**UNITEDSTATES****SECURITIES AND EXCHANGE COMMISSION****Washington, D.C. 20549**

**Amendment No. 1**

**TO**

**FORM10-Q**
| **(Mark One)**                                                                                                                                              |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                                                                                                                                                        |   |
| **x**                                                                                                                                                       | **QUARTERLY REPORT  PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|                                                                                                                                                        |   |
| **For the  quarterly period ended June 30, 2006**                                                                                                           |
|                                                                                                                                                        |   |
| **o**                                                                                                                                                       | **TRANSITION REPORT  PURSUANT TO SECTION 13 OR 15(d) THE SECURITIES EXCHANGE ACT OF 1934** |
|                                                                                                                                                        |   |
| **For the  transition period from                       to** |

 

**Commission file number 00-32019**

**TASKER PRODUCTS CORP.**(Exact name of registrant as specified in its charter)

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

 

**39 Old Ridgebury Road-Suite 14, Danbury, CT06810-5116**

(Address of principalexecutive offices)

**(203) 730-4350**

(Registrant’s telephonenumber)

**TASKER CAPITAL CORP.**

(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 definitionof “accelerated filer and large accelerated filer” in Rule 12b-2 of theExchange 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 of shares outstanding of the registrant’scommon stock as of August 11, 2006 was 105,026,704.****

 

----

 

**ExplanatoryNote**

 

**TaskerProducts Corp. hereby amends its Quarterly Report on Form 10-Q forthe quarterly period ended June 30, 2006, filed on August 14, 2006, as setforth in this Quarterly Report on Form 10-Q/A (AmendmentNo. 1), in****response to comments from the Securities and ExchangeCommission related to our Registration Statement on Form S-1, as amended, filedon April 26, 2006  **

 

2

----

 

**TASKERPRODUCTS CORP.**

**INDEX**
| **PART I. FINANCIAL  INFORMATION** |                                                                                                         |
|------------------------------------|--------------------------------------------------------------------------------------------------------------|
|                               |                                                                                                         |   |
| **Item 1.**                        | **Financial  Statements**                                                                                    |   |
|                               | Unaudited Condensed Consolidated Balance Sheets as of  June 30, 2006 and December 31, 2005                   |   |
|                               | Unaudited Condensed Consolidated Statements of  Operations for the three months ended June 30, 2006 and 2005 |   |
|                               | Unaudited Condensed Consolidated Statements of  Operations for the six months ended June 30, 2006 and 2005   |   |
|                               | Unaudited Condensed Consolidated Statements of Cash  Flow for the six months ended June 30, 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**    |                                                                                                         |
|                               |                                                                                                         |   |
| **Item 1.**                        | **Legal Proceedings**                                                                                        |   |
|                               |                                                                                                         |   |
| **Item 1A.**                       | **Risk Factors**                                                                                             |   |
|                               |                                                                                                         |   |
| **Item 2.**                        | **Unregistered  Sales Of Equity Securities And Use Of Proceeds**                                             |   |
|                               |                                                                                                         |   |
| **Item 4.**                        | **Submission  of Matters to a Vote of Security Holders**                                                     |   |
|                               |                                                                                                         |   |
| **Item  6.**                       | **Exhibits**                                                                                                 |   |
|                               |                                                                                                         |   |
| **SIGNATURES**                     |                                                                                                         |

 

3

----

 

**PART I —FINANCIAL INFORMATION**

**Item 1. Financial Statements**

**TASKERPRODUCTS CORP. AND SUBSIDIARIES****UNAUDITED CONDENSED CONSOLIDATED BALANCESHEETS****(In thousands except per share data)**
| ** **                                                                                                                                                            | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                            | ** ** | **2006**          | ** ** | **2005**              | ** ** |
| **ASSETS**                                                                                                                                                            |       |              |       |                  |       |
|                                                                                                                                                                  |       |              |       |                  |       |
| Current assets:                                                                                                                                                       |       |              |       |                  |       |
| Cash and cash equivalents                                                                                                                                             |       | $                 | 367        |                  | $          | 1,037 |   |
| Marketable securities                                                                                                                                                 |       | 3,700             |       | —                |       |
| Accounts receivable, net of allowance for doubtful  accounts of $51 and $80 as of June 30, 2006 and December 31, 2005,  respectively                                  |       | 265               |       | 155                   |       |
| Notes receivable                                                                                                                                                      |       | 701               |       | 654                   |       |
| Inventories, net of reserve of $0 and $75 as of June  30, 2006 and December 31, 2005, respectively                                                                    |       | 1,342             |       | 1,351                 |       |
| Prepaid expenses & other current assets                                                                                                                           |       | 211               |       | 192                   |       |
| Total current assets                                                                                                                                                  |       | 6,586             |       | 3,389                 |       |
|                                                                                                                                                                  |       |              |       |                  |       |
| Property and  equipment, net                                                                                                                                          |       | 1,437             |       | 1,525                 |       |
| Investment in  equity investee                                                                                                                                        |       | 656               |       | 665                   |       |
| Intangible  assets, net                                                                                                                                               |       | 8,300             |       | 21,562                |       |
| Goodwill                                                                                                                                                              |       | 23,764            |       | 41,677                |       |
| Deposit, net                                                                                                                                                          |       | 39                |       | 36                    |       |
| Total assets                                                                                                                                                          |       | $                 | 40,782     |                  | $          | 68,854 |   |
|                                                                                                                                                                  |       |              |       |                  |       |
| **LIABILITIES AND STOCKHOLDERS’  EQUITY**                                                                                                                        |       |              |       |                  |       |
| Current liabilities:                                                                                                                                                  |       |              |       |                  |       |
| Convertible debentures                                                                                                                                                |       | $                 | —     |                  | $          | 194 |   |
| Accounts payable                                                                                                                                                      |       | 1,161             |       | 1,740                 |       |
| Notes payable — acquisition of IRL                                                                                                                               |       | 446               |       | 446                   |       |
| Other accrued liabilities                                                                                                                                             |       | 1,487             |       | 1,612                 |       |
| Total current liabilities                                                                                                                                             |       | 3,094             |       | 3,992                 |       |
|                                                                                                                                                                  |       |              |       |                  |       |
| Long-term liabilities:                                                                                                                                                |       |              |       |                  |       |
| Notes payable — shareholders                                                                                                                                     |       | 457               |       | 444                   |       |
| Notes payable — acquisition of IRL                                                                                                                               |       | 595               |       | 1,077                 |       |
| Other long term liabilities                                                                                                                                           |       | 47                |       | 53                    |       |
| Total long-term liabilities                                                                                                                                           |       | 1,099             |       | 1,574                 |       |
|                                                                                                                                                                  |       |              |       |                  |       |
| Stockholders’  equity:                                                                                                                                           |       |              |       |                  |       |
| Common stock, $0.001 par value; 300,000 shares  authorized; 105,002 and 89,167 shares issued and outstanding as of June 30,  2006 and December 31, 2005, respectively |       | 105               |       | 89                    |       |
| Additional paid-in capital                                                                                                                                            |       | 101,163           |       | 89,265                |       |
| Accumulated deficit                                                                                                                                                   |       | (64,679           | )          | (26,066               | )          |
| Total stockholders’ equity                                                                                                                                       |       | 36,589            |       | 63,288                |       |
| Total  liabilities and stockholders’ equity                                                                                                                      |       | $                 | 40,782     |                  | $          | 68,854 |   |

 

See accompanying notes

4

 

----

 

**TASKERPRODUCTS CORP. AND SUBSIDIARIES****UNAUDITED CONDENSED CONSOLIDATED STATEMENTSOF OPERATIONS****(In thousands except per share data)**
| ** **                                        | ** ** | **THREE MONTHS ENDED  JUNE 30,** | ** **  |
|---------------------------------------------------|------------|-------------------------------------------------|-------------|
| ** **                                        | ** ** | **2006**                                        | ** **  | **2005** | ** ** |
|                                              |       |                                            |        |   |   |
| **Revenues**                                      |       | $                                               | 537         |   | $ | 244 |   |
| **Cost of  goods sold**                           |       | 145                                             |        | 84 |   |
| **Gross  margin**                                 |       | 392                                             |        | 160 |   |
|                                              |       |                                            |        |   |   |
| **Expenses**                                      |       |                                            |        |   |   |
| Selling, general & administrative             |       | 2,860                                           |        | 3,158 |   |
| Product development                               |       | 514                                             |        | 620 |   |
| Depreciation and amortization                     |       | 579                                             |        | 25 |   |
| Impairment of goodwill and intangible asset       |       | 30,152                                          |        | — |   |
| **Total  expenses**                               | ** ** | **34,105**                                      | ** **  | **3,803** |   |
|                                              |       |                                            |        |   |   |
| **Loss  from operations**                         | ** ** | **(33,713**                                     | **)**       | **(3,643** | **)** |
|                                              |       |                                            |        |   |   |
| Other income  (expense):                          |       |                                            |        |   |   |
| Interest income                                   |       | 100                                             |        | 44 |   |
| Interest expense                                  |       | (22                                             | )           | (42 | ) |
| Liquidated damages                                |       | (49                                             | )           | (62 | ) |
| Other                                             |       | (4                                              | )           | (10 | ) |
| **Total  other expense, net**                     | ** ** | **25**                                          |        | **(70** | **)** |
|                                              |       |                                            |        |   |   |
| **Net  loss**                                     | ** ** | **$**                                           | **(33,688** | **)** | **$** | **(3,713** | **)** |
|                                              |       |                                            |        |   |   |
| **Net loss per common share,  basic and diluted** | ** ** | **$**                                           | **(0.32**   | **)** | **$** | **(0.06** | **)** |

 

See accompanying notes

5

 

----

 

 **TASKERPRODUCTS CORP. AND SUBSIDIARIES**

**UNAUDITEDCONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS**

**(Inthousands except per share data)**
| ** **                                        | ** ** | **SIX MONTHS ENDED   JUNE 30,** | ** **  |
|---------------------------------------------------|------------|-----------------------------------------------------|-------------|
| ** **                                        | ** ** | **2006**                                            | ** **  | **2005** | ** ** |
|                                              |       |                                                |        |   |   |
| **Revenues**                                      |       | $                                                   | 758         |   | $ | 305 |   |
| **Cost of  goods sold**                           |       | 213                                                 |        | 110 |   |
| **Gross  margin**                                 |       | 545                                                 |        | 195 |   |
|                                              |       |                                                |        |   |   |
| **Expenses**                                      |       |                                                |        |   |   |
| Selling, general & administrative             |       | 6,941                                               |        | 6,032 |   |
| Product development                               |       | 889                                                 |        | 986 |   |
| Depreciation and amortization                     |       | 1,154                                               |        | 37 |   |
| Impairment of goodwill and intangible asset       |       | 30,152                                              |        | — |   |
| **Total  expenses**                               | ** ** | **39,136**                                          | ** **  | **7,055** | ** ** |
|                                              |       |                                                |        |   |   |
| **Loss  from operations**                         | ** ** | **(38,591**                                         | **)**       | **(6,860** | **)** |
|                                              |       |                                                |        |   |   |
| Other income (expense):                           |       |                                                |        |   |   |
| Interest income                                   |       | 138                                                 |        | 90 |   |
| Interest expense                                  |       | (49                                                 | )           | (155 | ) |
| Liquidated damages                                |       | (136                                                | )           | (62 | ) |
| Loss on disposal of vehicle                       |       | (50                                                 | )           | — |   |
| Other                                             |       | 75                                                  |        | (10 | ) |
| **Total  other expense, net**                     | ** ** | **(22**                                             | **)**       | **(137** | **)** |
|                                              |       |                                                |        |   |   |
| **Net  loss**                                     | ** ** | **$**                                               | **(38,613** | **)** | **$** | **(6,997** | **)** |
|                                              |       |                                                |        |   |   |
| **Net loss per common share,  basic and diluted** | ** ** | **$**                                               | **(0.38**   | **)** | **$** | **(0.11** | **)** |

 

See accompanying notes

6

 

----

 

**TASKER PRODUCTS CORP. ANDSUBSIDIARIES**

**UNAUDITEDCONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(In thousands)**
| ** **                                                                    | ** ** | **Six Months Ended June 30,** | ** ** |
|-------------------------------------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                                    | ** ** | **2006**                                          | ** ** | **2005** | ** ** |
| **Cash flows from operating  activities:**                                    |       |                                              |       |   |   |
| Net loss                                                                      |       | $                                                 | (38,613    | ) | $ | (6,997 | ) |
| Adjustments to  reconcile net loss to net cash used in operating activities:  |       |                                              |       |   |   |
| Depreciation and  amortization                                                |       | 1,154                                             |       | 37 |   |
| Non-cash interest -  liquidated damages                                       |       | 136                                               |       | 35 |   |
| Non-cash interest -  interest payable on convertible debentures               |       | 19                                                |       | — |   |
| Non cash - loss on  disposal of vehicle                                       |       | 50                                                |       | — |   |
| Non-cash interest -  note payable and note receivable                         |       | (33                                               | )          | — |   |
| Stock option  compensation expense                                            |       | 2,831                                             |       | 484 |   |
| Impairment charge of  goodwill and intangible asset                           |       | 30,152                                            |       | — |   |
| Allowance for  uncollectible accounts receivable                              |       | 10                                                |       | — |   |
| Loss on equity investee                                                       |       | 9                                                 |       | 11 |   |
| Common stock, warrants  and options for services                              |       | —                                            |       | 2,577 |   |
| Changes in operating  assets and liabilities:                                 |       |                                              |       |   |   |
| Accounts receivable                                                           |       | (120                                              | )          | (225 | ) |
| Inventories                                                                   |       | 9                                                 |       | (1,001 | ) |
| Prepaid expenses                                                              |       | (10                                               | )          | (327 | ) |
| Prepaid commissions                                                           |       | (10                                               | )          | (45 | ) |
| Accounts payable                                                              |       | (489                                              | )          | 706 |   |
| Other accrued  liabilities                                                    |       | (286                                              | )          | (176 | ) |
| Net cash used in  operating activities                                        |       | (5,191                                            | )          | (4,921 | ) |
|                                                                          |       |                                              |       |   |   |
| **Cash flows from investing  activities:**                                    |       |                                              |       |   |   |
| Purchases of  available-for-sale securities                                   |       | (6,350                                            | )          | — |   |
| Proceeds from  available-for-sale securities                                  |       | 2,650                                             |       | — |   |
| Purchases of property  and equipment                                          |       | (93                                               | )          | (430 | ) |
| Repayment of notes                                                            |       | —                                            |       | (3,486 | ) |
| Payment of acquisition  costs                                                 |       | —                                            |       | (572 | ) |
| Investments in equity  investee                                               |       | —                                            |       | (718 | ) |
| Payments for deposits  and other                                              |       | (2                                                | )          | (16 | ) |
| Net cash used in  investing activities                                        |       | (3,795                                            | )          | (5,222 | ) |
|                                                                          |       |                                              |       |   |   |
| **Cash flows from financing  activities:**                                    |       |                                              |       |   |   |
| Proceeds from private  placement                                              |       | 9,335                                             |       | — |   |
| Payment of private placement  broker fees                                     |       | (593                                              | )          | — |   |
| Exercise of  warrants/options                                                 |       | 57                                                |       | 167 |   |
| Repayments on note  payable - IRL                                             |       | (483                                              | )          | — |   |
| Other                                                                         |       | —                                            |       | 1 |   |
| Net cash provided by  financing activities                                    |       | 8,316                                             |       | 168 |   |
|                                                                          |       |                                              |       |   |   |
| **Net decrease in cash and cash  equivalents**                                |       | (670                                              | )          | (9,975 | ) |
| **Cash and cash equivalents,  beginning of period**                           |       | 1,037                                             |       | 14,225 |   |
|                                                                          |       |                                              |       |   |   |
| **Cash and cash equivalents, end  of period**                                 |       | $                                                 | 367        |   | $ | 4,250 |   |
|                                                                          |       |                                              |       |   |   |
| **Supplemental disclosures of  cash flow information:**                       |       |                                              |       |   |   |
| Interest paid                                                                 |       | $                                                 | 13         |   | $ | 27 |   |
| **Supplemental disclosures of  non-cash investing and financing activities:** |       |                                              |       |   |   |
| Fair value of warrants  issued as private placement fees                      |       | $                                                 | 593        |   | $ | — |   |
| Conversion of debt and accrued interest into common  stock                    |       | $                                                 | 194        |   | $ | 270 |   |

 

See accompanying notes

7

 

----

 

**TASKER PRODUCTS CORP. ANDSUBSIDIARIES**

**NOTESTO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

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

Tasker Products Corp. (formerly known as TaskerCapital Corp.) was formed on May 13, 1996 and was in the developmentstage through December 31, 2005. The quarterly period ended March31, 2006 is the first period during which Tasker Products Corp. isconsidered an operating company.

In June 2006 theshareholders of Tasker approved an amendment to Tasker’s articles ofincorporation to change Tasker’s name to Tasker Products Corp. The name changebecame effective on June 28, 2006.

The accompanyingunaudited condensed consolidated financial statements of Tasker Products Corp.and its subsidiaries (collectively, “the Company”) as of June 30, 2006 andDecember 31, 2005 and for the three and six month periods ended June 30, 2006and 2005 reflect all adjustments of a normal and recurring nature to presentfairly the consolidated financial position, results of operations and cashflows for the interim periods.  These unaudited condensed, consolidatedfinancial statements have been prepared by the Company pursuant to theinstructions to Form 10-Q, and Article 10 of Regulation S-X.  Pursuant tosuch instructions, certain financial information and footnote disclosuresnormally included 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 and six monthperiods ended June 30, 2006 are not necessarily indicative of the results thatmay occur for the year ending December 31, 2006.

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

**2. Liquidity**

The Company has incurredlosses in its operations in each quarter since it changed its businessdirection in late 2002. For the three and six months ended June 30, 2006 theCompany has incurred a net loss of approximately $33.7 million and $38.6million, respectively, inclusive of an impairment charge for goodwill andintangible assets of approximately $30.2 million. For the three and six monthsended June 30, 2005 the Company has incurred a net loss of approximately $3.7million and 7.0 million, respectively. In addition the Company has notgenerated positive cash flow from operations for the three and six months endedJune 30, 2006 and 2005. The Company expects to continue to incurlosses for at least the short term. To become profitable, the Companymust increase revenue substantially and achieve and maintain positive gross andoperating margins. If the Company is not able to increase revenue and gross andoperating margins sufficiently to achieve profitability, the Company’s resultsof operations and financial condition will be materially and adverselyaffected.

At June 30, 2006, theCompany had a total of approximately $4.1 million of cash, cash equivalents andmarketable securities as a result of the January 2006 private placement.

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 operationsmay not provide adequate funding for the Company’s working capital over thenext twelve months. The Company is rapidly depleting its cash resourcesand its ability to continue to operate and grow its business is dependent uponobtaining new financing and/or generating revenue growth from operations.  The cost of any new financing may beprohibitive. While the Company has been in the process of aggressivelydeveloping, marketing and selling its products, there can be no assurances thatthose efforts will be met with success in the marketplace or that the timing ofthe Company’s efforts will be consistent with its cash availability and burnrate. If the Company is unable to arrange new financing and/or generatesufficient revenue growth from existing and new business arrangements by thefourth quarter of 2006, the Company will not have sufficient cash to supportits operations and meet its obligations and it will be forced to consider thefurther restructuring of its operations, disposition of various assets, seekingof protection from its creditors, or ceasing of operations and liquidation.TheCompany anticipates that it will need approximately an additional $3 to $5million to support its operations and meet its obligations over the next twelvemonths. The Company is currently reviewing alternative methods of financing,including private issuances of debt and/or equity. 

8

 

----

 

Since the Company’sinception, the Company has funded operations and investing activities throughthe sale of common stock, warrants and convertible debt under several privateplacements. Requirements for liquidated damages under some of these 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. At June 30, 2006, the Company’s derivative liabilitybalance, related to the April 2004 and July 2004 registration rightsagreements, was approximately $150,000. Additionally, included in the otheraccrued liabilities at June 30, 2006 is approximately $130,000 of interestand late fees and approximately $423,000 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.

**3. Impairment of Goodwill and IntangibleAssets**

In the secondquarter of 2006, the Company’s management tested for impairment of itsintangible assets and its goodwill in accordance with Statement of FinancialAccounting Standards (SFAS) No. 144 “Accounting for the Impairment orDisposal of Long-Lived Assets” (SFAS No. 144) and Statement of FinancialStandards No. 142 “Goodwill and Other Intangible Assets” (SFASNo. 142) respectively. The testing was triggered by the following eventsand circumstances that constitute impairment indicators under the literature:

·                         apreliminary expectation that third and fourth quarter 2006 originally projectedrevenues will not be attained;

 

·                         adecrease in expected future cash flows; and

 

·                         adecline in the market price of the Company’s common stock 

 

Upon completion ofthe impairment tests, the Company recorded non-cash impairment charges toidentifiable intangible assets and goodwill of $12.2 million and $17.9 million,respectively.  Note 8 describes the impactof accounting for the adoption of SFAS No. 142, “Goodwill and Other IntangibleAssets”, the impairment tests performed during the second quarter of 2006 andthe underlying assumptions.

**4. Share-Based Payments**

Effective January 1,2006, the Company adopted Statement of Financial Accounting Standard No. 123(revised 2004), “Share-Based Payment” (SFAS 123R). Under SFAS 123(R), theCompany is required to recognize, as expense, the estimated fair value of allshare-based payments to employees. For the three and six months ended June 30,2006, the Company recorded expense of approximately $1.7 million andapproximately $2.8 million, respectively, in connection with its share-basedpayment awards to its employees.

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 six months ended June 30, 2006 based on the grant dateestimate of fair value for those awards. Prior period financial information hasnot been restated.

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 following tableillustrates the effect on net loss and loss per share as if the Company hadapplied the fair value recognition provisions of FASB Statement No. 123,“Accounting for Stock Based Compensation,” to its share based paymentarrangements for the three and six months ended June 30, 2005.

9

 

----

 
|                                                                                                                                               | ** ** | **Three Months  Ended  June 30, 2005**     | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------|------------|
| ** **                                                                                                                                    | ** ** | **(In thousands  except per  share data)** | ** ** |
| Net loss, as  reported                                                                                                                        |       | $                                                         | (3,713     | ) |
| Add: Stock-based  employee compensation expense included in reported net loss                                                                 |       | $                                                         | —     |   |
| Deduct: Total  stock-based employee compensation expense determined under fair value based  method for all awards, net of related tax effects |       | $                                                         | (1,246     | ) |
| Pro forma net  loss                                                                                                                           |       | $                                                         | (4,959     | ) |
|                                                                                                                                          |       |                                                      |       |
| Basic and  diluted net loss per share, as reported:                                                                                           |       | $                                                         | (0.06      | ) |
| Pro forma basic and  diluted net loss per share:                                                                                              |       | $                                                         | (0.08      | ) |

 

10

 

----

 
|                                                                                                                                               | ** ** | **Six Months   Ended  June 30, 2005** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------|------------|
| ** **                                                                                                                                    | ** ** | **(In thousands  except per  share data)** | ** ** |
| Net loss, as  reported                                                                                                                        |       | $                                                         | (6,997     | ) |
| Add: Stock-based  employee compensation expense included in reported net loss                                                                 |       | $                                                         | 484        |   |
| Deduct: Total  stock-based employee compensation expense determined under fair value based  method for all awards, net of related tax effects |       | $                                                         | (3,523     | ) |
| Pro forma net  loss                                                                                                                           |       | $                                                         | (10,036    | ) |
|                                                                                                                                          |       |                                                      |       |
| Basic and  diluted net loss per share, as reported:                                                                                           |       | $                                                         | (0.11      | ) |
| Pro forma basic and  diluted net loss per share                                                                                               |       | $                                                         | (0.16      | ) |

 

Compensation costassociated with employee stock options represented approximately $1.1 millionand $2.8 million, respectively, for the three and six months ended June 30,2006. Stock based compensation expense increased by approximately $1.1 millionand $2.3 million during the three and six months ended June 30, 2006 from noexpense and $484,000 for the three and six months ended June 30, 2005,respectively.

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 options werevalued taking into consideration a forfeiture rate of 6.6% based on historicalexperience and using a straight-line pro-rated method of valuation. Theresulting fair value is recorded as compensation cost on a straight line basisover the option vesting period. The assumptions made for purposes of estimatingfair value under the Black-Scholes model for options granted during the sixmonths ended June 30, 2006 were as follows:
| Dividend yield:                    |   | 0          | %      |
|------------------------------------|--------|------------|--------|
| Expected term of  options (years): |   | 6          |   |
| Risk free  interest rate:          |   | 4.88% -5.0 | 4%     |
| Volatility:                        |   | 132%-13    | 5%     |

 

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 six months ended June 30, 2006, by reference to actual stock pricesduring this period and historic stock prices over the past five years. The riskfree interest rate was based on the five year Treasury note. The specific stockoption valuation assumptions used for awards granted prior to January 1,2006 are as disclosed in the Company’s 2005 annual report on Form 10-KSB, asfiled with the SEC.

11

 

----

 

A summary of stock option activity for the six monthsended June 30, 2006 is as follows:
|                                       | ** ** | **Number of  shares** | ** ** | **Weighted  average  exercise price  per share** | ** ** | **Weighted  average  remaining  contractual  term (years)** | ** ** | **Aggregate  Intrinsic Value** | ** ** |
|---------------------------------------|------------|----------------------------|------------|------------------------------------------------------------|------------|------------------------------------------------------------------|------------|-------------------------------------|------------|
| ** **                            | ** ** | **(In thousands)**    | ** ** | ** **                                                 | ** ** | ** **                                                       | ** ** | **(In thousands)**             | ** ** |
| Outstanding,  December 31, 2005       |       | 16,541                     |       | $                                                          | 0.91       |                                                             |       |                                |       |   |
| Granted                               |       | 5,645                      |       | $                                                          | 1.00       |                                                             |       |                                |       |   |
| Exercised                             |       | (175                       | )          | $                                                          | 0.25       |                                                             |       |                                |       |   |
| Outstanding,  March 31, 2006          |       | 22,011                     |       | $                                                          | 0.94       |                                                             | 8.7        |                                | $          | 4,328 |   |
| Granted                               |       | 530                        |       | $                                                          | 1.00       |                                                             |       |                                |       |   |
| Exercised                             |       | (100                       | )          | $                                                          | 0.25       |                                                             |       |                                |       |   |
| Outstanding,  June 30, 2006           |       | 22,441                     |       | $                                                          | 0.94       |                                                             | 8.4        |                                | $          | 2,213 |   |
| Options exercisable at  June 30, 2006 |       | 16,336                     |       | $                                                          | 0.87       |                                                             | 8.2        |                                | $          | 2,000 |   |

 

The weighted average grant date fair value of optionsgranted during the three months ended June 30, 2006 and 2005 was $0.53 and$2.70, respectively. The total intrinsic value of options exercised during thethree months ended June 30, 2006 was approximately $40,000. No options wereexercised in the three months ended June 30, 2005. As of June 30, 2006 therewas approximately $4.0 million of unrecognized compensation cost related tostock option awards that is expected to be recognized as expense over aweighted average period of 2 years.

The weighted averagegrant date fair value of options granted during the six months ended June 30,2006 and 2005 was $0.69 and $3.00, respectively. The total intrinsic value ofoptions exercised during the six months ended June 30, 2006 and 2005 wasapproximately $122,000 and $1.4 million, respectively.  As of June 30, 2006 there was approximately$4.0 million of unrecognized compensation cost related to stock option awardsthat is expected to be recognized as expense over a weighted average period of2 years.

**5. Net Loss Per Common Share**

The following table setsforth the computation of basic and diluted net loss per common share for thethree and six months ended June 30, 2006 and 2005.
|                                                            | ** ** | **Three Months Ended**                                  | ** ** |
|------------------------------------------------------------|------------|-------------------------------------------------------------------|------------|
| ** **                                                 | ** ** | **June 30,**                                                 | ** ** |
| ** **                                                 | ** ** | **(in thousands except per share data)** | ** ** |
| ** **                                                 | ** ** | **2006**                                                          | ** ** | **2005** | ** ** |
| **Numerator  for basic & diluted net loss per share:** |       |                                                              |       |   |   |
| Net loss                                                   |       | $                                                                 | (33,688    | ) | $ | (3,713 | ) |
| Net loss available to common stockholders                  |       | $                                                                 | (33,688    | ) | $ | (3,713 | ) |
|                                                       |       |                                                              |       |   |   |
| **Denominator:**                                           |       |                                                              |       |   |   |
| Denominator for basic & diluted net loss               |       |                                                              |       |   |   |
| per share - weighted-average shares                        |       | 104,947                                                           |       | 63,707 |   |
|                                                       |       |                                                              |       |   |   |
| **Basic & diluted earnings  net loss per share:**      |       | $                                                                 | (0.32      | ) | $ | (0.06 | ) |

 

12

 

----

 
|                                                                                   | ** ** | **Six Months Ended**                                    | ** ** |
|-----------------------------------------------------------------------------------|------------|-------------------------------------------------------------------|------------|
| ** **                                                                        | ** ** | **June 30,**                                                 | ** ** |
| ** **                                                                        | ** ** | **(in thousands except per share data)** | ** ** |
| ** **                                                                        | ** ** | **2006**                                                          | ** ** | **2005** | ** ** |
| **Numerator  for basic & diluted net loss per share:**                        |       |                                                              |       |   |   |
| Net loss                                                                          |       | $                                                                 | (38,613    | ) | $ | (6,997 | ) |
| Net loss available to common stockholders                                         |       | $                                                                 | (38,613    | ) | $ | (6,997 | ) |
| **Denominator:**                                                                  |       |                                                              |       |   |   |
| Denominator for basic & diluted net loss per  share - weighted-average shares |       | 102,749                                                           |       | 61,284 |   |
| **Basic & diluted earnings  net loss per share:**                             |       | $                                                                 | (0.38      | ) | $ | (0.11 | ) |

 

As of June 30, 2006, 22,440,777options and 21,497,200 warrants were excluded from the computation of net lossper share because their effect would be anti-dilutive. As of June 30, 200518,614,999 options, 7,847,350 warrants, and 2,540,000 of convertible debentureswere excluded from the computation of net loss per share because the effectwould be anti-dilutive.

**6. 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 be classifiedas one of the following: held-to-maturity, available-for-sale, or trading.

The Company’s marketablesecurities consist of auction rate securities which are invested in agenciesand institutions affiliated with U.S. states. The Company’s auction rate investmentsare classified as available-for-sale and are recorded at fair value. Interestincome on the Company’s marketable securities is recognized in the statement ofoperations when earned. The cost of securities sold is determined based on thespecific identification method.

The Company’savailable-for-sale investments may be offered for sale at auction every 28days. The auction rate securities have stated contractual maturities, whichrepresents the date they will be redeemed by the issuer, ranging from approximately22 to approximately 40 years, and may, at the option of the issuer, be redeemedprior to the stated maturity date. As of June 30, 2006, the Company hadinvested $3.7 million in marketable securities.

**7. Inventories**

Inventories consisted of the following:
|                    | ** ** | **June 30,**       | ** ** | **December 31,** | ** ** |
|--------------------|------------|-------------------------|------------|-----------------------|------------|
| ** **         | ** ** | **2006**                | ** ** | **2005**              | ** ** |
| ** **         | ** ** | **(in thousands)** | ** ** |
| Raw Materials      |       | $                       | 921        |                  | $          | 956 |   |
| Finished Goods     |       | 421                     |       | 470                   |       |
| Inventory  Reserve |       | —                  |       | (75                   | )          |
|               |       | $                       | 1,342      |                  | $          | 1,351 |   |

 

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

**8.Goodwill and Other Intangible Assets**

The Company accounts for goodwill and other intangibleassets at their estimated fair values in accordance with SFAS No. 142,“Goodwill and Other Intangible Assets”. In connection with the July 2005 assetacquisition, the Company recorded goodwill based on the excess of the purchaseprice over the identifiable tangible and intangible assets acquired andliabilities assumed. Goodwill is tested annually for impairment, or morefrequently when indicators of impairment are present. If the carrying amount ofthe goodwill exceeds its fair value, an impairment loss is recognized for anyexcess of the carrying amount of the reporting unit’s goodwill over the impliedfair value of that goodwill. The implied fair value of goodwill is determinedin the same manner as would occur in a purchase 

13

 

----

 

transaction, treating the fair value of the reportingunit as the equivalent of the purchase price and deducting from that amount,the fair value of the net assets assigned to the reporting unit. The Company isthe reporting unit for the purpose of this impairment calculation.

The Company considered the impairment indicatorspreviously discussed in Note 3 “Impairment of Goodwill and Intangible Asset”.With the assistance of an independent valuation firm, we determined the fairvalues of our reporting unit utilizing the discounted cash flow method. Theanalysis indicated that the carrying amount of our reporting unit exceeded itsfair value. Accordingly, under SFAS No. 142, we were required to performthe second step of the impairment testing for the reporting unit. This stepinvolved the adjustment of the assets and liabilities of the reporting unit totheir fair market values as of June 30, 2006, for purposes of comparingthe implied fair value of the reporting unit’s goodwill to the carrying amountof such goodwill. The analysis indicated a goodwill impairment of approximately$17.9 million. This amount was recorded in the second quarter of 2006.

The Company’sspecifically identifiable intangible assets, which consist exclusively ofutility patents, are reported at cost, net of accumulated amortization. Theseintangible assets are being amortized over their estimated useful lives, whichis 11.5 years, at amortization rates that reflect the life of the underlyingpatent and the asset’s estimated economic benefit 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 inoperations when indicators of impairment are present and undiscounted cashflows estimated to be generated by these assets are less than the assets’carrying amount.

Accordingly, we initiatedan impairment analysis of our long-lived assets and determined that the carryingvalue of these assets exceeded their projected undiscounted net cash flows. Wecalculated the fair values of our long-lived assets based on the discountedcash flow method. Cash flow projections were based on management’s forecastrelating to the intellectual properties and life was based on the remainder ofthe underlying patent life. Under the relief from royalty valuation method, weevaluate what the royalty we would have to pay would be, if we did not own therights to the patent. The assumptions underlying the method include aprojection of sales related to the utilization of the patents and what theroyalty rate we would expect to pay resulting in a total royalty amount,adjusted for an appropriate discount rate and amortization benefit. The fair valuesindicated that an impairment of the Company’s intangible assets existed.Accordingly, during the second quarter of 2006 the Company recorded animpairment charge of approximately $12.2 million related to the acquiredutility patents. The amounts are recorded within impairment of goodwill andintangible assets on the consolidated statements of operations

The approximatenet carrying value of the goodwill and other intangible assets at June 30, 2006and December 31, 2005 are asfollows:
|                            | ** ** | **June 30, 2006** | ** ** |
|----------------------------|------------|-----------------------------|------------|
| ** **                 | ** ** | **(in thousands)**     | ** ** |
| ** **                 | ** ** | **Gross  carrying  amount** | ** ** | **Impairment  charge** | ** ** | **Accumulated  amortization** | ** ** | **Net  carrying  value** | ** ** |
| Amortized  utility patents |       | $                           | 22,505     |   | $ | 12,239 |   | $ | 1,966 |   | $ | 8,300 |   |
| Unamortized  goodwill      |       | 41,677                      |       | 17,913 |   | — |   | 23,764 |   |
| Total intangible assets    |       | $                           | 64,182     |   | $ | 30,152 |   | $ | 1,966 |   | $ | 32,064 |   |

 
|                            | ** ** | **December 31, 2005** | ** ** |
|----------------------------|------------|---------------------------------|------------|
| ** **                 | ** ** | **(in thousands)**         | ** ** |
| ** **                 | ** ** | **Gross  carrying  amount**     | ** ** | **Accumulated  amortization** | ** ** | **Net  carrying  value** | ** ** |
| Amortized  utility patents |       | $                               | 22,505     |   | $ | 943 |   | $ | 21,562 |   |
| Unamortized  goodwill      |       | $                               | 41,677     |   | $ | — |   | $ | 41,677 |   |
| Total intangible assets    |       | $                               | 64,182     |   | $ | 943 |   | $ | 63,239 |   |

 

For the three and six months ended June 30, 2006, theCompany recorded amortization expense of approximately $489,000 andapproximately $1.0 million respectively, related to the intangible assets.

Estimated amortization expense for the intangibleasset for the remaining two quarters of the current fiscal year, and subsequentfiscal years, is as follows:

14

 

----

 
|                     | ** ** | **(in thousands)** | ** ** |
|---------------------|------------|-------------------------|------------|
| 2006                |       | $                       | 395        |   |
| 2007                |       | $                       | 790        |   |
| 2008                |       | $                       | 790        |   |
| 2009                |       | $                       | 790        |   |
| 2010                |       | $                       | 790        |   |
| 2011 and thereafter |       | $                       | 4,745      |   |

 

**9. Derivative Instruments**

The Company has issued and outstanding  **severalfinancial** instruments withembedded derivative features  **consisting of** convertible debt  **and warrants**. The Company analyzes these financial instruments inaccordance with Statement of Financial Accounting Standards (“SFAS”) No. 133and Emerging Issues task Force (“EITF”) Issue Nos. 00-19 and 05-02to determine if these hybrid contracts have embedded derivatives that must bebifurcated. In addition, free standing warrants are accounted for as eitherequity or liabilities in accordance with the 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, **‘**Accounting for Derivative Financial Instruments Indexed to,and Potentially Settled in, a Company**’**s Own Stock**’”** addresses financial instruments, such as convertible notesand stock purchase warrants, which are accounted for under EITF 00-19,that are issued with a corresponding right to have these securities registeredpursuant to a registration rights agreement that includes a liquidated damagesclause. Alternativeaccounting treatments of registration rights are discussed in EITF Issue No.05-4. One alternativetreatment discussed in EITF Issue No. 05-4 could require the warrants, theconvertible debt and the registration rights agreement to be treated as asingle financial instrument. If the EITF implements this approach, theconvertible debt and the warrants **theCompany has** issued wouldneed to be recorded as a liability at fair value and changes in the fair valueof the liability would need to be recorded in the statement of operations eachperiod. Implementation of this approach may have a material non-cash impact to **the Company’s**consolidated financial statement. 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 has** given only prospective application to this guidance. Further impact on **its** consolidated financial statements of adopting thestandard, if any, will follow the transition guidance when released.  

In April and July 2004, **theCompany** entered intoprivate placement agreements for convertible debentures, registration rightsagreements and warrants (see Note 6). Based on the interpretive guidance in EITFIssue No. 05-4 due to an uncapped liquidated damages provision in theregistration rights agreements, **theCompany** 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 theCompany’s December 2004 and January 2006 private placements, the Company’sestimated fair value of the related registration rights derivative wasimmaterial at the inception and at each reporting date since and the Companyhas not recorded a liability. At each reporting period, the Company calculatethe estimated fair value of the registration rights derivatives. If theunderlying assumptions of the calculation change such that the estimated fairvalue is not immaterial, the Company will record a liability at that time. Inconnection with the Company’s September 2005 private placement, the Company’sestimated fair value of the related registration rights derivative at itsinception was immaterial and the Company did not record a liability.Subsequently, in connection with the January 2006 private placement, theCompany amended its September 2005 agreement with the rights holder to waivethe liquidated damages relating to its inability to have such registrationstatement declared effective by May 23, 2006. On April 26, 2006, the Companyfiled a registration statement registering resale of securities purchased inthe September 2005 and January 2006 private placements. As it relates to theSeptember 2005 private placement, the Company believes that it has used itsbest efforts to cause the registration statement to be declared effective and,therefore, pursuant to the terms of the September 2005 registration rightsagreement, the Company believes that it is not currently liable for liquidateddamages as a result of the registration statement not being declared effectiveby May 23, 2006. Should the rights holders dispute that the Company’s bestefforts were used, and the Company either accedes to their assertion or isfound to not have used its best efforts, the estimated maximum amount ofliquidated 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  June30, 2006, no shares were issuable as**

15

 

----

 

**liquidated damages under the terms of the January2006 registration rights agreement. However, if the Company fails to meet certainconditions of the January 2006 registration rights agreement, it will berequired to issue to each holder in the January 2006 private placement, sharesand warrants equal to one percent, or 266,718 of the respective number ofshares 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 estimated fair value of theregistration rights derivative liability are recorded in the consolidatedstatement of operations. There was no change in the fair value of theregistration rights derivative liability in the second quarter of 2006. At June30, 2006, the derivative liability was approximately $150,000 and was reportedunder other accrued liabilities.

In connection with **theCompany’s** examination ofpast transactions for application of EITF Issue No. 05-4, **theCompany** noted that for theperiod from entering into the April 2004 Securities Purchase Agreement until **the Company** increased**its** authorized sharesin August 2004, **the Company** had insufficient shares to meet all potential obligationsto issue shares under **its** convertible notes and exercisable warrants and options. Under EITF Issue No. 00-19, a liability shouldbe recognized for those financial instruments for that period, with any changesin the fair value of such liabilities recognized in **its** consolidated statement of operations. Based on **theCompany’s** analysis of suchliabilities, **it** determined the effect of any such amounts to beimmaterial.  

**10. Contractual Obligations andCommitments**

The Company has thefollowing commitments as of June 30, 2006, which are comprised primarily of aresearch and development fee contract, consulting and employment contracts,vendor agreements, notes payable, as well as numerous operating leases.
|                                                            | ** ** | **(in thousands)**   | ** ** |
|------------------------------------------------------------|------------|---------------------------|------------|
| ** **                                                 | ** ** | **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) |       | $                         | 139        |   | $ | 139 |   | $ | — |   | $ | — |   | $ | — |   |
| Consulting  agreements                                     |       | 136                       |       | 136 |   | — |   | — |   | — |   |
| Employment  agreements (2)                                 |       | 2,284                     |       | 559 |   | 1,725 |   | — |   | — |   |
| Vendor  agreements                                         |       | 41                        |       | 10 |   | 31 |   | — |   | — |   |
| Operating leases                                           |       | 1,249                     |       | 183 |   | 957 |   | 109 |   | — |   |
| Note(s) payable                                            |       | 1,543                     |       | 450 |   | 1,085 |   | 8 |   | — |   |
| **Total**                                                  | ** ** | **$**                     | **5,392**  | ** ** | **$** | **1,477** | ** ** | **$** | **3,798** | ** ** | **$** | **117** | ** ** | **$** | **—** | ** ** |

----

(1) On January 26, 2006, R&D fees payable under aPatent and Sub-License Agreement with pHarlo IP were amended so that these feesare (i) payable on a quarterly basis within 30 days after the end of eachcalendar quarter and (ii) are based on gross sales of the Company (or itsaffiliates) of products using the pHarlo technology. For fiscal year 2006, theR&D Fees must not be less than $150,000 and are capped at $500,000. TheR&D Fees have no minimum amounts payable after 2006; however, they arecapped at $2,000,000 for 2007, $4,000,000 for 2008, $8,000,000 for 2009 and$10,000,000 for 2010 and beyond. In the second quarter of 2006 the Companypaid, under this agreement, approximately $11,000 of R&D fees related tothe revenue generated in the first quarter of 2006.

(2) In the first quarter of fiscal 2006, the Companyterminated several of its existing employment agreements with some of itssenior management and entered into new employment agreements with its currentexecutive management. As of June 30, 2006 the revised estimated future minimumannual compensation under these employment agreements, including the new andterminated agreements for 2006, 2007, 2008 and 2009, is approximately $558,900,$892,800, $782,800 and $49,000, respectively.

**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 

16

 

----

 

net sales (as defined inthe Exclusive Field of Use License Agreement and Product Sale Agreement) soldby Wynn Starr for which payment is received from customers. As of June 30, 2006no royalties were due and none had been paid to us under this royaltyarrangement. The Company is currently renegotiating an amendment to thisroyalty arrangement to align its terms to the current market demand for theproduct. Steven B. Zavagli, one of the Companys’s directors, is the founder,Chairman and the Chief Executive Officer of Wynn Starr and Wynn Starr’sultimate parent company, Wynn Starr Flavors, Inc.

TheCompany paid Mr. Gordon O. Davis, the former Chairman of the board ofdirectors, approximately $50,000 for consulting services during the six monthsended June 30, 2006.

17

 

----

 

**12. Sale of Equity Securities**

In connection withthe January 2006 private placement, the Company obtained waivers of all claims forliquidated damages relating to the inability of the Company to have theregistration statement registering resale of securities purchased in theSeptember 2005 private placement declared effective by the deadline specifiedin the applicable registration rights agreement. The Company received thesewaivers from shareholders representing more than a majority of all outstandingsecurities issued 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.  On April 26, 2006, the Company filed aregistration statement registering resale of securities purchased in theSeptember 2005 and January 2006 private placements.  **As it relates to the September 2005 privateplacement, th**e Company believes that it has used itsbest efforts to cause this registration statement to be declared effective and,therefore, pursuant to the terms of the September 2005  registration rights agreements, the Companybelieves that is not currently liable for liquidated damages as a result ofthis registration statement not being declared effective by May 23, 2006.Should the rights holders dispute that the Company used its best efforts, andthe Company either accedes to their assertion or is found to not have used itsbest efforts, 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 private placement,the Company has used its best efforts to respond to the SEC comments withinfifteen days from the date of the receipt of those comments. As of  June 30, 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.**

## **13.Restructuring Charges**

During the fourth quarterof fiscal year 2005 the Company recorded and paid approximately $29,000 ofseverance to one executive and five staff members. Seven more staff memberswere terminated but no severance was paid to them during this time period.Additionally, in a separate cost reduction action during the first quarter offiscal year 2006, the Company recorded severance costs of approximately$224,000 for one executive and four administrative staff members whoseemployment was terminated as a result of the Company’s effort to reduceoperating costs. In the first fiscal quarter of 2006, the Company paid $117,000of the $224,000 severance obligation it recorded in the same quarter.Consequently, the severance obligation accrual balance as of March 31, 2006 was$107,000. In the second fiscal quarter of 2006 the Company paid $92,000 of the$107,000 severance obligation accrual that remained as of March 31, 2006. Theremaining $15,000 of severance obligation outstanding as of June 30, 2006 waspaid in July 2006. The severance obligation accrual is included on theunaudited condensed consolidated balance sheets as a part of other accruedliabilities. The Company expects to experience cost reductions of approximately$75,000 per quarter starting in the third quarter of 2006 related to thisaction. No severance accrual remained at the end of third quarter of fiscalyear 2006 related to this reduction action.

**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,“Disclosure About Segments of an Enterprise and Related Information,” theCompany has one reportable segment for financial statement purposes.

18

 

----

*Revenueby Product*

The Company’srevenue by product is as follows:
|                          | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|--------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **               | ** ** | **2006**                                            | ** ** | **2005**                                          | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **               | ** ** | **(in thousands)**                             | ** ** |
| Unifresh®  Footbath |       | $                                                   | 477        |                                              | $          | — |   | $ | 606 |   | $ | — |   |
| Close CallTM         |       | 60                                                  |       | 244                                               |       | 152 |   | 305 |   |
|                     |       | $                                                   | 537        |                                              | $          | 244 |   | $ | 758 |   | $ | 305 |   |

 

## *Dependence on Certain Customers*

The Company’s dependenceon certain customers as a percentage of total revenue is as follows:
|            | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended   June 30,** | ** ** |
|------------|------------|-------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** ** | ** ** | **2006**                                        | ** ** | **2005**                                            | ** ** | **2006** | ** ** | **2005** | ** ** |
| Customer A |       | 39.8                                            | %          | —                                              | %          | 30.9 | % | — | % |
| Customer B |       | 24.7                                            | %          | —                                              | %          | 19.9 | % | — | % |
| Customer C |       | —                                          | %          | 33.6                                                | %          | — | % | 26.9 | % |
| Customer D |       | —                                          | %          | 14.5                                                | %          | — | % | 11.6 | % |
| Customer E |       | —                                          | %          | 14.5                                                | %          | — | % | 11.6 | % |

 

**15. Subsequent Events**

In August 2006, werevised the salary structure of three of our employees and we terminated sixother employees. In relation to these reductions we recorded severance costs ofapproximately $15,000. We expect that these severance costs will be paid infull in the third quarter of 2006. The Company expects that these severancecosts will be paid in full in the third quarter of 2006 and will result in costsavings of approximately $150,000 per quarter starting late in the thirdquarter of 2006.

 

**Item 2.Management’s Discussion And Analysis of Financial Condition And Results OfOperations**

This Form 10-Q, containsforward-looking statements, which include all statements regarding our expectedfinancial position, results of operations, cash flows, financing plans, strategy,budgets, capital and other expenditures, competitive positions, growthopportunities, benefits from new technology, plans and objectives ofmanagement, and markets for stock. These forward-looking statements are basedlargely on our expectations and, like any other business, are subject to anumber of risks and uncertainties, many of which are beyond our control. Insome cases, you can identify forward-looking statements by words such as *“may,” “should,” “expect,” “plan,” “could,”“anticipate,” “intend,” “believe,” “estimate,” “predict,” “potential,” “goal,”*or *“continue”* or similarterminology.

Forward-lookingstatements are not guarantees of performance. They involve risks, uncertaintiesand assumptions. Future results may differ materially from those expressed inthe forward-looking statements. Many of the factors that will determine theseresults are beyond our ability to control or predict. Current and potentialinvestors are cautioned not to put undue reliance on any forward-lookingstatements, which speak only to the date made.

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 Part II, Item 1A of this Form 10-Q. Some ofthe risks that current and potential investors should be aware of include, butare not limited to, the following:

·                     If we are unable to ****obtain new financingand/or generate revenue growth by the fourth quarter of  2006, our liquidity position will becomesignificantly impaired****;

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

·                     Our limited operating history inour present markets;

19

 

----

 

·                     Our limited experience inmarketing our products;

·                     Our need to obtain regulatoryapproval for the manufacturing and sale of some of our current products andproducts under development;

·                     Our ability to protect ourintellectual property rights;

·                     Intense competition in our currentmarkets; and

·                     Our products, like most regulatedproducts, may be subject to various enforcement actions, which could require,among other things, the relabeling, reformulation or recall of products and/orthe submission of additional information in support of product claims orsafety, or punitive actions, any of which could harm our reputation andbusiness.

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 of products using a patented process, which we referto as the “pHarlo technology,” that utilizes a highly charged and acidified,yet stable and safe, solution that enables copper sulfate, a compound with bacteriostaticproperties, to remain active throughout a wide range of pH values. We own theutility patent applications and provisional patent applications associated withthe pHarlo technology and have entered into a sub-license agreement for thebase patents associated with the pHarlo technology, in the following fields ofuse:

·                     AntimicrobialComposition for Pre-Harvest and Post-Harvest Treatment of Plants and Animals

·                     AntimicrobialFood Additive and Treatment for Cooked Food, Water and Wastewater

·                     AntimicrobialProcessingAid and Food Additive (US Provisional Application)

·                     Oral HealthCare Drink and Method for Reducing Malodors

·                     Skin CareComposition for Dermatological Disorders including burn and wrinkle creams (USProvisional Application) Hangover Remedy and Alcohol Abatement Composition

We currently market:

·                     Unifresh ® Footbath, a groomingaid for dairy cows;

·                     Close CallTM, an oral hygienebreath drink;

·                     Tasker Pacific BlueTM Seafood Wash;and

·                     Tasker Blue, an antimicrobialprocessing aid in poultry scalders.

In December 2005 wedecided to concentrate our efforts on the development and commercialization ofour poultry processing products, seafood processing applications, and Unifresh®Footbath and Unifresh® Pen Spray products. We also decided to seek to licenseand/or sell the Close CallTM brand and derivative applications.

### *Unifresh®Footbath*

We currentlymarket Unifresh®Footbath concentrate, a grooming aid that helps cleanand disinfect the hooves of dairy cows. Because of the bacteriostaticproperties of the pHarlo technology, this product helps control bacteria thatinfect the hooves of cows and cause interdigital dermatitis, or a bacterialinfection of the skin on a cow’s hoof, and interdigital papillomatosis, or adisease that affects a cow’s hoof that may cause severe lameness, decreasedmilk yield, body weight loss, decreased reproductive performance and 

20

 

----

increased veterinaryexpenses. Unifresh ®Footbath concentrate was launched during the thirdquarter of 2005. In the fourth quarter of 2005, we discovered that our Unifresh®Footbath product’s effectiveness was diminished in water that hadabnormally high alkaline content, a term commonly used to refer to themeasurement of pH, for example, of soil. We reformulated our Unifresh®Footbath concentrate with the addition of a compound that neutralizesalkali, or a type of base that has a pH greater than 7, which can increase thepH of water or soil. In the first quarter of 2006, we introduced our enhancedformulation to the market. It is currently being sold to dairy farms throughoutthe U.S. through our sales force, independent brokers and farm product distributors.We currently market the product as a grooming aid. No federal agency approvalsare required for marketing this product.

### *Close CallTM*

Our oral hygiene drink,Close CallTM, is marketed as an oral hygiene breath drink that eliminates odorsfrom tobacco, garlic, onion and alcohol. The FDA requires companies makingstructure or function claims relating to a dietary supplement product, such asClose CallTM, to “certify that the firm has substantiation that the claim istruthful and not misleading.” While the FDA does not require any presentationof this support, it does require a notice of dietary supplement ingredients andclaims. This is currently being prepared. We currently market the product as abeverage, but there can be no assurance that the FDA will agree with thischaracterization or the product claims, which could result in additionalregulatory requirements and potentially subject us to a variety of enforcementactions.

We believe that our CloseCallTM product could be marketed more efficiently by a company either alreadyestablished in the industry or with more commercial resources. Therefore, weplan to seek to license and/or sell the Close CallTM brand or derivativeapplications.

*Poultry Processing*

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 initialconsent from the USDA to continue in-plant testing in two additional plants. Wecompleted these tests and we submitted their results of the tests to USDA forreview in the second quarter of 2006. In August 2006 we received a letter fromthe USDA indicating that it had no objection to the use of our product as an antimicrobialprocessing aid in poultry scalders. This letter enables us to begincommercialization of the product in the United States.

### *SeafoodProcessing Products*

We recently beganmarketing the pHarlo technology for use in pathogen reduction, or a process bywhich certain bacteria that cause disease or illness are reduced in number oreliminated, and shelf life extension, or the act of increasing the length ofthe time a product can spend during processing, distribution and retail beforebecoming unacceptable for consumption, in seafood processing, subject to thereceipt of any necessary regulatory approvals. Our product, Tasker Pacific BlueSeafood Wash, has been tested at the North Carolina State Center for MarineScience & Technology, Virginia Tech University and Mississippi StateUniversity on shrimp, mahi mahi, salmon, flounder, scallops and catfish. Theresults of these studies indicated that the pHarlo technology could possiblydouble the shelf life on catfish filets and significantly increase the shelflife of scallops.

**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.

We had a net loss ofapproximately $33.7 million in the three months ended June 30, 2006 compared toa net loss of $3.7 million in the three months ended June 30, 2005. Excludingthe charge for the impairment of goodwill and intangible assets ofapproximately $30.2 million and the stock based compensation expense ofapproximately $1.1 million, our net loss for the three months ended June 30,2006 decreased by approximately $1.3 million to $2.4 million as compared to anet loss of $3.7 million for the three months ended June 30, 2005. There was nostock based compensation expense for the three months ended June 30, 2005.

We had a net loss ofapproximately $38.6 million in the six months ended June 30, 2006 compared to anet loss of $7.0 million in the six months ended June 30, 2005. Excluding thecharge for the impairment of goodwill and intangible assets of approximately$30.2 million and the stock based compensation expense of $2.8 million our netloss for the six months ended June 30, 2006 decreased by approximately $880,000to $5.6 million as compared to a net loss of $6.5 million for the three monthsended June 30, 2005, excluding stock based compensation expense ofapproximately $484,000. The increase in stock based compensation expense is dueto

21

----

 

the adoption of SFAS 123R “Share Based Payment” onJanuary 1, 2006. As a result of the adoption of SFAS 123(R), the fair value ofall stock-based compensation is now recorded as expense in our financialstatements, rather than as a footnote disclosure.

*Liquidity*

Based upon our forecastof future revenues from our products in conjunction with the cash andmarketable securities on hand, cash expected to be generated from operationsmay not provide adequate funding for our working capital over the next twelvemonths. We are rapidly depleting our cash resources and our ability tocontinue to operate and grow our business is dependent upon obtaining new financingand/or generating revenue growth from operations.  The cost of any new financing may beprohibitive. While we have been in the process of aggressively developing,marketing and selling our products, there can be no assurances that thoseefforts will be met with success in the marketplace or that the timing of ourefforts will be consistent with our cash availability and burn rate. If we areunable to arrange new financing and/or generate sufficient revenue growth fromexisting and new business arrangements by the fourth quarter of 2006, we willnot have sufficient cash to support our operations and meet our obligations andwe will be forced to consider the further restructuring of our operations,disposition of various assets, seeking of protection from our creditors, orceasing of operations and liquidation.We anticipate that we will needapproximately an additional $3 to $5 million to support our operations and meetour obligations over the next twelve months. We are currently reviewingalternative methods of financing, including private issuances of debt and/orequity. 

**Impairment of goodwill and intangible assets**

Goodwill

We account for goodwill and other intangible assets attheir estimated fair values in accordance with SFAS No. 142, “Goodwill andOther Intangible Assets”. In connection with the July 2005 asset acquisition, werecorded goodwill based on the excess of the purchase price over theidentifiable tangible and intangible assets acquired and liabilities assumed.Goodwill is tested annually for impairment, or more frequently when indicatorsof impairment are present. If the carrying amount of the goodwill exceeds itsfair value, an impairment loss is recognized for any excess of the carryingamount of the reporting unit’s goodwill over the implied fair value of thatgoodwill. The implied fair value of goodwill is determined in the same manneras would occur in a purchase transaction, treating the fair value of thereporting unit as the equivalent of the purchase price and deducting from thatamount, the fair value of the net assets assigned to the reporting unit. TheCompany is the reporting unit for the purpose of this impairment calculation.

In the second quarter of 2006 we tested for impairmentof its goodwill in accordance with SFAS No. 142. The testing was triggeredby a preliminary expectation that third and fourth quarter 2006 originallyprojected revenues will not be attained, a decrease in expected future cashflows and a decline in the market price of our common stock. These events andcircumstances constitute impairment indicators under the literature. Uponcompletion of the impairment tests, we recorded non-cash impairment charge togoodwill of $17.9 million. At June 30, 2006, the carrying value of goodwillbefore the impairment charge was approximately $41.7 million and the carryingvalue of the reporting unit was $68.2 million. The estimate of the fair value of the reporting unit, and afterrecording impairments to our intangible assets and goodwill, the carryingvalue, was $38.1 million, and our estimate of the market capitalization basedon the closing price of the common stock on June 30, 2006 was $51.5 million,which exceeded our estimate of fair value by $13.4 million. At June 30, 2006,after recording an impairment charge to the intangible assets of $12.2 millionbased on their estimated fair value, the carrying value of the reporting unitwas $56.0 million, resulting in an impairment charge to goodwill of $17.9million. After the impairment charge, the carrying value of the goodwill was$23.8 million.

The fair value of the reporting unit was based on theincome approach using a discounted cash flow model. Cash flow projections werebased on our revenue projections for our products. As a result of thecircumstances outlined in the following, we reduced our revenue projections by68% in 2006 and in 2007, 54% in 2008, 46% in 2009 and 43% in 2010. We projectedrevenue growth rates of 300% in 2007, as compared to the significantly reducedrevenue amount base in 2006, and from reduced revenue levels, growth rates peryear of 80%, 55% and 38% in 2008, 2009 and 2010, respectively, a growth rate of7% per year in 2011 through 2015 and a terminal growth rate of 5% for allsubsequent years. The majority of the reduction in the amount of revenue wasdue to the indefinite delay in the implementation of the enforcement frameworkof EU regulations regarding the welfare of poultry birds. We removed from ourprojections all revenue related to our poultry pen spray product since we arenot certain of the timing of the enforcement of these regulations.Additionally, in order for this product to be sold in the U.S., we need to makeadditional revisions to its formulation that will require time and additionalresources. Consequently, we have not included any U.S. revenue in ourprojections. We also reduced our projections related to our Unifresh Footbathproduct since our distributors were unable to devote the level of sale andtechnical personnel to promote and educate our customers on the benefits of ourproducts that we originally anticipated. On the other hand, the expectation ofreceipt of USDA approval in the third quarter of 2006 (received in August 2006)for the application of our poultry processing wash in the scalder processresulted in the increase of projected revenues related to this 

22

----

 

product. However, we are still in the process of completing the commercialverification process for the poultry processing wash and the Tasker PacificBlue Seafood Wash as we do not yet have a proven record of acceptance of ourproducts by our target audience. Customers in our industry are traditionallyaverse to entering into long-term agreements, therefore limiting our ability tocommit distributors or predict specific customer purchase volumes. If we do notcommercially verify these products, we may need to record an additionalimpairment charge. To the extent an additional impairment charge is required,it will likely have a material impact on our financial results.

The discount rate used was 25% and was based onventure capital rates for start-up companies in similar industries.

The table below presents a sensitivity analysis for 5%change per projected year in earnings before taxes and 1% changes in thediscount rate:
| Earnings Before Taxes | ** ** | **24%  Discount  Rate** | ** ** | **25%  Discount  Rate** | ** ** | **26%  Discount  Rate** | ** ** |
|---------------------------------|------------|-------------------------|------------|-------------------------|------------|-------------------------|------------|
| ** **                      | ** ** | **(in millions)**  | ** ** |
| -5%                             |       | $                       | 38.7       |                    | $          | 35.7                    |       | $ | 33.0 |   |
| As projected                    |       | $                       | 41.3       |                    | $          | 38.1                    |       | $ | 35.3 |   |
| +5%                             |       | $                       | 43.9       |                    | $          | 40.5                    |       | $ | 37.4 |   |

 

The table below presents the 1% sensitivity analysis(including tax amortization benefit) for revenue terminal growth rate anddiscount rate:
| Terminal Growth Rate | ** ** | **24%  Discount  Rate** | ** ** | **25%  Discount  Rate** | ** ** | **26%  Discount  Rate** | ** ** |
|--------------------------------|------------|-------------------------|------------|-------------------------|------------|-------------------------|------------|
| ** **                     | ** ** | **(in millions)**  | ** ** |
| 4%                             |       | $                       | 40.4       |                    | $          | 37.3                    |       | $ | 34.6 |   |
| 5%                             |       | $                       | 41.3       |                    | $          | 38.1                    |       | $ | 35.3 |   |
| 6%                             |       | $                       | 42.3       |                    | $          | 38.9                    |       | $ | 35.9 |   |

 

Intangible assets

Our specificallyidentifiable intangible assets, which consist exclusively 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 reflect the life of the underlying patent and theasset’s estimated economic benefit to the Company.

We review the carryingvalue of these intangible assets annually, or more frequently when indicatorsof impairment are present, in accordance with the provisions of SFAS No. 144,“Accounting for the Impairment or Disposal of Long-Lived Assets” which requiresimpairment losses to be recorded on long-lived assets used in operations whenindicators of impairment are present and undiscounted cash flows estimated tobe generated by these assets are less than the assets’ carrying amount.

Accordingly, we initiated an impairment analysis ofour long-lived assets and determined that the carrying value of these assetsexceeded their projected undiscounted net cash flows. We calculated the fairvalues of our long-lived assets based on the discounted cash flow method . Cashflow projections were based on management’s forecast relating to theintellectual properties and life was based on the remainder of the underlyingpatent life. Under the relief from royalty valuation method, we evaluate whatthe royalty we would have to pay would be, if we did not own the rights to thepatent. The assumptions underlying the method include a projection of salesrelated to the utilization of the patents and what the royalty rate we wouldexpect to pay resulting in a total royalty amount, adjusted for an appropriatediscount rate and amortization benefit. The fair values indicated that animpairment of the Company’s intangible assets existed. Accordingly, during thesecond quarter of 2006 the Company recorded an impairment charge ofapproximately $12.2 million related to the acquired utility patents. Theamounts are recorded within impairment of goodwill and intangible assets on theconsolidated statements of operations

Our projection of revenues, the same as used in ourreporting unit cash flow projections for purposes of evaluating any impairmentof goodwill, assumes growth rates of 300% in 2007, as compared to a relativelylow revenue base in 2006, growth rates per year of 80%, 55% and 38% in 2008,2009 and 2010, respectively, and a growth rate of 7% per year in 2011 through2015. The majority of the reduction in the amount of revenue was due to theindefinite delay of the enforcement framework of EU regulations 

23

----

 

regarding the welfare of poultry birds. We removedfrom our projections all revenue related to our poultry pen spray product sincewe are not certain of the timing of the enforcement of these regulations.Additionally, in order for this product to be sold in the U.S., we need to makeadditional revisions to its formulation. Consequently, we have not included anyU.S. revenue in our projections. We also reduced our projections related to ourUnifresh Footbath product since our distributors were unable to devote thelevel of sale and technical personnel to promote and educate our customers onthe benefits of our product that we originally anticipated. On the other hand,the expectation of receipt of USDA approval in the third quarter of 2006(received in August 2006) for the application of our poultry processing wash inthe scalder process resulted in the increase of projected revenues related tothis product.  However, we are still inthe process of completing the commercial verification process for the poultryprocessing wash and the Tasker Pacific Blue Seafood Wash as we do not yet havea proven record of acceptance of our products by our target audience. Customersin our industry are traditionally averse to entering into long-term agreements,therefore limiting our ability to commit distributors or predict specificcustomer purchase volumes. If we do not commercially verify these products, wemay need to record an additional impairment charge. To the extent an additionalimpairment charge is required, it will likely have a material impact on ourfinancial results.

The discount rate used increased from the December2005 amount, to 16%, primarily due to changes in interest rates. The discountrate was based on a cost of equity analysis, which was based on industry ratesof returns, by applying the Capital Asset Pricing Model (CAPM). The royaltyrate was 5%, which was based primarily on the royalty rate we paid to pHarlo IPLLC prior to the acquisition of the patents, as well as economic factors.

The table below presentsthe sensitivity analysis for a 5% revenue increase or decrease per projectedyear (including tax amortization benefit) and a 1% increase or decrease in thediscount rate:

| Revenue Change for  Each Year | ** ** | **15%  Discount  Rate** | ** ** | **16%  Discount  Rate** | ** ** | **17%  Discount  Rate** | ** ** |
|----------------------------------------------|------------|-------------------------|------------|-------------------------|------------|-------------------------|------------|
| ** **                                   | ** ** | **(in millions)**  | ** ** |
| -5%                                          |       | $                       | 8.1        |                    | $          | 7.7                     |       | $ | 7.3 |   |
| As projected                                 |       | $                       | 8.8        |                    | $          | 8.3                     |       | $ | 7.8 |   |
| +5%                                          |       | $                       | 9.4        |                    | $          | 8.9                     |       | $ | 8.4 |   |

 

The table below presentsthe sensitivity analysis for 1% increase or decrease in the royalty rate and inthe discount rate:

| Royalty Rate | ** ** | **15%  Discount  Rate** | ** ** | **16%  Discount  Rate** | ** ** | **17%  Discount  Rate** | ** ** |
|-------------------|------------|-------------------------|------------|-------------------------|------------|-------------------------|------------|
| ** **        | ** ** | **(in millions)**  | ** ** |
| 4%                |       | $                       | 6.2        |                    | $          | 5.9                     |       | $ | 5.6 |   |
| 5%                |       | $                       | 8.8        |                    | $          | 8.3                     |       | $ | 7.8 |   |
| 6%                |       | $                       | 11.2       |                    | $          | 10.6                    |       | $ | 10.1 |   |

 

**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. We arecurrently renegotiating this royalty arrangement to align its terms to thecurrent market demand for the product. Steven B. Zavagli, one of our directors,is the founder, Chairman and the Chief Executive Officer of Wynn Starr and WynnStarr’s ultimate parent company, Wynn Starr Flavors, Inc.

TheCompany paid Mr. Gordon O. Davis, the former Chairman of the board ofdirectors, approximately $30,000 for consulting services during the quarterended June 30, 2006.

24

----

 

**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 six monthsended June 30, 2006, we recorded approximately $2.8 million of stock basedcompensation expense, with approximately $1.7 million of this expense,attributable to employee stock options and the remainder approximately $1.1attributable to stock options awarded to consultants and non-employee boardmembers.

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 forthe expected option term.

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 years and was derived based on the average ofthe sum of the vesting term and the original contract term. In estimating ourstock price volatility, we analyzed our historic volatility for a period equalto the expected term of our stock options awarded in the six months ended June30, 2006, by reference to actual stock prices during this period and calculatedan estimated volatility between 132% to 135%. We believe that each of theseestimates, both expected term and volatility, is reasonable in light of thedata we analyzed. However, as with any estimate, the ultimate accuracy of theseestimates 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 three and six months ended June 30, 2006 relates tooptions granted in the six months ended June 30, 2006. We expect that stockcompensation expense will continue to have a material impact on our financialresults for the remainder of the fiscal year. For the remainder of fiscal 2006we expect to incur stock compensation expenses of approximately $885,000 perquarter.

25

----

 

**Three Months Ended June 30, 2006Compared to Three Months Ended June 30, 2005**

**Revenues**

Revenues for the threemonths ended June 30, 2006 were approximately $537,000 compared withapproximately $244,000 for the corresponding period in 2005. This increase isprimarily due to increased sales in Unifresh ® Footbath. The revenue for thethree months ended June 30, 2005, was entirely due to sales of Close CallTM. Weexpect that revenue will continue to increase throughout fiscal year 2006primarily due to the increased sales in Unifresh® Footbath and to a lesserextent due to the sales of our new products for the poultry and seafoodprocessing industries.

**Selling, General and Administrative**

Selling, General, andAdministrative (“SGA”) expenses are primarily comprised of sales and marketingcosts, compensation costs, professional fees, and general administrative costs.SGA costs for the three months ended June 30, 2006 decreased by approximately$300,000 from approximately $3.2 million for the three months ended June 30,2005, to approximately $2.9 million for the three months ended June 30, 2006.We anticipate that SGA costs will continue to decrease, as a percentage ofrevenues and in absolute dollars, 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 $79,000 due to marketing research, branding and promotion for ourUnifresh® Footbath product line roll-out, as well as increased compensationexpense due to the hiring of additional sales personnel.

Compensation expenseconsists primarily of salaries and other related costs for senior management,finance and administrative employees of our company. Compensation expensedecreased by approximately $239,000 primarily due to a reduction in administrativeand warehouse personnel. In August 2006, we revised the salary structure ofthree of our employees and we terminated six other employees. As a result ofthese reductions we expect that we will experience cost savings ofapproximately $150,000 per quarter starting late in the third quarter of 2006.

Professional fees for thethree months ended June 30, 2006 decreased by $1.3 million primarily due to anon-cash charge for stock options issued to an investor relations consultantfor services provided in the three months ended June 30, 2005.

General andadministrative expenses consist primarily of rent, insurance and travel andentertainment expenses. The increase in general administrative costs for thethree months ended June 30, 2006 by approximately $58,000 was attributable toan increase in travel costs of approximately $105,000, insurance costs ofapproximately $106,000, and rent and associated utility expenses for our Texasfacility, acquired in the July 2005 acquisition, of approximately $35,000. Theincrease was partially offset by an expense reduction of approximately $169,000due to the settlement of vendor trade obligations at amounts lower than thoseoriginally invoiced to us and a decrease of approximately $13,000 in boarddirectors fees.

Stock based compensationexpense increased by approximately $1.1 million for the three months ended June30, 2006. There was no compensation expense for the same period in 2005. Thisincrease is the result of implementing SFAS 123(R) in January 2006. The expenseassociated with these awards is recorded as expense within the same functionalexpense category as cash compensation for the respective employee is recorded.For the three months ended June 30, 2006, stock compensation expense wasallocated as follows:
|                             | ** ** | **(in thousands)** | ** ** |
|-----------------------------|------------|-------------------------|------------|
| Sales and  marketing        |       | $                       | 38         |   |
| Product  development        |       | 118                     |       |
| General and  administrative |       | 968                     |       |
|                        |       | $                       | 1,124      |   |

**Product Development**

Product developmentconsists primarily of personnel costs to support product development. Productdevelopment and research costs for the three months ended June 30, 2006decreased by approximately $106,000 or 17% to approximately $514,000 fromapproximately $620,000 for the three months ended June 30, 2005. This decreaseis primarily due to our decision to focus our development efforts in a selectsmaller number of products, which were closer to commercialization rather thanthe larger number of products we were developing in the same time period in2005.  The decrease in the number ofproducts we are developing and testing in the three months ended June 30, 2006resulted in the decrease in consulting expenses of approximately $209,000 andthe decrease in third party laboratory testing cost of approximately $124,000,partially offset by an increase in stock based compensation of 

26

----

 

approximately $118,000 and an increase of warehouseexpenses of approximately $62,000. We expect that in fiscal 2006 productdevelopment expense will increase in absolute dollars but decrease as apercentage of revenue.

**Depreciation and Amortization Expense**

Depreciation andamortization expense, which includes the amortization of identifiableintangible assets, increased by approximately $554,000 from approximately$25,000 in the three months ended June 30, 2005, to approximately $579,000 forthe three months ended June 30, 2006, primarily due to the amortization of ourutility patent intangible acquired in the July 15, 2005 acquisition. Thispatent intangible, after the impairment charge of approximately $12.2 millionrecorded in the second quarter of 2006, has a current estimated value ofapproximately $8.3 million and is being amortized over 11.5 years.

**Impairment of goodwill and intangible assets**

In the secondquarter of 2006, we initiated  testingfor impairment of our intangible assets and our goodwill due to the presence ofimpairment indicators including a preliminary expectation that third and fourthquarter 2006 originally projected revenues will not be attained, a decrease inexpected future cash flows and a decline in the market price of our commonstock . Upon completion of the impairment tests, we recorded non-cashimpairment charges to intangible assets and goodwill of $12.2 million and $17.9million, respectively.  We did not recordan impairment charge for the same three month period in 2005. Also, seediscussion under “Financial Overview.”

**Interest Expense**

Interest expensedecreased by approximately $20,000 from $42,000 for the three months ended June30, 2005 to approximately $22,000 for the three months ended June 30, 2006   primarily dueto a reduction in interest payable for convertible debt that was converted infull in January 2006.

**Interest Income**

Interest income increasedby approximately $56,000 from $44,000 for the three months ended June 30, 2005to approximately $100,000 for the three months ended June 30, 2006 primarilydue to an increased interest received on the Company’s investments inmarketable securities in the three months ended June 30, 2006, as compared tothe same period ending June 30, 2005.

**Other expenses, net**

We incurred otherexpenses, net of approximately $49,000 for the three months ended June 30, 2006as compared to $62,000 for the three months ended June 30, 2005. The decreaseis solely due to the decrease in the accrual of liquidated damages for failureto have a current prospectus available for the resale of common stock sold inthe April 2004 and July 2004 private placements. The decrease in the accrual isdue to the fact that the prospectus was current in April 2006 and our obligationto accrue liquidated damages under the April 2005 agreement ceased in April2006.

**Six Months Ended June 30, 2006Compared to Six Months Ended June 30, 2005**

**Revenues**

Revenues for the sixmonths ended June 30, 2006 were approximately $758,000 compared withapproximately $305,000 for the corresponding period in 2005. This increase isprimarily due to increased sales in Unifresh® Footbath.  The revenue for the six months ended June 30,2005, was entirely due to sales of Close CallTM. We expect that revenue willcontinue to increase throughout fiscal year 2006 primarily due to the increasedsales in Unifresh® Footbath and to a lesser extent due to the sales of our newproducts for the poultry and seafood processing industries.

**Selling, General and Administrative**

SGA expenses areprimarily comprised of sales and marketing costs, compensation, professionalfees, and general administrative costs. SGA costs for the six months ended June30, 2006 increased by approximately $900,000 from $6.0 million for the six monthsended June 30, 2005, to $6.9 million for the six months ended June 30, 2006. Weanticipate that SGA costs will continue to decrease, as a percentage ofrevenues and in absolute dollars, in fiscal year 2006.

27

----

 

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 $130,000 due to marketing research, branding and promotion forour Unifresh®Footbath product line roll-out, as well as increasedcompensation expense due to the hiring of additional sales personnel.

Compensation expenseconsists primarily of salaries and other related costs for senior management,finance and administrative employees of our company. Compensation expenseincreased by approximately $178,000 primarily due to an increase in severancecosts associated with a reduction in administrative and warehouse personnel,and to a lesser extent due to salaries for personnel acquired through the July2005 acquisition. In August 2006, we revised the salary structure of three ofour employees and we terminated six other employees. As a result of thesereductions we expect that we will experience cost savings of approximately$150,000 per quarter starting late in the third quarter of 2006.

Professional fees for thesix months ended June 30, 2006 decreased by $2.3 million primarily due to anon-cash charge of approximately $2.5 million for stock options issued to aninvestor relations consultant for services provided in the six months endedJune 30, 2005, partially offset by an increase of approximately $200,000 inlegal fees associated with our SEC filings for the six months ended June 30,2006.

General andadministrative expenses consist primarily of rent, insurance and travel andentertainment expenses. The increase in general and administrative costs forthe six months ended June 30, 2006, as compared to the six months ended June30, 2005, was approximately $694,000. This increase was attributable to asettlement fee of approximately $249,000 for the termination of minimumpurchase commitment obligations for Close CallTM bottles, increase in travel andentertainment expenses of  approximately$155,000, increase in general insurance costs of approximately $104,000,increase in rent and associated utility expenses for the Texas facility,acquired in the July 2005 acquisition, of approximately $72,000, increase dueto the settlement of the “BOC” claim, discussed under legal proceedings, ofapproximately $50,000, increase in recruiting fees of approximately $20,000,and increase in provision for allowance for doubtful accounts of approximately$10,000.

Stock based compensation expense increased byapproximately $2.3 million for the six months ended June 30, 2006 from $484,000for the six months ended June 30, 2005. This increase is the result ofimplementing SFAS 123(R) in January 2006. The expense associated with theseawards is recorded as expense within the same functional expense category ascash compensation for the respective employee is recorded. For the six monthsended June 30, 2006, stock compensation expense was allocated as follows :

|                             | ** ** | **(in thousands)** | ** ** |
|-----------------------------|------------|-------------------------|------------|
| Sales and  marketing        |       | $                       | 221        |   |
| Product  development        |       | 175                     |       |
| General and  administrative |       | 2,448                   |       |
|                        |       | $                       | 2,844      |   |

**Product Development**

Product developmentconsists primarily of personnel costs to support product development. Productdevelopment and research costs for the six months ended June 30, 2006 decreasedby approximately $97,000 or 10% to approximately $889,000 from approximately$986,000 for the six months ended June 30, 2005. This decrease is primarily dueto our decision to focus our development efforts in a select smaller number ofproducts, which were closer to commercialization rather than the larger numberof products we were developing in the same time period in 2005.  The decrease in the number of products we aredeveloping and testing in the six months ended June 30, 2006 resulted in thedecrease in consulting expenses of approximately $361,000 and a decrease inthird party laboratory testing costs of approximately $146,000 decrease.  This decrease was partially offset by anincrease in stock based compensation of approximately $158,000, an increase incompensation costs of approximately $92,000, an increase in warehouse costs ofapproximately $91,000 and an increase in production supplies of approximately$70,000.  We expect that in fiscal 2006product development expense will increase in absolute dollars as we continue todevelop and enhance our product lines, but should decrease as a percentage oftotal revenues.

 **Depreciationand Amortization Expense**

Depreciation andamortization expense, which includes the amortization of identifiableintangible assets, increased by approximately $1.1 million from approximately$37,000 in the six months ended June 30, 2005, to approximately $1.2 million forthe six months ended June 30, 2006, primarily due to the amortization of ourutility patent intangible. This patent intangible, after the impairment chargeof approximately $12.2 million recorded in the second quarter of 2006, has acurrent estimated value of approximately $8.3 million and is being amortizedover 11.5 years.

28

----

 

**Impairment of goodwill and intangible assets**

In the secondquarter of 2006, we initiated  testingfor impairment of our intangible assets and our goodwill due to the presence ofimpairment indicators including a preliminary expectation that third and fourthquarter 2006 originally projected revenues will not be attained, a decrease inexpected future cash flows and a decline in the market price of our commonstock . Upon completion of the impairment tests, we recorded non-cashimpairment charges to intangible assets and goodwill of $12.2 million and $17.9million, respectively.  We did not recordan impairment charge for the same six month period in 2005. Also, seediscussion under “Financial Overview.”

29

----

 

**Interest Expense**

Interest expensedecreased by approximately $106,000 from $155,000 for the six months ended June30, 2005 to approximately $49,000 for the six months ended June 30, 2006   primarily dueto a reduction in interest payable for convertible debt that was converted infull in January 2006.

**Interest Income**

Interest income increasedby approximately $48,000 from $90,000 for the six months ended June 30, 2005 toapproximately $138,000 for the six months ended June 30, 2006 primarily due toan increase in interest earned from the Company’s investments in marketablesecurities, as compared to the same period ending June 30, 2005.

**Other expenses, net**

We incurred otherexpenses, net of approximately $102,000 for the six months ended June 30, 2006as compared to $62,000 of accrued liquidated damages for the six months endedJune 30, 2005. We accrued approximately $136,000 for (i) liquidateddamages for failure to have a current prospectus available for the resale ofcommon stock sold in the April 2004 and July 2004 private placements, and (ii)a loss on a disposal of a vehicle in the amount of $50,000 as a result of theSettlement and Release Agreement we entered into with a former executive. Thisincrease in expense was partially offset by the reduction of the fair marketvalue of the registration rights liability by approximately $85,000.

**Liquidity and Capital Resources**

**Overview**

Since our inception, wehave funded operations and investing activities through the sale of commonstock, warrants and convertible debt under several private placements.Requirements for liquidated damages under some of these 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 June 30, 2006,our 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 June 30, 2006 isapproximately $130,000 of interest and late fees and approximately $423,000 ofincurred liquidated damages associated with the April 2004 and theJuly 2004 convertible debentures. The Company’s obligation to accrueliquidated damages under these registration rights agreements ceased in April30 and July 22, 2006, respectively. Through July 22, 2006, the Company hasaccrued $441,000 in liquidated damages related to these agreements. We have notincurred any liquidated damages liabilities related to any of our otherregistration rights agreements. 

Based upon ourforecast of future revenues from our products in conjunction with the cash andmarketable securities on hand, cash expected to be generated from operationsmay not provide adequate funding for our working capital over the next twelvemonths. We are rapidly depleting our cash resources and our ability tocontinue to operate and grow our business is dependent upon obtaining newfinancing and/or generating revenue growth from operations.  The cost of any new financing may beprohibitive. While we have been in the process of aggressively developing,marketing and selling our products, there can be no assurances that thoseefforts will be met with success in the marketplace or that the timing of ourefforts will be consistent with our cash availability and burn rate If we areunable to arrange new financing and/or generate sufficient revenue growth fromexisting and new business arrangements by the fourth quarter of 2006, we willnot have sufficient cash to support our operations and meet our obligations andwe will be forced to consider the further restructuring of our operations,disposition of various assets, seeking of protection from our creditors, orceasing of operations and liquidation.We anticipate that we will needapproximately an additional $3 to $5 million to support our operations and meetour obligations over the next twelve months. We are currently reviewingalternative methods of financing, including private issuances of debt and/orequity. 

30

----

** **

**Operating Activities**

At June 30, 2006 ourcash, cash equivalents and marketable securities balances were approximately$4.0 million compared with $1.0 million at December 31, 2005.

Net cash used inoperating activities for the six months ended June 30, 2006 was approximately$5.2 million, compared to net cash used in operating activities ofapproximately $4.9 million for the six months ended June 30, 2005.

We have fully reservedour note receivable of $890,000 from the Biofilm shareholders as there is noassurance that it is collectible. Also see discussion under “Off-Balance SheetArrangements”.

31

----

 

**Investing Activities**

Net cash used ininvesting activities for the six months ended June 30, 2006 was approximately$3.8 million as compared to approximately $5.2 million for the six months endedJune 30, 2005. The decrease in net cash used in investing activities wasprimarily due to the repayment of loans in the six months ended June 30, 2005.

**Financing Activities**

Net cash provided byfinancing activities during the six months ended June 30, 2006 wasapproximately $8.3 million, as compared to approximately $168,000 for the sixmonths ended June 30, 2005.

The net cash provided byfinancing activities for the six months ended June 30, 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 inequal bi-weekly principal installments of $37,153, plus interest, through July2007. During the six months ended June 30, 2006 we paid approximately $483,000under the IRL promissory note.

During the six months ended June 30, 2006, wecontinued to be in violation of certain representations and covenants containedin our convertible debentures issued on April 30, 2004 and July 22, 2004. Thisviolation related to the fact that our disclosure controls and procedures werenot effective because of material weaknesses in our internal controls overfinancial reporting which resulted in the restatement of our financialstatements filed with the SEC for the quarters ended June 2004, September 2004and September 2005. The violation also related to the fact that we did not maketimely quarterly payments to the bondholders. As a result of this violation,principal and accrued interest on outstanding debentures became immediately dueand payable at the option of holders and, as a result, as of December 31,2005, the Company had classified the entire remaining principal balance in theamount of approximately $194,000 and interest of approximately $119,000 as acurrent liability and has amortized the debt discount associated with theremaining principal balance. The convertible debt was exercised in full inJanuary 2006. In addition, during the six months ended June 30, 2006, we werein default of certain of our obligations under the April and July 2004registration rights agreements. As a result of these violations, we accrued$423,000 in liquidated damages. The Company’s obligation to accrue liquidateddamages under these registration rights agreements ceased in April 30 and July22, 2006, respectively. Through July 22, 2006, the Company has accrued $441,000in liquidated damages related to these agreements.

**Registration Rights Agreements**

In connection with the January 2006 private placement,the Company obtained waivers of all claims for liquidated damages relating tothe inability of the Company to have the registration statement registeringresale of securities purchased in the September 2005 private placement declaredeffective by the deadline specified in the applicable registration rightsagreement. The Company 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, the Company 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. Under the waiver, the date by which the registration statement covering resaleof the securities purchased in the September 2005 private placement wasrequired to be declared effective was extended to May 23, 2006.  On April26, 2006, the Company filed a registration statement registering resale ofsecurities purchased in the September 2005 and January 2006 privateplacements.  As it relates to theSeptember 2005 private placement, the Company believes that it has used itsbest efforts to cause this registration statement to be declared effective and,therefore, pursuant to the terms of the September 2005  registration rights agreements, the Companybelieves that is not currently liable for liquidated damages as a result ofthis registration statement not being declared effective by May 23, 2006.Should the rights holders dispute that the Company used its best efforts, andthe Company either accedes to their assertion or is found to not have used itsbest efforts, 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  June 30, 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 the January2006 registration rights agreement, it will be required to issue to each holderin the January 2006 private placement, shares and warrants equal to onepercent, or 266,718 of the respective number of shares and warrants purchasedby 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.

32

----

 

**Off-Balance Sheet Arrangements**

During the three and sixmonths ended June 30, 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 of Biofilmand thus we would not be required to consolidate the accounts of Biofilm. Webelieve that our maximum exposure to loss as a result of our involvement withBiofilm is limited to our initial investment of $718,000.

33

----

 

**Contractual Obligations andCommitments**

We had thefollowing commitments as of June 30, 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:
|                                                            | ** ** | **(in thousands)**   | ** ** |
|------------------------------------------------------------|------------|---------------------------|------------|
| ** **                                                 | ** ** | **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) |       | $                         | 139        |   | $ | 139 |   | $ | — |   | $ | — |   | $ | — |   |
| Consulting  agreements                                     |       | 136                       |       | 136 |   | — |   | — |   | — |   |
| Employment  agreements (2)                                 |       | 2,284                     |       | 559 |   | 1,725 |   | — |   | — |   |
| Vendor  agreements                                         |       | 41                        |       | 10 |   | 31 |   | — |   | — |   |
| Operating leases                                           |       | 1,249                     |       | 183 |   | 957 |   | 109 |   | — |   |
| Note(s) payable                                            |       | 1,543                     |       | 450 |   | 1,085 |   | 8 |   | — |   |
| **Total**                                                  | ** ** | **$**                     | **5,392**  | ** ** | **$** | **1,477** | ** ** | **$** | **3,798** | ** ** | **$** | **117** | ** ** | **$** | **—** | ** ** |

 

----

(1) On January 26, 2006,R&D fees payable under a Patent and Sub-License Agreement with pHarlo IPwere amended so that these fees are (i) payable on a quarterly basis within 30days after the end of each calendar quarter and (ii) are based on gross salesof our Company (or our affiliates) of products using the pHarlo technology. Forfiscal year 2006, the R&D Fees must not be less than $150,000 and arecapped at $500,000. The R&D Fees have no minimum amounts payable after2006; however, they are capped at $2,000,000 for 2007, $4,000,000 for 2008,$8,000,000 for 2009 and $10,000,000 for 2010 and beyond. In the second quarterof 2006 we paid, under this agreement, approximately $11,000 of R&D feesrelated to the revenue generated in the first quarter of 2006.

(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 June 30, 2006 the revisedestimated future minimum annual compensation under these employment agreements,including the new and terminated agreements for 2006, 2007, 2008 and 2009, isapproximately $558,900, $892,800, $782,800 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 any derivativeinstruments in the past and do not presently plan to in the future. Ourinvestment portfolio consists of demand deposits and marketable securities. Dueto 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.

**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

34

----

 

2005 and under Item 9A of Part II in our Annual Reporton Form 10-KSB for the year ended December 31, 2005, we have alreadyinstituted and are continuing to implement, corrective actions with respect tothe deficiencies 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 accounting staffthat does not allow for a thorough review process. We have engaged a consultantto design financial reports so that we do not rely on spreadsheets and we willadd additional accounting staff when our financial condition allows us to doso.

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 forthe District of Connecticut.  In the complaint, The BOC Group alleges thatMr. 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 claimed that we, Mr. Porter and Mr. Cableviolated Connecticut’s statutes governing trade secrets and unfair tradepractices. In July 2006, the matter was resolved by our payment of $50,000 toThe BOC Group.

On January 18, 2006, a civil action captioned DallasXXIX Corporate Square, L.P., v. Coast to Coast Laboratories and Tasker CapitalCorp. was filed in the Circuit Court of Pinellas County, Florida. Theplaintiff alleged that Coast to Coast Laboratories Corp., a wholly ownedsubsidiary of our company, breached a lease agreement and that we breached aguaranty. In June 2006 the matter was resolved by our payment of $25,000 toDallas XXIX Corporate Square, L.P. The settlement and the stipulation ofdismissal with prejudice was filed with the Court.

On May 25, 2006, acivil action captioned James Collins v. Tasker Products Corp. was filedin the Connecticut Superior Court for the Judicial District of Stamford.  In the complaint, Mr. Collins alleges thatTasker breached the employment agreement between him and our company.  Specifically, Mr. Collins alleges that he isdue severance compensation pursuant to the employment agreement.  On June 29, 2006, we filed our answer to thecomplaint.  The answer also allegesnumerous counterclaims against Mr. Collins, including a violation ofConnecticut’s Uniform Trade Secrets Act, breach of duty of loyalty and variouscomputer related offenses.  We are alsopresently seeking permission to implead our former President and CEO, Robert P.Appleby, for breach of duty of care, breach of duty of loyalty, and fraud inthe inducement related to his entering into the employment agreement with Mr.Collins. The motion is currently pending.

35

----

 

**Item 1A.Risk Factors**

The following revises inits entirety the risk factors discussed in “ Risk Factors” in our Annual Reporton Form 10-KSB for the year ended December 31, 2005. These risk factors couldmaterially affect our business, financial condition or future results.

**RISKSRELATED TO OUR BUSINESS**

##### *Unless we obtain newfinancing and/or generate revenue growth in the near future, our liquidityposition will become significantly impaired and we could be forced torestructure or discontinue our operations*

We are rapidly depleting our cash resources and ourability to continue to operate and grow our business is dependent uponobtaining new financing and/or generating revenue growth from operations. Thecost of any new financing may be prohibitive. While we have been in the processof aggressively developing, marketing and selling our products, there can be noassurance that those efforts will be met with success in the marketplace orthat the timing of our efforts will be consistent with our cash availabilityand burn rate. If we are unable to arrange new financing and/or generatesufficient revenue growth from existing and new business arrangements by thefourth quarter of 2006, we will not have sufficient cash to support ouroperations and meet our obligations and we will be forced to consider thefurther restructuring of our operations, disposition of various assets, seekingof protection from our creditors, or ceasing of operations and liquidation. Weanticipate that we will need approximately an additional $3 to $5 million tosupport our operations and meet our obligations over the next twelve months. Weare currently reviewing alternative methods of financing, including privateissuances of debt and/or equity.

##### *We have lost moneyin each fiscal quarter since we changed our business model to the developmentof products in the oral care, food processing, skin care, water purificationand pet industries. We expect future losses and we may never become profitable.*

We have incurred losses in our operations in eachquarter since we changed our business direction in late 2002. Net loss for thesix months ended June 30, 2006 and the years ended December 31, 2005,December 31, 2004, December 31, 2003 and December 31, 2002 wereapproximately $38.6 million, $18.3 million, $6.1 million, $607,000 and$761,000, respectively. We expect to continue to incur losses in the shortterm. We expect operating expense to increase as we work to build our brands,expand our customer base and develop new products. To become profitable, wemust increase revenue substantially and achieve and maintain positive grossmargins. We may not be able to increase revenue and gross margins sufficiently toachieve profitability. If we are not able to achieve profitability, our resultsof operations and financial condition will be materially and adverselyaffected.

##### *To the extent thatfuture impairment charges occur, they will likely have a material impact on ourfinancial results.*

In the second quarter of 2006, we tested forimpairment of our intangible assets and our goodwill in accordance withStatement of Financial Accounting Standards (SFAS) No. 144 “Accounting forthe Impairment or Disposal of Long-Lived Assets” (SFAS No. 144) andStatement of Financial Standards No. 142 “Goodwill and Other IntangibleAssets” (SFAS No. 142), respectively. Our testing was triggered by thefollowing events and circumstances that constitute impairment indicators underthe literature:

a preliminary expectation that third and fourthquarter 2006 originally projected revenues will not be attained;

a decrease in expected future cash flows; and

a decline in the market price of our common stock

Upon completion of the impairment tests, we recordednon-cash impairment charges to intangible assets and goodwill of $12.2 millionand $17.9 million, respectively. Note 8 to our unaudited condensedconsolidated financial statements for the period ended June 30, 2006 describesthe impairment tests performed and their impact during the second quarter of2006. There can be no assurance that there will not be impairment charges insubsequent periods as a result of our future periodic impairment reviews. Tothe extent that future impairment charges occur, they will likely have amaterial impact on our financial results.

##### *We have a limitedoperating history in our present market and prospective investors have alimited historical basis on which to judge our ability to be successful.*

We were originally organized for the purpose ofengaging in the acquisition and exploration of mineral properties, primarily inthe Province of British Columbia, Canada. During 2001, we allowed the option onour mineral property to lapse and began to investigate other businessopportunities. In late 2002, we entered into an exclusive license to sell,develop, market and distribute consumer deodorant breath products, animaldeodorant breath products and soft drink products using the pHarlo technology.Since late 2002, we have pursued this business plan and have expanded it toinclude the use of the pHarlo technology in the pre- and post-harvest foodprocessing, skin care, pet care, hangover remedy, alcohol abatement and waterpurification industries. Additionally, we are investigating the applicabilityof the pHarlo technology to other aspects of the seafood industry.

36

----

 

Since inception, we have suffered recurring losses andnet cash outflows from operations. We expect to continue to incur substantiallosses to complete the development of our business. In addition, we onlyrecently began shipping our first product, Close CallTM, in February of 2005. We thushave a limited operating history upon which investors may evaluate our likelyfuture performance.

##### *We recentlycompleted a significant acquisition of certain assets of pHarlo CitrusTechnologies, Inc. and other related entities. We cannot guarantee that we willbe able to manage these new assets profitably.*

On July 15, 2005, we purchased certain assets ofpHarlo Citrus Technologies, Inc., Indian River Labs, LLC, pHarlo CitrusProperties Partnership, LLLP and Coast to Coast Laboratories, LLC, which fourentities are referred to in this prospectus as the “Selling Entities.” Thisacquisition, or our 2005 Acquisition, represented a highly significant eventfor our company. Prior to the acquisition, we licensed the use of certainpatent applications covering various uses for the pHarlo technology andimprovements from the Selling Entities and also purchased the pHarloconcentrate, a concentrate made using the pHarlo technology from Indian RiverLabs. As a result of the 2005 Acquisition and the purchase of all of theworking assets of Indian River Labs, we now control various uses of pHarlotechnology in the manufacturing process for the pHarlo concentrate. Ourbusiness, financial condition and results of operations could suffer materiallyif we fail to successfully manage these assets and the manufacturing process.

##### *Recent restatementsand amendments to our interim financial statements and quarterly reports, aswell as deficiencies in our disclosure controls and procedures and internalcontrol over financial reporting, may present a risk of future restatements anddisclosure compliance errors which could lead to legal exposure.*

We have recently restated and amended our interimfinancial statements for the periods ended June 30, 2004,September 30, 2004 and September 30, 2005 and have recently filedamendments to our quarterly reports on Form 10-QSB for each of thoseperiods reflecting these restatements. While in the process of amending ourquarterly reports on Form 10-QSB to restate these financialstatements, we became aware of certain required information that had beenomitted and other information that needed to be changed or corrected. As aresult of the foregoing, we revised these quarterly reports to correct thisinformation and to state, among other things, that our disclosure controls andprocedures were not effective as of June 30, 2004, September 30, 2004and September 30, 2005.

As of December 31, 2005, March 31, 2006 and June30, 2006, our management concluded that our disclosure controls and procedureswere not effective. We are taking what we believe to be reasonable andappropriate steps to correct these deficiencies. We will also continue toassess the adequacy and appropriateness of these actions and adjust ourremediation plan as needed or to reflect changes in our business. However, wecannot be certain when these deficiencies will ultimately be remediated and weexpect that we will need a period of time over which to demonstrate that ourdisclosure controls are functioning appropriately to conclude that we haveadequately remediated the deficiencies. Any failure to implement and maintainimprovements in our disclosure and internal controls may present a risk offuture restatements and disclosure compliance errors and could in turn lead tolegal exposure. Any failure to improve these controls to address the identifieddeficiencies, or any other unidentified deficiencies, could also causeinvestors to lose confidence in our reported financial information, which couldhave a negative impact on the trading price of our common stock. This couldhave a material adverse effect on our business and financial results.

##### *We have limitedexperience in the marketing of our products and may not be able to market themsuccessfully.*

We currently market Unifresh® Footbath, a grooming aidthat helps clean and disinfect the hooves of dairy cows, Close CallTM, an oral hygiene breathdrink, Tasker Pacific BlueTM Seafood Wash, a product used in commercial andretail seafood processing to extend shelf life. Shelf life extension is the actof increasing the length of the time a product can spend during processing,distribution and retail before becoming unacceptable for consumption. We alsobegan the commercialization phase of the pHarlo technology as an antimicrobialprocessing aid in poultry scalders.

These are diverse markets and we may not be aware ofall the customs and practices and may not be able to successfully compete inthese industries. We believe that we will need to hire appropriate consultantsand staff to reach all of these markets successfully. The consultants that wemay retain may not have sufficient experience to enable us to completelyunderstand the characteristics of these diverse industries. There can be noassurance that we will properly ascertain or assess any and all risks inherentin our proposed markets or that we will successfully enter into new markets orgrow in our existing markets.

##### *Our ability to reachsome of the markets currently set forth in our business plan will requireregulatory approval. In addition, new products that we may develop or acquiremay also require regulatory approval.*

The ingredients that we use to produce the pHarloconcentrate are approved as Generally Recognized as Safe by the FDA. Therefore,we believe that our current line of products that utilize the pHarloconcentrate, including the intended uses of these products, do not requirefurther approval by the FDA. However, we may develop or acquire future productsthat use ingredients that will need to be approved by the FDA, or we may alterthe intended uses of our current product, such that those products requireadditional FDA approval(s). There can be no assurance that FDA approval, ifnecessary, will be obtained.

37

----

 

The use of our pHarlo technology in the meat andpoultry food processing applications requires the approval of the USDA. InAugust 2006, we received a Letter of No Objections from the Food Safety andInspection Services agency of the USDA, or FSIS, and we began thecommercialization phase of this application of the pHarlo technology. There canbe no assurance that we will successfully complete the commercial verificationprocess. If we do not successfully complete the commercial verificationprocess, this may have a material adverse effect on our business plan.

In addition to the poultry processing industry, wealso intend to market the pHarlo technology for use in seafood processing, andmay resume efforts to introduce the pHarlo technology in skin care and pet careproducts. If marketed in the United States or internationally, each of theseproduct lines could potentially be subject to a variety of federal, state, andinternational regulatory authorities that could require additional testing,registration, pre-market approval, labeling, manufacturing, safety,recordkeeping and other obligations. There can be no assurance that theproducts will obtain the necessary approvals, or, if granted, that theapprovals will not include significant limitations on the indicated uses forwhich the products may be marketed or other restrictions or requirements thatmay reduce the value of the products.

##### *A key component ofour business strategy is the proprietary nature of the pHarlo concentrate, and,therefore, our inability to protect our intellectual property rights couldmaterially harm our business.*

The pHarlo concentrate that we produce is based uponboth the patent applications that we purchased in the 2005 Acquisition, as wellas on certain base patents and base patent applications, or patents andapplications that we license. We have entered into an exclusive worldwideroyalty free sub-license with pHarlo IP, the exclusive licensee of the basepatents and base patent applications, to exploit these base patents andapplications in certain fields of use. Protecting this intellectual property,in addition to protecting the patent applications that we purchased in the 2005Acquisition, is a key component to the success of our business. Although wehave retained the right to enforce our rights as a sub-licensor under the basepatents and base patent applications, if an infringement occurs within thefield of use specified in our sub-license agreement, there can be no assurancethat we would be successful in any action to protect our rights under thepatent applications that we have purchased. In addition, there can be noassurance that the base patent applications or the patent applications that wehave purchased will ultimately be protected by an issued patent.

##### *Intense competitioncould harm our financial performance and the value of your investment.*

Some of the industries in which we are or will bemarketing our products are characterized by intense competition.

Our Unifresh Footbath treats a highly infectiousdisease known as digital dermatitis that causes lameness, swelling and fever indairy cows, resulting in a drastic decrease in milk production. Forms oftreatment include antibiotic bandaging and topical sprays using TerramycinÒ(oxytetracycline – an antibiotic) and footbaths using Formalin (a saturatedsolution of formaldehyde), copper sulfate, Tetracycline (a broad-spectrumantibiotic) or Peracetic Acid (a disinfectant and sanitizer). Unifresh Footbath’sunderlying technology, pHarlo technology, uses a highly acidified form ofcopper sulfate that helps control the bacteria that cause digital dermatitis.Some competing products using copper sulfate include QuickHit, Healthy Foot andHoofPro+ by SSI Corporation; Double-ActionÔHoof Treatment by West Agro, Inc.; and Hoofcare Supercharger manufactured byMarabo.

Although our oral hygiene product for humans, CloseCall, is swallowed rather than expelled like mouthwash, our product may competewithin the mouthwash industry generally. The mouthwash industry is a matureindustry with several mass products such as Listerine®, Scope®, Act®, Peroxyl® and Cepacol® from participants, many of which are divisionsof large corporations, such as Pfizer, Procter & Gamble, Johnson &Johnson, Colgate and Combe. These are well-established companies with vastlygreater resources than we have.

Currently, there is little competition for bacterialinhibitors in the scalding process of poultry processors. We intend to expandthe use of the pHarlo technology into the remaining operations of poultryprocessing, specifically the on-line reprocessing area, or an approved processthat allows chicken with fecal material on the skin to be sprayed with achemical disinfectant so that all such material is disinfected and/or removedprior to entry into the chilling process, or freezing process. However, webelieve we will encounter competition in the chill process from manufacturersof sodium hydrochloride or sodium hypochlorite, chemical compound solutionsfrequently used as disinfectants and bleaching agents. The chill process iscold water or air that is used in poultry processing to reduce the temperatureof the carcass to 40 degrees Fahrenheit in order to maintain food safety.

Currently, our seafood application product, PacificBlueÔ, is the treatment in the market that eliminatesodors on seafood by reducing the bacteria that causes spoilage. When and if themarket for Pacific BlueÔ develops,additional products created by competitors may enter the market and compete.

In addition, ammonia is an ever-present element of theatmosphere in poultry houses. The detrimental effects of ammonia in poultryfarming are widely known and several products focused on litter treatment areavailable in the market using sodium bisulfate 

38

----

 

and aluminum sulfate (Alum) that convert litterammonium to ammonium sulfate, emitting a significantly lower ammonia level. Yuccaschidigera extract is also used as an enzyme treatment in the poultry diet toreduce ammonia evolving from poultry manure. Some products currently availablein the market include PLTÒ(Poultry Litter Treatment), Ultra Litter TreatmentÔand Poultry GuardÔ, which are granulated products, BZTÒand Premium Bio-Treat Poultry Blend.

There may be a number of companies, universities andresearch organizations actively engaged in research and development oftechnology that could be similar to our processes and ultimately become ourcompetitors. We cannot assure you that we will be able to successfully competewith current or future competitors who may have substantially greater assets,technical staff, established market share and greater financial and operatingresources than we have. If we are unable to successfully compete with theseindustry competitors, it may have a material adverse effect on our businessplan.

##### *Some provisions ofour amended and restated articles of incorporation, bylaws, and Nevada law mayinhibit potential acquisition bids that may be considered favorable to ourstockholders.*

Our corporate documents contain provisions that mayenable our board of directors to resist a change in control of our company evenif a change in control were to be considered favorable by our stockholders.These provisions include:

limitations on persons authorized to call a specialmeeting of stockholders;

the ability of a majority of the directors then inoffice to fill vacancies in directorships; and

no cumulative voting.

These and other provisions contained in our amendedand restated articles of incorporation and bylaws could delay or discouragetransactions involving an actual or potential change in control of us or ourmanagement, including transactions in which our stockholders might otherwisereceive a premium for their shares over then current prices, and may limit theability of stockholders to remove our current management or approvetransactions that our stockholders may deem to be in their best interests and,therefore, could adversely affect the price of our common stock.

In addition, we are subject to control shareacquisitions provisions and affiliated transaction provisions of the NevadaGeneral Corporation Law, the applications of which may have the effect ofdelaying or preventing a merger, takeover or other change of control of us andtherefore could discourage attempts to acquire our company.

**RISKSRELATED TO OUR COMMON STOCK**

##### *If we are unable tocomply with the terms of registration********rights agreements to which we are a party, we may beobligated to pay liquidated********damages to some of our security holders.*

In connection with our April 2004, July 2004, December2004, September 2005 and January 2006 private placements, we entered intoregistration rights agreements with certain of our security holders in which weagreed to prepare and file with the SEC registration statements to registercertain shares of common stock, which registration statements must bemaintained effective for certain specified periods. If we are unable to complywith these provisions of these registration rights agreements, we may beobligated to pay liquidated damages to the holders of the securities covered bysuch registration rights agreements. If we are required to pay such liquidated damages or other amounts tothese holders, our business, financial condition, operating results and cashflows would be materially adversely affected.

Registration statements with respect to the April2004, July 2004 and December 2004 private placements were filed and declaredeffective in a timely manner. However, on June 14, 2006, we notified theholders of securities acquired in these private placements that theprospectuses contained within these registration statements contained financialand other information that was not current and that, as a result, suchprospectuses could not be used to offer and sell such securities. Ourobligation to accrue liquidated damages under these registration rightsagreements ceased in April 30 and July 22, 2006, respectively. Through July 22,2006, we have accrued $441,000 in liquidated damages related to theseagreements.

We were unable to have the registration statementregistering resale of securities purchased in the September 2005 privateplacement declared effective by the deadline specified in the applicableregistration rights agreement. However, in connection with the January 2006private placement, we obtained waivers of all claims for liquidated damagesrelating to our inability to have such registration statement declaredeffective by the specified deadline. Under the waiver, the date by which the registrationstatement covering resale of the securities purchased in the September 2005private placement was required to be declared effective was extended to May 23,2006. On April 26, 2006, we filed a registration statement registering resaleof securities purchased in the September 2005 and January 2006 privateplacements. We believe, however, that as it relates to the September 2005private 

39

----

 

placement, we have used our best efforts to cause theregistration statement to be declared effective and, therefore, pursuant to theterms of the September 2005 registration rights agreement, we believe that weare not currently liable for liquidated damages as a result of the registrationstatement not being declared effective by May 23, 2006. Should the rights holdersdispute that our best efforts were used, and we either accede to theirassertion or are found to not have used our best efforts, the estimated maximumamount of liquidated damages for which we would be liable, assuming(i) ineffectiveness from May 23, 2006 to the end of the period covered bythe registration agreement and (ii) a stock price of $0.37 for periodssubsequent to July 26, 2006, is approximately $270,000. Also, we believe thatas it relates to the January 2006 private placement, we have used our bestefforts to respond to the SEC comments within fifteen days from the date of thereceipt of those comments. As of September 30, 2006, no shares were issuable asliquidated damages under the terms of the January 2006 registration rightsagreement. However, if we fail to meet certain conditions of the January 2006registration rights agreement, we will be required to issue to each holder inour January 2006 private placement, shares and warrants equal to one percent,or 266,718 of the respective number of shares and warrants purchased by eachholder, for each 30 days of failure to meet any one of these conditions. We maybe required to issue a maximum aggregate of 4 million shares and warrants.

##### *Future sales of ourcommon stock may cause our stock price to decline.*

Since our inception, we have funded operations throughcommon stock issuances in order to meet our strategic objectives. We havecompleted six private sales of common stock and securities convertible intocommon stock. We may, in the future, issue more shares of common stock in salesthat may or may not be registered under the Securities Act of 1933, or theSecurities Act. Our stock price may decline due to future sales of our sharesor even the perception that such sales may occur.

##### *Our stock price canbe extremely volatile.*

Our common stock is traded on the OTC Bulletin Board.There can be no assurance that an active public market will continue for thecommon stock, or that the market price for the common stock will not declinebelow its current price. The price of our common stock may be influenced bymany factors, including, but not limited to, investor perception of us and ourindustry and general economic and market conditions. The trading price of ourcommon stock could be subject to wide fluctuations in response to announcementsof our business developments or our competitors, quarterly variations inoperating results and other events or factors. In addition, stock markets haveexperienced extreme price volatility in recent years. This volatility has had asubstantial effect on the market prices of companies, at times for reasonsunrelated to their operating performance. Such broad market fluctuations mayadversely affect the price of our common stock.

##### *The large number ofshares available for future sale could adversely affect the price of our commonstock.*

As of June 30, 2006, approximately 16.3 million sharesof common stock were issuable upon exercise of outstanding stock options with aweighted average exercise price of $0.87 per share, and approximately 21.5million shares of common stock were issuable upon exercise of outstandingwarrants with an exercise price of between $0.01 to $2.00 per share. Inaddition, the registration rights agreement for the January 2006 privateplacement requires us to pay any liquidated damages in additional common stockand warrants. As of September 30, 2006, no shares were issuable as liquidateddamages under the terms of the January 2006 registration rights agreement.However, if we fail to meet certain conditions of the January 2006 registrationrights agreement, we will be required to issue to each holder in our 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. We may be required toissue a maximum aggregate of 4 million shares and warrants. Substantially allof the shares underlying these options and warrants have been or would be registeredfor resale, and none of them are subject to any contractual restrictions onresale. Future sales of any of these shares, or the anticipation of such sales,could adversely affect the market price of our common stock and couldmaterially impair our future ability to raise capital through an offering ofequity securities. Further, any issuance of a substantial number of theseshares would dilute the ownership interest of existing stockholders and couldresult in increased volatility in the price of our common stock.

##### *Our common stock,which is quoted on the OTC Bulletin Board, has several disadvantages from thosesecurities traded on The Nasdaq Stock Market.*

Our common stock, whichis quoted on the OTC Bulletin Board, has several disadvantages from thosesecurities traded on The Nasdaq Stock Market. These disadvantages include thefollowing:

The SEC’s order handling rules, which apply toNasdaq-listed securities, do not apply to securities quoted on the OTC BulletinBoard.

Although The Nasdaq Stock Market has rigorous listingstandards to ensure the high quality of its issuers, and can delist issuers fornot meeting those standards, the OTC Bulletin Board has no listing standards.Rather, it is the market maker who chooses to quote a security on the system byfiling an application with the NASD. The NASD cannot deny an application by amarket maker to quote the stock of a company. The only requirement forinclusion in the OTC Bulletin Board is that the issuer be current in itsreporting requirements with the SEC.

40

----

 

Trading activity on the OTC Bulletin Board in generalis not conducted as efficiently and effectively as with Nasdaq-listedsecurities. Investors must contact a broker-dealer to trade OTC Bulletin Boardsecurities. Investors do not have direct access to the bulletin board service.For bulletin board securities, there only has to be one market maker.

Bulletin board transactions are conducted almostentirely manually. Because there are no automated systems for negotiatingtrades on the bulletin board, they are conducted via telephone. In times ofheavy market volume, the limitations of this process may result in asignificant increase in the time it takes to execute investor orders.Therefore, when investors place an order to buy or sell a specific number ofshares at the current market price, it is possible for the price of a stock togo up or down significantly during the lapse of time between placing a marketorder and getting execution.

Shares traded on the OTC Bulletin Board generally arequoted with greater spreads between bid and ask and may be more expensive tobuy or sell.

Because bulletin board stocks are usually not followedby analysts, there may be lower trading volume than for Nasdaq-listedsecurities.

##### *If we fail to remaincurrent on our reporting requirements, we could be removed from the OTCBulletin Board, which would limit the ability of broker-dealers to sell oursecurities and the ability of stockholders to sell their securities in thesecondary market.*

Companies like us that trade on the OTC Bulletin Boardmust be reporting issuers under Section 12 of the Exchange Act of 1934,and must be current in their reports under Section 13, in order tomaintain price quotation privileges on the OTC Bulletin Board. If we fail to remaincurrent on our reporting requirements, we could be removed from the OTCBulletin Board. In such event, the market liquidity for our securities could beseverely adversely affected by limiting the ability of broker-dealers to sellour securities and the ability of stockholders to sell their securities in thesecondary market.

##### *Since our commonstock is subject to the SEC’s penny stock rules, broker-dealers may experiencedifficulty in completing customer transactions and trading activity in oursecurities may be adversely affected.*

A public company’s common stock is subject to thepenny stock rules promulgated under the Securities Exchange Act of 1934, orExchange Act, unless its net tangible assets are greater than $2,000,000 or itscommon stock has a market price per share greater than $5.00. Under theserules, broker-dealers who recommend such securities to persons other thaninstitutional accredited investors must:

make a special written suitability determination forthe purchaser;

receive the purchaser’s written agreement to atransaction prior to sale;

provide the purchaser with risk disclosure documentsthat identify certain risks associated with investing in “penny stocks” andthat describe the market for these “penny stocks,” as well as a purchaser’slegal remedies; and

obtain a signed and dated acknowledgment from thepurchaser demonstrating that the purchaser has actually received the requiredrisk disclosure document before a transaction in “penny stock” can becompleted.

Since our common stock issubject to these rules, broker-dealers may find it difficult to effect customertransactions and trading activity in our securities may be adversely affected.As a result, the market price of our securities may be depressed, and you mayfind it more difficult to sell our securities

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

During the three-monthperiod ended June 30, 2006, we granted the following stock options:

·                     On May 11,2006, stock options to purchase an aggregate of 530,000 shares of common stock,at an exercise price of $1.00 per share, with a contract term of ten years anda vesting term of two year, were granted to six non-executive employees

The grants of stock options were not registered underthe Securities Act because such grants were exempt from registration pursuantto Section 4(2) of the Securities Act, as they were transactions by anissuer that did not involve a public offering of securities.

41

----

 

**Item 4.****           Submission of Mattersto a Vote of Security Holders**

We held our 2006 Annual Meeting of Stockholders onJune 16, 2006. The following matters were voted upon at the Annual Meeting:

Holdersof 76,303,187 shares of our common stock voted to elect James Burns to servefor a term of one year and holders of 3,869,649 shares of our common stockwithheld votes from this director.

Holdersof 66,118,754 shares of our common stock voted to elect Albert Canosa to servefor a term of one year and holders of 14,054,082 shares of our common stockwithheld votes from this director.

Holdersof 79,382,472 shares of our common stock voted to elect Richard Falcone toserve for a term of one year and holders of 790,364 shares of our common stockwithheld votes from this director.

Holdersof 79,496,972 shares of our common stock voted to elect William Miller to servefor a term of one year and holders of 675,864 shares of our common stockwithheld votes from this director.

Holdersof 79,175,562 shares of our common stock voted to elect Steven Zavagli to servefor a term of one year and holders of 3,997,274 shares of our common stockwithheld votes from this director.

Holdersof 79,210,878 shares of our common stock voted to amend the Company’s Articlesof Incorporation to increase the maximum size of the Company’s Board ofDirectors from five to seven, holders of 940,358 shares of our common stockvoted against this resolution and holders of 21,600 shares of our common stockwithheld votes from this resolution.

Holdersof 79,662,119 shares of our common stock voted to amend the Company’s Articlesof Incorporation to change the Company name from Tasker Capital Corp. to TaskerProducts Corp., holders of 217,031 shares of our common stock voted againstthis resolution and holders of 293,686 shares of our common stock withheldvotes from this resolution.

Holdersof 32,793,063 shares of our common stock voted to approve the Company’s 2006Stock Plan, authorizing the issuance of 2,500,000 shares of our common stock,holders of 2,294,484 shares of our common stock voted against this resolution,holders of 3,127,705 shares of our common stock withheld votes from thisresolution and holders of 41,957,854 shares of our common abstained fromvoting.

Holders of 78,868,487shares of our common stock voted to ratify the appointment of Rothstein, Kass& Company, P.C. as our independent auditors for the current fiscal year,holders of 976,847 shares of our common stock voted against ratifying thisappointment and holders of 327,502 shares withheld votes from thisratification.

**Item 6. Exhibits**
| 3.1  |   | Articles of Incorporation of Tasker Products Corp.,  as amended (incorporated by reference to Exhibit 4.2 to our Registration  Statement on Form S-8 filed on July 20, 2006) |
|------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.1 |   | Termination Agreement with James Burns as of August  1, 2006                                                                                                                 |
| 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                                                                                                                  |

 

42

----

 

**SIGNATURES**

In accordance with the requirements of the ExchangeAct, the registrant caused this report to be signed on its behalf by theundersigned, thereunto duly authorized.

 
|                                  |   | TASKER PRODUCTS CORP. |
|----------------------------------|--------|-----------------------|
|                             |   |                  |   |   |
|                             |   |                  |   |   |
| Date: October 26, 2006 |   | By:                   |   | /s/ Stathis Kouninis |
|                             |   |                  |   | Stathis Kouninis |
|                             |   |                  |   | Chief Financial Officer, Treasurer and Secretary  (Principal Financial and Accounting Officer) |

 

43

----

** **

**ExhibitIndex**
| 3.1   |   | Articles of Incorporation of Tasker Products Corp.,  as amended (incorporated by reference to Exhibit 4.2 to our Registration  Statement on Form S-8 filed on July 20, 2006) |
|-------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.1* |   | Termination Agreement with James Burns as of August  1, 2006                                                                                                                 |
| 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                                                                                                                  |

 

----

* Previously filed withthis Form 10-Q

44

----