a settlement in principle of the “BOC” claim discussed under legalproceedings and other miscellaneous expenses of approximately $23,000.

Stock based compensationexpense increased by approximately $1.2 million, to $1.7 million for the threemonths ended March 31, 2006, from $484,000 for the three months ended March,2005. This increase is associated with share-based payments in connection withour adoption of SFAS 123(R) on January 1, 2006. The expense associated withthese awards is recorded as expense within the same functional expense categoryas cash compensation for the respective employee is recorded. For the threemonths ended March 31, 2006, stock compensation expense was allocated asfollows:

| Sales and marketing         |   | $         | 183,000   |   |
|-----------------------------|--------|-----------|-----------|--------|
| Product  development        |   | 57,000    |      |
| General and  administrative |   | 1,480,000 |      |
|                        |   | $         | 1,720,000 |   |

 

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**Depreciation and Amortization Expense**

Depreciation andamortization expense, which includes the amortization of identifiableintangible assets, increased by approximately $562,000 from approximately$12,000 in the three months ended March 31, 2005, to approximately $574,000 forthe three months ended March 31, 2006, primarily due to the amortization of ourutility patent intangible. This intangible has a current estimated value ofapproximately $21 million and is being amortized over 11.5 years.

**Interest Expense**

Interest expensedecreased by approximately $87,000 from $114,000 for the three months endedMarch 31, 2005 to approximately $27,000 for the three months ended March 31,2006 primarily due to a reduction in interest payable for convertible debt.

**Interest Income**

Interest income decreasedby approximately $7,000 from $46,000 for the three months ended March 31, 2005to approximately $39,000 for the three months ended March 31, 2006 primarilydue to a decreased cash balance in the three months ended March 31, 2006, ascompared to the same period ending March 31, 2005.

**Other expenses, net**

We incurred otherexpenses, net of approximately $46,000 for the three months ended March 31,2006 as compared to no expense in the three months ended March 31, 2005. Weaccrued approximately $87,000 for (i) liquidating damages for failure tohave a current prospectus available for the resale of common stock sold in theApril 2004 and July 2004 private placements and (ii) a loss on a disposal of avehicle in the amount of $50,000 as a result of the Settlement and ReleaseAgreement we entered into with a former executive. This increase in expense waspartially offset by the reduction of the fair market value of the registrationrights liability by approximately $85,000.

**Liquidity and Capital Resources**

**Overview**

Since our inception, wehave funded operations and investing activities through the issuance of commonstock and other financing activities under several private placements.Requirements for liquidated damages under some of our private placements mayhave an impact on our future liquidity. To date we have satisfied and/orreceived waivers for the provisions of a majority the agreements that wouldhave otherwise required us to pay liquidated damages. At March 31, 2006, theCompany’s derivative liability balance, related to the April 2004 and July 2004registration rights agreements, was approximately $150,000. Additionally,included in the other accrued liabilities at March 31, 2006 is approximately$373,000 of incurred liquidated damages associated with the April 2004 and theJuly 2004 convertible debentures. The Company has not incurred anyliquidated damages liabilities related to any of its other registration rightsagreements.

We may be unable to meet our future capitalrequirements. We may require additional financing in the future in order tocontinue to implement our product and services development, marketing and othercorporate programs. We may not be able to obtain such financing or obtain it onacceptable terms. Without additional financing, we may be forced to delay,scale back or eliminate some or all of our product and services development,marketing and other corporate programs. If we are able to obtain suchfinancing, the terms may contain restrictive covenants that might negativelyaffect our common stock, such as limitations on payments of dividends or, inthe case of a debt financing, reduced earnings due to interest expenses. Anyfurther issuance of equity securities would likely have a dilutive effect onthe holders of our common stock. Our business, operating results and financialcondition may be materially harmed if revenues do not develop or grow slowerthan we anticipate, if operating expenses exceed our expectations or cannot bereduced accordingly, or if we cannot obtain additional financing.

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Based upon our forecastof future revenues from our products in conjunction with the cash andmarketable securities on hand, cash expected to be generated from operationswill provide adequate funding for the Company’s working capital over the nextnine months.  As with all business forecasts, management’s currentassessment of future revenues is based upon its assumptions andexpectations.  Future market trends for its products may not develop asmanagement has predicted, and regulatory approvals required to market productsas the Company currently plans may not be obtained, and, in the future, theCompany may find that its cash on hand and cash from operations is not sufficientto fund existing operations or new opportunities may present themselves overthe course of the next twelve months, in which case the Company may find thatits cash on hand and cash from operations is not sufficient. Such changes may,or may not, require it to seek additional outside funding and, if required,there can be no assurance that suitable outside financing will be available tothe Company.

**Operating Activities**

At March 31, 2006 ourcash, cash equivalents and marketable securities balances were approximately $7million compared with $1.0 million at December 31, 2005.

Net cash used inoperating activities for the three months ended March 31, 2006 wasapproximately $2.5 million, compared to net cash used in operating activitiesof approximately $1.9 million for the three months ended March 31, 2005.

We have also fullyreserved our note receivable of $890,000 from the Biofilm shareholders as thereis no assurance that it is collectible. Also see discussion under “Off-BalanceSheet Arrangements”.

**Investing Activities**

Net cash used ininvesting activities for the three months ended March 31, 2006 wasapproximately $3.5 million as compared to approximately $3.0 million for thethree months ended March 31, 2005.

As of March 31, 2006approximately $3.4 million of the January 2006 private placement proceeds areinvested in marketable securities.

**Financing Activities**

Net cash provided byfinancing activities during the three months ended March 31, 2006 wasapproximately $8.5 million, as compared to approximately $128,000 for the threemonths ended March 31, 2005.

The net cash provided byfinancing activities for the three months ended March 31, 2006 principallyrepresents proceeds from the sale of common stock and warrants. In January2006, we completed a private placement in which we raised gross proceeds of$9.3 million through the sale of 13,335,295 shares of our common stock at apurchase price of $.70 per share, which were sold together with warrants topurchase an additional 13,335,295 shares of our common stock at an exerciseprice of $1.00.

As partial considerationfor the purchase of the pHarlo assets in the July 2005 acquisition, we issued apromissory note in the amount of $1,931,973 to Indian River Labs, L.L.C. (“IRL”).The promissory note bears interest of 3.4% per annum and is payable in equalbi-weekly principal installments of $37,153, plus interest, through July 2007.During the quarter ended March 31, 2006 we paid approximately $260,000 underthe IRL promissory note.

**Registration Rights Agreement**

In connection withthe January 2006 private placement, we obtained waivers of all claims forliquidated damages relating to our inability to have the registrationstatement registering resale of securities purchased in the September 2005 privateplacement declared effective by the deadline specified in the RegistrationRights Agreement. We received these waivers from shareholders representingmore than a majority of all outstanding securities issued in connection withthe September 2005 private placement. In consideration for obtaining thewaiver, we repriced the warrants issued to shareholders providing thewaiver such that the exercise price of the warrants issued in connection withthe September 2005 private placement was reduced from $3.00 to $1.00.  Underthe waiver, the date by which the registration statement covering resale of thesecurities purchased in the September 2005 private placement was requiredto be declared effective was extended to May 23, 2006.  While we filed aregistration statement with the SEC on April 26, 2006, we believe it isunlikely that such registration statement will be declared effective by May 23,2006.  We believe, however, that it we have used our bestefforts to cause the registration statement to be declared effective and that,therefore, pursuant to the terms of the applicable registration rightsagreement, we will not be liable for liquidated damages. . Should the rights holders dispute that theCompany’s best efforts were used, and the Company either accedes to theirassertion or is found to not have used its best efforts, the estimated maximumamount of liquidated damages for which the Company would be liable, assuming(i) ineffectiveness from May 23, 2006 to the end of the period covered by theregistration agreement and (ii) a stock price of $0.37 for periods subsequentto July 26, 2006, is approximately $270,000. Also, the Company believes that asit relates to the January 2006 private placement, the Company has used its bestefforts to respond to the SEC comments within fifteen days from the date of thereceipt of those comments. As of March 31, 2006, no shares were issuable asliquidated damages under the terms of the January 2006 registration rightsagreement. However, if the Company fails to meet certain conditions of theJanuary 2006 registration rights agreement, it will be required to issue toeach holder in the January 2006 private placement, shares and warrants equal toone percent, or 266,718 of the respective number of shares and warrantspurchased by each holder, for each 30 days of failure to meet any one of theseconditions. The Company may be required to issue a maximum aggregate of 4million shares and warrants.

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**Off-Balance Sheet Arrangements**

During the three monthsended March 31, 2006, we did not engage in material off-balance sheetactivities, including the use of structured finance, special purpose entities;material trading activities in non-exchange traded commodity contracts; ortransactions with persons or entities that benefit from their non-independentrelationship with us.

In April 2005, wepurchased from Electric Aquagenies Unlimited, Inc. 359,000 common shares ofBiofilm, representing 27% of Biofilm’s outstanding common stock, for cashconsideration of $718,000. We believe that our 27% equity interest in Biofilmis a significant variable interest, as defined by FIN 46(R) “ *Consolidation of Variable Interest Entities*“, however we believe that we are currently not the primary beneficiary ofBiofilm and thus we would not be required to consolidate the accounts ofBiofilm. We believe that our maximum exposure to loss as a result of ourinvolvement with Biofilm is limited to our initial investment of $718,000

**Contractual Obligations andCommitments**

  We had thefollowing commitments as of March 31, 2006, which are comprised primarily of aresearch and development fee contract, consulting and employment contracts, avendor agreement, notes payable, as well as numerous operating leases:
| ** **                                                 | ** ** | **Payments Due by Period** | ** **    |
|------------------------------------------------------------|------------|-------------------------------------------|---------------|
| ** **                                                 | ** ** | ** **                                | ** **    | **Less Than** | ** ** | **1-3** | ** ** | **3-5** | ** ** | **More Than** | ** ** |
| **Contractual Obligations**                           | ** ** | **Total**                                 | ** **    | **1 Year** | ** ** | **Years** | ** ** | **Years** | ** ** | **5 Years** | ** ** |
| Research &  development (“R&D”) fees (1) |       | $                                         | 150,000       |   | $ | 150,000 |   | $ | — |   | $ | — |   | $ | — |   |
| Consulting agreements                                      |       | 194,267                                   |          | 194,267 |   | — |   | — |   | — |   |
| Employment agreements  (2)                                 |       | 2,295,433                                 |          | 970,850 |   | 1,324,583 |   | — |   | — |   |
| Vendor agreements                                          |       | 150,000                                   |          | 150,000 |   | — |   | — |   | — |   |
| Operating leases                                           |       | 1,345,252                                 |          | 295,395 |   | 987,628 |   | 62,228 |   | — |   |
| Note(s) payable                                            |       | 1,741,699                                 |          | 691,266 |   | 1,042,198 |   | 8,235 |   | — |   |
| **Total**                                                  | ** ** | **$**                                     | **5,876,651** | ** ** | **$** | **2,451,778** | ** ** | **$** | **3,354,409** | ** ** | **$** | **70,463** | ** ** | **$** | **—** | ** ** |

 

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(1) On January 26, 2006,R&D fees payable under the Sub-License Agreement with pHarlo IP wereamended so that these fees are (i) payable on a quarterly basis within 30 daysafter the end of each calendar quarter and (ii) are based on gross sales of ourCompany (or our affiliates) of products using the pHarlo technology. For fiscalyear 2006, the R&D Fees must not be less than $150,000 and are capped at$500,000. The R&D Fees have no minimum amounts payable after 2006; however,they are capped at $2,000,000 for 2007, $4,000,000 for 2008, $8,000,000 for2009 and $10,000,000 for 2010 and beyond.

(2) Subsequent toDecember 31, 2005, we terminated several of our existing employment agreementswith some of our senior management and entered into new employment agreementswith our current executive management. As of March 31, 2006 the revisedestimated future minimum annual compensation under these employment agreements,including the new and terminated agreements for 2006, 2007, 2008 and 2009 isapproximately $970,850, $687,800, $587,800 and $49,000, respectively.

**Item 3.Quantitative and Qualitative Disclosures about Market Risk**

**Interest Rate Risk**

Our exposure to marketrisk, including changes in interest rates, relates primarily to changes in themarket value of our investment in marketable securities. These investments bearinterest at a variable interest rate, which is subject to market changes. Wehave not entered into any interest rate swap agreements, or other instrumentsto minimize our exposure to interest rate fluctuations. We have not had anyderivative instruments in the past and do not presently plan to in the future.Our investment portfolio consists of demand deposits and marketable securities.Due to the highly liquid nature of our investment, a sudden sharp change ininterest rates would not have a material adverse effect on the value of theportfolio.

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**Item 4. Controls and Procedures**

As required by Rule13a-15 under the Securities Exchange Act of 1934 (the “Exchange Act”), wecarried out an evaluation of the effectiveness of the design and operation ofour disclosure controls and procedures as of the end of the period covered bythis report. This evaluation was carried out under the supervision and with theparticipation of our Chief Executive Officer, Richard Falcone, and ChiefFinancial Officer, Stathis Kouninis.

Disclosure controls andprocedures are controls and other procedures that are designed to ensure thatinformation required to be disclosed in our reports filed or submitted underthe Exchange Act is recorded, processed, summarized and reported, within thetime periods specified in the Securities and Exchange Commission’s rules andforms. Disclosure controls and procedures include, without limitation, controlsand procedures designed to ensure that information required to be disclosed inour reports filed under the Exchange Act is accumulated and communicated tomanagement, including our Chief Executive Officer and Chief Financial Officer,to allow timely decisions regarding required disclosure.

Based upon thatevaluation, our Chief Executive Officer and Chief Financial Officer concludedthat our disclosure controls and procedures as of the end of the period coveredby this report were not effective. As described in our Quarterly Reportsthroughout 2005 and under Item 9A of Part II in our Annual Report on Form10-KSB for the year ended December 31, 2005, we have already institutedand are continuing to implement, corrective actions with respect to thedeficiencies in our disclosure controls and procedures.

Although we haveinstituted and are continuing to implement corrective actions with respect tothe deficiencies in our disclosure controls and procedures, such correctiveactions were not sufficient to detect an error in our Excel spreadsheet for thecalculation of certain line items in the column captioned “May 13, 1996(inception) to December 31, 2005” in our Consolidated Statements of Operationsfor the three years ended December 31, 2005 (the “Inception Column”). As aresult of this error, we reported incorrect values in the Inception Column asfollows:

·                  Althoughthe amount of “Total Expenses” was correct, the components of Total Expenses(i.e., selling, general & administrative; product development; anddepreciation and amortization) were incorrect.

·                  Althoughthe amount of “Total other expense, net” was correct, two of the components ofTotal other expense, net (i.e., interest expense, net and liquidated damages)were incorrect.

Such error was caused bythe lack of an automated financial reporting system and a small accountingstaff that does not allow for a thorough review process. We have engaged aconsultant to design financial reports so that we do not rely on spreadsheets andwe will add additional accounting staff when our financial condition allows usto do so.

As noted above and underItem 9A of Part II in the our Annual Report on Form 10-KSB for the year endedDecember 31, 2005, there were changes to the our internal control overfinancial reporting that occurred during the our last fiscal quarter that havematerially affected, or are reasonably likely to materially affect, ourinternal controls over financial reporting.

While every effort willbe made to ensure the financial reporting system will adhere to our internalcontrols, we cannot be certain that additional material weaknesses will not beidentified prior to the filing of management’s annual report on internalcontrol over financial reporting.

**PARTII — OTHER INFORMATION**

**Item 1. Legal Proceedings**

On October 26, 2005, acivil action captioned “The BOC Group, Inc. v. Tasker Capital Corp., RandyCable, and Shaun Porter” was filed in the United States District Court for theDistrict of Connecticut.  In the complaint, The BOC Group alleges that Mr.Porter and Mr. Cable, employees of Tasker, have breached certain restrictivecovenants contained in their employment agreements with The BOC Group, and thatwe tortuously interfered with The BOC Group’s agreements with Mr. Porter andMr. Cable. The BOC Group also claims that we, Mr. Porter and Mr. Cable violatedConnecticut’s statutes governing trade secrets and unfair trade practices. TheBOC Group and we have agreed in principal to resolve the matter by the paymentof $50,000 by us to The BOC Group. The final paperwork reflecting thesettlement and the stipulation of dismissal with prejudice to be filed with theCourt is in the process of being finalized.

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OnJanuary 18, 2006, a civil action captioned “Dallas XXIX Corporate Square, L.P.,v. Coast to Coast Laboratories and Tasker Capital Corp.” was filed in theCircuit Court of Pinellas County, Florida. The plaintiff alleges that Coast toCoast Laboratories Corp., a wholly owned subsidiary of our company, hasbreached a lease agreement and that we have breached a guaranty. Dallas XXIXCorporate Square, L.P. and we have agreed in principal to resolve the matter bythe payment of $25,000 by us to Dallas XXIX Corporate Square, L.P. The finalpaperwork reflecting the settlement and the stipulation of dismissal withprejudice to be filed with the Court is in the process of being finalized.

**Item 1A.Risk Factors**

In addition to the otherinformation set forth in this report, you should carefully consider the factorsdiscussed in “ Risk Factors” in our Annual Report on Form 10-KSB for the yearended December 31, 2005, which could materially affect our business, financialcondition or future results. The risk factors described in our Annual Report onForm 10-KSB are not the only risks facing our Company. Additional risks anduncertainties not currently known to us or that we currently deem to beimmaterial also may materially adversely affect our business, financialcondition and/or operating results.

**Item 2.Unregistered Sales of Equity Securities and Use of Proceeds**

On January 26, 2006,we entered into a Securities Purchase Agreement with several accreditedinvestors pursuant to which the Registrant sold 13,335,925 units, each unitconsisting of one share of common stock and a five-year warrant to purchase oneshare of common stock at an exercise price of $1.00 per share for $0.70 perunit. The gross proceeds to us at the closing of this private placement,exclusive of the exercise price of the warrants, were $9,335,148. EmergingGrowth Equities, Ltd. served as placement agent for the transaction. Ascompensation for serving as placement agent, Emerging Growth Equities, Ltd.received a cash payment equal to 6% of the gross proceeds from the privateplacement, and also received a warrant exercisable for shares of common stockin an amount equal to 6% of the gross proceeds from the sale of the shares andwarrants divided by $0.70. The warrant to Emerging Growth Equities has anexercise price of $1.00 and is exercisable immediately for a term of fiveyears. The aforementioned securities were issued by us in transactions exemptfrom the registration requirements under the Securities Act of 1933, by reasonof Section 4(2) and/or Rule 506 of Regulation D of the SecuritiesAct. Pursuant to the terms of the Securities Purchase Agreement, we were ableto rely upon the representations and warranties provided by the investorscontained therein in connection with the issuance of the aforementionedsecurities without registration.

During the three-monthperiod ended March 31, 2006, we granted the following stock options:

On January 25, 2006, the Registrant issued ten-yearstock options to purchase an aggregate of 4,450,000 shares of common stock, atan exercise price of $1.00 per share, to three non-employee directors of theRegistrant.

On February 3, 2006, the Registrant issued ten-yearstock options to purchase an aggregate of 1,050,000 shares of common stock, atan exercise price of $1.00 per share, to one non-executive employee, oneexecutive officer and one non-employee director of the Registrant.

On March 3, 2006, the Registrant issued ten-year stockoptions to purchase an aggregate of 125,000 shares of common stock, at anexercise price of $1.00 per share, to one consultant of the Registrant.

On March 5, 2006, the Registrant issued ten-year stockoptions to purchase an aggregate of 20,000 shares of common stock, at anexercise price of $1.00 per share, to one non-executive employee of theRegistrant.

The grants of stock options were not registered under theSecurities Act because such grants were exempt from registration pursuant toSection 4(2) of the Securities Act, as they were transactions by an issuerthat did not involve a public offering of securities.

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**Item 6. Exhibits**

See the Exhibit Index for a list of exhibits filed aspart of this Quarterly Report on Form 10-Q/A, which Exhibit Index isincorporated herein by reference.

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**SIGNATURES**

In accordance with therequirements of the Exchange Act, the registrant caused this report to besigned on its behalf by the undersigned, thereunto duly authorized.
|                                   | TASKER CAPITAL CORP. |
|-----------------------------------|----------------------|
|                              |                 |
|                              |                 |
| Date: October  26, 2006 | By:                  | /s/ Stathis Kouninis |   |
|                              |                 | Stathis Kouninis |
|                              |                 | Chief Financial Officer , Treasurer and Secretary  (Principal Financial and Accounting Officer) |

 

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**ExhibitIndex**
| 10.1 |   | Securities Purchase Agreement, dated as of January  26, 2006, by and among Tasker Capital Corp. and the Purchaser parties thereto  (incorporated by reference to Exhibit 10.68 to the Registrant’s Form S-1  filed on April 26, 2006)  |
|------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.2 |   | Registrations Rights Agreement, dated as of January  26, 2006, by and among Tasker Capital Corp. and the Purchaser parties thereto  (incorporated by reference to Exhibit 10.69 to the Registrant’s Form S-1  filed on April 26, 2006) |
| 10.3 |   | Employment Agreement, dated as of February 9, 2006  between Tasker capital Corp. and Richard D. Falcone (incorporated by  reference to Exhibit 10.70 to the Registrant’s Form S-1 filed on April 26,  2006)                            |
| 10.4 |   | Consultant Agreement, dated as of February 9, 2006  between Tasker capital Corp. and Gordon Davis (incorporated by reference to  Exhibit 10.71 to the Registrant’s Form S-1 filed on April 26, 2006)                                   |
| 10.5 |   | Employment Agreement, dated as of February 13, 2006  between Tasker capital Corp. and Stathis Kouninis (incorporated by reference  to Exhibit 10.72 to the Registrant’s Form S-1 filed on April 26, 2006)                              |
| 10.6 |   | Separation Agreement and General Release, dated as  of February 8, 2006 between Tasker capital Corp. and Robert D. Jenkins (incorporated  by reference to Exhibit 10.73 to the Registrant’s Form S-1 filed on April 26,  2006)         |
| 21.1 |   | Subsidiaries of the registrant (incorporated by  reference to Exhibit 21.1 to the Registrant’s Registration Statement on Form  SB-2 filed on August 30, 2005)                                                                          |
| 31.1 |   | Rule 13a-14(a)/15d-14(a) Certification by Principal  Executive Officer                                                                                                                                                                      |
| 31.2 |   | Rule 13a-14(a)/15d-14(a) Certification by Principal  Financial Officer                                                                                                                                                                      |
| 32.1 |   | Section 1350 Certifications by Principal Executive  Officer                                                                                                                                                                                 |
| 32.2 |   | Section 1350 Certifications by Principal Financial  Officer                                                                                                                                                                                 |

 

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