**UNITED
      STATES**


**SECURITIES
      AND EXCHANGE COMMISSION**


**Washington,
      DC 20549**





**FORM
      10-Q**








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** .





_____  TRANSITION
      REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934


for
      the
      transition period from _____ to _____.





Commission
      File Number


0-50481





**AEOLUS
      PHARMACEUTICALS, INC.**


(Exact
      Name of Registrant as Specified in Its Charter)








Delaware
              
              56-1953785(State
                  or Other Jurisdiction of
                  Incorporation or Organization)
              
              (I.R.S. Employer Identification
                  No.)23811
                  Inverness Place
                Laguna
                  Niguel, California
              
              92677(Address
                  of Principal Executive Offices)
              
              (Zip Code)(Registrant’s
                  Telephone Number, Including Area Code)949-481-9825




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





Indicate
      by check mark whether the registrant is a large accelerated filer, an
      accelerated filer, or a non-accelerated filer. See definition of accelerated
      filer and large accelerated filer in Rule 12b-2 of the Exchange Act:




Large
      accelerated filer [ ] Accelerated filer [ ] Non-accelerated filer [X]




Indicate
      by check mark whether the registrant is a shell company (as defined in Rule
      12b-2 of the Exchange Act). **** YES
      [ ]
      NO [X]





Indicate
      the number of shares outstanding of each of the issuer’s classes of common
      stock, as of the latest practicable date.





Class
            Outstanding
                as of August 10,
                2006Common Stock, par value $.01 per
              share
            29,244,416
                shares


1


AEOLUS
      PHARMACEUTICALS, INC.


FORM
      10-Q


For
      the
      Quarter Ended June 30, 2006


Table
      of
      Contents


**Page****PART
                I****.****FINANCIAL
                INFORMATION**Item
                1.
            Financial
                StatementsStatement
                Regarding Financial Information
            3Condensed
                Consolidated Balance Sheets as of June 30,
                2006
              (unaudited)
                and September 30,
                2005
            4Condensed
                Consolidated Statements of Operations for the
                Three Months and Nine Months ended June 30, 2006 and 2005
                (unaudited)
            5Condensed
                Consolidated Statements of Cash Flows for the
              Nine
                Months ended June 30, 2006 and 2005
                (unaudited)
            6Notes
                to Condensed Consolidated Financial
                Statements
            7Item
                2.
            Management’s
                Discussion and Analysis of Financial Condition
                and Results of Operations
            15Item
                3.
            Quantitative
                and Qualitative Disclosures About Market
                Risk
            20Item
                4.
            Controls
                and Procedures
            21**PART
                II.****OTHER
                INFORMATION**Item
                1.
            Legal
                Proceedings
            21Item
                1A.
            Risk
                Factors
            21Item
                2.
            Unregistered
                Sales of Equity Securities and Use of
                Proceeds
            21Item
                3.
            Defaults
                Upon Senior Securities
            22Item
                4.
            Submission
                of Matters to a Vote of Security
                Holders
            22Item
                5.
            Other
                Information
            22Item
                6.
            Exhibits
            23SIGNATURES
            24


2


**AEOLUS
      PHARMACEUTICALS, INC.**










**PART
      I - FINANCIAL INFORMATION**





ITEM
      1.Financial
      Statements.





**Statement
      Regarding Financial Information**





The
      condensed consolidated financial statements of Aeolus Pharmaceuticals, Inc.
      and
      its wholly-owned subsidiary, Aeolus Sciences, Inc. (collectively the “Company”),
      included herein have been prepared by management, without audit (except for
      the
      Consolidated Balance Sheet as of September 30, 2005), pursuant to the rules
      and
      regulations of the Securities and Exchange Commission (“SEC”). Certain
      information normally included in the consolidated financial statements prepared
      in accordance with accounting principles generally accepted in the United States
      has been condensed or omitted pursuant to such rules and regulations. However,
      the Company believes that the disclosures are adequate to make the information
      presented not misleading. The Company recommends that you read the consolidated
      financial statements included herein in conjunction with the audited
      consolidated financial statements and notes thereto included in the Company’s
      Annual Report on Form 10-K for the fiscal year ended September 30, 2005, filed
      with the SEC on December 27, 2005.











3


AEOLUS
                PHARMACEUTICALS, INC.CONDENSED
                CONSOLIDATED BALANCE
                SHEETS(In
                thousands, except shares and per share data)June
                30,
            
            September
                30,2006
            
            2005(Unaudited)ASSETSCurrent
                assets:Cash
                and cash equivalents
            
            
            
            
            $
            4,003
            
            $
            626Accounts
                receivable
            
            
            
            
            
            9
            
            
            14Prepaids
                and other current assets
            
            
            
            
            
            314
            
            
            289Total
                current assets
            
            
            
            
            
            4,326
            
            
            929Investment
                in CPEC LLC
            
            
            
            
            
            126
            
            
            8Total
                assets
            
            
            
            
            $
            4,452
            
            $
            937LIABILITIES
                AND STOCKHOLDERS' DEFICITCurrent
                liabilities:Accounts
                payable
            
            
            
            
            $
            662
            
            $
            712Accrued
                expenses
            
            
            
            
            
            3
            
            
            290Current
                maturity of long-term note payable
            
            
            
            
            
            933
            
            
            -Total
                current liabilities
            
            
            
            
            
            1,598
            
            
            1,002Warrant
                liability
            
            
            
            
            
            6,827
            
            
            -Long-term
                note payable
            
            
            
            
            
            -
            
            
            867Total
                liabilities
            
            
            
            
            
            8,425
            
            
            1,869Stockholders'
                deficit:Preferred
                stock, $.01 par value per share, 10,000,000 shares authorized atJune 30, 2006 and 3,000,000 shares authorized at September 30,
                2005:Series
                B nonredeemable convertible preferred stock, 600,000 shares
                authorized;475,087 shares issued and outstanding at June 30, 2006 andSeptember 30, 2005
            
            
            
            
            
            5
            
            
            5Common
                stock, $.01 par value per share, 50,000,000 shares
                authorized;29,223,583 and 14,038,259 shares issued and outstanding at June 30,
                2006and September 30, 2005, respectively
            
            
            
            
            
            292
            
            
            140Additional
                paid-in capital
            
            
            
            
            
            148,417
            
            
            146,016Accumulated
                deficit
            
            
            
            
            
            (152,687
            )
            
            (147,093
            )Total
                stockholders' deficit
            
            
            
            
            
            (3,973
            )
            
            (932
            )Total
                liabilities and stockholders' deficit
            
            
            
            
            $
            4,452
            
            $
            937The
                accompanying notes are an integral part of these unaudited condensed
                consolidated financial statements.


4


AEOLUS
                PHARMACEUTICALS, INC.CONDENSED
                CONSOLIDATED STATEMENTS OF
                OPERATIONS(Unaudited)(In
                thousands, except per share data)Three
                Months Ended
            
            Nine
                Months EndedJune
                30,
            
            June
                30,2006
            
            2005
            
            2006
            
            2005RevenueGrant
                income
            
            $
            -
            
            $
            121
            
            $
            92
            
            $
            236Costs
                and expenses:Research
                and development
            
            
            419
            
            
            849
            
            
            2,677
            
            
            3,621General
                and administrative
            
            
            524
            
            
            898
            
            
            1,571
            
            
            1,851Total
                costs and expenses
            
            
            943
            
            
            1,747
            
            
            4,248
            
            
            5,472Loss
                from operations
            
            
            (943
            )
            
            (1,626
            )
            
            (4,156
            )
            
            (5,236
            )Interest
                expense, net
            
            
            (10
            )
            
            (10
            )
            
            (29
            )
            
            (17
            )Equity
                in income of CPEC LLC
            
            
            -
            
            
            -
            
            
            433
            
            
            -Other
                income
            
            
            17
            
            
            -
            
            
            53
            
            
            -Increase
                in fair value of common stock warrants
            
            
            (2,216
            )
            
            -
            
            
            (1,815
            )
            
            -Net
                loss
            
            
            (3,152
            )
            
            (1,636
            )
            
            (5,514
            )
            
            (5,253
            )Preferred
                stock dividend accreted
            
            
            (26
            )
            
            -
            
            
            (81
            )
            
            -Net
                loss attributable to common stockholders
            
            $
            (3,178
            )
            $
            (1,636
            )
            $
            (5,595
            )
            $
            (5,253
            )Net
                loss per weighted share attributable to common
                stockholders:(basic
                and diluted)
            
            $
            (0.17
            )
            $
            (0.12
            )
            $
            (0.36
            )
            $
            (0.38
            )Weighted
                average common shares outstanding:(basic
                and diluted)
            
            
            18,234
            
            
            13,976
            
            
            15,450
            
            
            13,966The
                accompanying notes are an integral part of these unaudited condensed
                consolidated financial statements.


5


AEOLUS
                PHARMACEUTICALS, INC.CONDENSED
                CONSOLIDATED STATEMENTS OF CASH
                FLOWS(Unaudited)(In
                thousands)Nine
                Months EndedJune
                30,2006
            
            2005Cash
                flows from operating activities:Net
                loss
            
            $
            (5,514
            )
            $
            (5,253
            )Adjustments
                to reconcile net loss to net cash used in operating
                activities:Depreciation
                and amortization
            
            
            -
            
            
            8Noncash
                compensation
            
            
            264
            
            
            329Noncash
                interest expense
            
            
            66
            
            
            59Noncash
                licensing fee
            
            
            12
            
            
            -Equity
                in income of CPEC LLC
            
            
            (433
            )
            
            -Increase
                in fair value of common stock warrants
            
            
            1,815
            
            
            -Change
                in assets and liabilities:Accounts
                receivable
            
            
            5
            
            
            9Prepaids
                and other assets
            
            
            (25
            )
            
            (69
            )Accounts
                payable and accrued expenses
            
            
            (337
            )
            
            (437
            )Net
                cash used in operating activities
            
            
            (4,147
            )
            
            (5,354
            )Cash
                flows from financing activities:Proceeds
                from dividend from CPEC LLC
            
            
            315
            
            
            -Proceeds
                from issuance of Series A Preferred Stock
            
            
            2,413
            
            
            -Proceeds
                from issuance of common stock
            
            
            4,754
            
            
            -Proceeds
                from exercise of stock options
            
            
            42
            
            
            -Net
                cash provided by financing activities
            
            
            7,524
            
            
            -Net
                increase (decrease) in cash and cash equivalents
            
            
            3,377
            
            
            (5,354
            )Cash
                and cash equivalents at beginning of period
            
            
            626
            
            
            7,381Cash
                and cash equivalents at end of period
            
            $
            4,003
            
            $
            2,027The
                accompanying notes are integral part of these unaudited condensed
                consolidated financial statements.


6








**AEOLUS
        PHARMACEUTICALS, INC.**


**NOTES
      TO CONDENSED CONSOLIDATED FINANCIAL
      STATEMENTS**





A.  Organization
      and Business and Basis of Presentation





Aeolus
      Pharmaceuticals, Inc. is a San Diego-based biopharmaceutical company that is
      developing a new class of catalytic antioxidant compounds for diseases and
      disorders of the central nervous system, respiratory system, autoimmune system
      and oncology. The Company has reported positive safety results from a completed
      Phase I single dose study of its lead product, AEOL 10150, in patients diagnosed
      with amyotrophic lateral sclerosis (“ALS,” also commonly referred to as “Lou
      Gehrig’s disease”) and in
      September 2005, we launched a Phase I multiple dose study of AEOL 10150 in
      patients diagnosed with ALS. We expect to complete this study during the first
      quarter of fiscal year 2007. The
      safety data from these studies could be utilized to support subsequent efficacy
      studies of AEOL 10150 in ALS, as well as other indications for which the Company
      has developed preclinical efficacy data. In addition, the Company has launched
      the “Aeolus Pipeline Initiative” whereby the Company, in conjunction with a
      variety of academic collaborations, is focused on identifying between 1-2
      compounds evaluated from six disease categories for potential entrance into
      human clinical evaluation in 2006. The Aeolus Pipeline Initiative is an internal
      development initiative focused on advancing several of the most promising
      catalytic antioxidant compounds from our proprietary library of 200 compounds.
      The initial therapeutic focus areas for the Aeolus Pipeline Initiative are:
      radiation therapy/protection and tumor therapy; Parkinson’s disease; Cystic
      Fibrosis; Chronic Obstructive Lung Disease; tumor suppression/bone marrow
      transplantation; and stroke. These therapeutic focus areas were selected based
      upon preliminary data developed using our catalytic antioxidant
      compounds.





The
      “Company” or “Aeolus” refers collectively to Aeolus Pharmaceuticals, Inc., a
      Delaware corporation (“Aeolus”), and its wholly owned subsidiary, Aeolus
      Sciences, Inc., a Delaware corporation. As of June 30, 2006, Aeolus also owned
      a
      35.0% interest in CPEC LLC, a Delaware limited liability company (“CPEC”). The
      Company’s primary operations are located in San Diego, California.




All
      significant intercompany activity has been eliminated in the preparation of
      the
      consolidated financial statements. The unaudited condensed consolidated
      financial statements have been prepared in accordance with the requirements
      of
      Form 10-Q and Rule 10-01 of Regulation S-X. Some information and footnote
      disclosures normally included in financial statements prepared in accordance
      with generally accepted accounting principles have been condensed or omitted
      pursuant to those rules and regulations. In the opinion of management, the
      accompanying unaudited consolidated financial statements include all adjustments
      (consisting only of normal recurring adjustments) necessary to present fairly
      the consolidated financial position, results of operations and cash flows of
      the
      Company. The consolidated balance sheet at September 30, 2005 was derived from
      the Company’s audited financial statements included in the Company’s Annual
      Report on Form 10-K for the fiscal year ended September 30, 2005. The unaudited
      condensed consolidated financial statements included herein should be read
      in
      conjunction with the audited consolidated financial statements and the notes
      thereto included in that Annual Report on Form 10-K and in the Company’s other
      SEC filings. Results for the interim period are not necessarily indicative
      of
      the results for any other period.





7


B.  Liquidity





The
      Company has incurred significant losses from operations of $4,156,000 and
      $6,937,000, and cash outflows from operations of $4,147,000 and $6,842,000,
      for
      the nine months ended June 30, 2006 and for the fiscal year ended September
      30,
      2005, respectively. The Company expects to incur additional losses and negative
      cash flow from operations during the remainder of fiscal year 2006 and for
      several more years.





M anagement
      believes the Company has adequate financial resources to conduct operations
      through the third quarter of fiscal year 2007. This raises substantial doubt
      about our ability to continue as a going concern, which will be dependent on
      our
      ability to generate sufficient cash flows to meet our obligations on a timely
      basis, to obtain additional financing and, ultimately, to achieve operating
      profit.





The
      Company intends to explore strategic and financial alternatives, including
      a
      merger or acquisition with or by another company, the sale of shares of stock,
      the establishment of new collaborations for current research programs that
      include initial cash payments and on-going research support and the
      out-licensing of our compounds for development by a third party. The Company
      believes that without additional investment capital it will not have sufficient
      cash to fund its activities in the near future, and will not be able to continue
      operating. As such, the Company’s continuation as a going concern is dependent
      upon its ability to raise additional financing. The Company is actively pursuing
      additional equity financing to provide the necessary funds for working capital
      and other planned activities.





If
      the
      Company is unable to obtain additional financing to fund operations beyond
      the
      third quarter of fiscal year 2007, it will need to eliminate some or all of
      its
      activities, merge with another company, sell some or all of its assets to
      another company, or cease operations entirely. There can be no assurance that
      the Company will be able to obtain additional financing on favorable terms
      or at
      all, or that the Company will be able to merge with another Company or sell
      any
      or all of its assets.








C.  Net
      Loss Per Common Share





The
      Company computes basic net loss per weighted average share attributable to
      common stockholders using the weighted average number of shares of common stock
      outstanding during the period. The Company computes diluted net loss per
      weighted average share attributable to common stockholders using the weighted
      average number of shares of common and dilutive potential common shares
      outstanding during the period. Diluted weighted average common shares excluded
      incremental shares of approximately 18,971,000 as of June 30, 2006 issuable
      upon
      the exercise or conversion of stock options to purchase common stock,
      convertible preferred stock, convertible debt and warrants to purchase common
      stock. These shares were excluded due to their antidilutive effect as a result
      of the Company’s net losses.








8


D.  Shareholder’s
      Equity (Deficit)





***Common
      Stock***





On
      June
      5, 2006, Aeolus Pharmaceuticals, Inc. entered into a Subscription Agreement
      (the
“Subscription Agreement”) with certain accredited investors (the “Investors”)
      pursuant to which the Company sold to the Investors an aggregate of 10,000,000
      shares of the Company’s Common Stock (the “Shares”) at a purchase price of $0.50
      per share for aggregate gross proceeds of $5,000,000, issued to the Investors
      warrants (the “Investor Warrants”) to purchase up to an aggregate of 7,000,000
      shares of common stock of the Company with an exercise price of $0.75 per share
      and issued to Efficacy Biotech Master Fund Ltd. a warrant (the “Efficacy
      Warrant”) to purchase up to an aggregate of 4,000,000 shares of common stock of
      the Company with an exercise price of $0.50 per share (the "Financing"). The
      Investor Warrants are exercisable until June 5, 2011 and may be exercised by
      the
      holder only pursuant to a cash payment. The Efficacy Warrant is exercisable
      until June 5, 2007 and may be exercised by the holder only pursuant to a cash
      payment.





The
      aggregate net proceeds to the Company from the Financing, after deducting for
      expenses, were approximately $4,754,000. The Company intends to use the net
      proceeds from the Financing to finance the clinical development of AEOL 10150
      and to fund ongoing operations of the Company.





The
      fair
      value of the warrants on June 5, 2006 was estimated to be $4,716,000 using
      the
      Black-Scholes option pricing model with the following assumptions: dividend
      yield of 0%; risk free interest rate of 5.0%; expected volatility of 120% for
      the Investor Warrant and 124% for Efficacy Warrant; and an expected life of
      five
      years for the Investor Warrants and one year for the Efficacy Warrant. The
      proceeds from the private placement were first allocated to the fair value
      of
      the warrants and the remaining proceeds were attributed to the value of the
      common stock.





Pursuant
      to the terms of the Subscription Agreement, the Company filed a registration
      statement which was declared effective on July 31, 2006. The subscription
      agreement further provides that if a registration statement is not filed,
      declared effective within specified time periods or its effectiveness
      maintained, the Company would be required to pay each holder an amount in cash,
      as liquidated damages, equal to 1.0% per month of the aggregate purchase price
      paid by such holder in the private placement for the common stock and warrants
      then held. In accordance with EITF 00-19, “Accounting for Derivative Financial
      Instruments Indexed To, and Potentially Settled In a Company’s Own Stock,” and
      the terms of the warrants and the transaction documents, at the closing date,
      June 5, 2006, the fair value of the warrants issued in the private placement
      were accounted for as a liability. The warrant liability was reclassified to
      equity when the Securities and Exchange Commission declared the registration
      statement effective. From June 5, 2006 to July 31, 2006, the date in which
      a
      registration statement registering the shares underlying the warrants was
      declared effective, the warrant liability was revalued at each balance sheet
      date and changes in fair value were charged to the statement of operations.
      Between June 5, 2006 and June 30, 2006, the fair value of the warrant increased
      by $2,111,000 which was charged to the statement of operations. The warrant
      liability and revaluations have not and will not have any impact on the
      Company’s working capital, liquidity, or business operations.





9


***Warrants***





In
      connection with the Private Placement in November, Aeolus issued warrants to
      purchase 2,500,000 shares at an exercise price of $1.00 per share. In accordance
      with the terms of the Certificate of Designations, Preferences and Rights of
      Series A Convertible Preferred Stock, the conversion price of the Company’s
      Series A Convertible Preferred Stock (the “Series A Preferred Stock”) and the
      exercise price of the warrants previously issued to the Series A Preferred
      Stock
      holders in November 2005 were each automatically reduced to $0.50 per share,
      the
      purchase price of the common stock issued in the Financing. As a result of
      the
      change in the exercise price, these warrants were revalued resulting in an
      increase in the value of $105,000 which was charged to the statement of
      operations.





As
      of
      June 30, 2006, warrants to purchase 15,957,402 whole shares of common stock
      were
      outstanding. Details of the warrants for common stock outstanding at June 30,
      2006 were as follows:





**Number
                of Shares**
            
            **Exercise
                Price**
            
            **Expiration
                Date**4,000,000
            
            $
            0.50
            
            
            June
                200750,000
            
            $
            0.50
            
            
            May
                20112,500,000
            
            $
            0.50
            
            
            November
                20107,000,000
            
            $
            0.75
            
            
            June
                201150,000
            
            $
            1.00
            
            
            May
                201135,000
            
            $
            1.00
            
            
            July
                200850,000
            
            $
            1.50
            
            
            May
                201150,000
            
            $
            2.00
            
            
            May
                201150,000
            
            $
            2.50
            
            
            May
                2011410,400
            
            $
            2.50
            
            
            April
                20091,641,600
            
            $
            4.00
            
            
            April
                20091,860
            
            $
            16.125
            
            
            August
                20061,759
            
            $
            19.90
            
            
            October
                2008106,783
            
            $
            20.25
            
            
            August
                200610,000
            
            $
            20.25
            
            
            October
                200615,957,402




10


E.  Series
      A Convertible Preferred Stock





On
      November 21, 2005, the Company completed a private placement whereby the Company
      issued to certain accredited investors an aggregate of 1,250,000 shares of
      Series A Convertible Preferred Stock (the “Series A Preferred Stock”) at a
      stated price of $2.00 per share and warrants to purchase up to an aggregate
      of
      2,500,000 shares of common stock at an exercise price of $1.00 per share and
      a
      five year term resulting in net proceeds of $2,413,000. The Series A Preferred
      Stock accrued dividends at the rate of 6% of the stated price annually, which
      were paid in our common stock and was accreted to earnings available to common
      stockholders on a quarterly basis. Each convertible preferred share was
      convertible into two shares of our common stock which was subsequently increased
      to four shares of our common stock and had a liquidation preference of $3.00
      per
      share. The warrants contain a “cashless exercise” feature that allows the
      holders, under certain circumstances, to exercise the warrants without making
      a
      cash payment to the Company.





The
      fair
      value of the warrants on November 21, 2005 was estimated to be $2,146,000 using
      the Black-Scholes option pricing model with the following assumptions: dividend
      yield of 0%; expected volatility of 112% risk free interest rate of 4.4%; and
      an
      expected life of five years. The proceeds from the private placement were first
      allocated to the fair value of the warrants and the remaining proceeds were
      attributed to the value of the preferred stock, resulting in a carrying value
      of
      the Series A Preferred Stock of $354,000. The carrying value of the Series
      A
      Preferred Stock was not accreted to its redemption value as the occurrence
      of
      the redemption event was not considered probable.





Offering
      costs of the private placement were $87,000 which were charged to additional
      paid in capital.





Pursuant
      to the terms of the registration rights agreement entered into in connection
      with the transaction, the Company filed a registration statement which was
      declared effective on March 1, 2006. The registration rights agreement further
      provides that if a registration statement is not filed, or declared effective
      within specified time periods, the Company would be required to pay each holder
      an amount in cash, as liquidated damages, equal to 1.5% per month of the
      aggregate purchase price paid by such holder in the private placement for the
      common stock and warrants then held. In accordance with EITF 00-19, “Accounting
      for Derivative Financial Instruments Indexed To, and Potentially Settled In
      a
      Company’s Own Stock,” and the terms of the warrants and the transaction
      documents, at the closing date, November 21, 2005, the fair value of the
      warrants issued in the private placement were accounted for as a liability.
      The
      warrant liability was reclassified to equity when the Securities and Exchange
      Commission declared the registration statement effective on March 1, 2006.
      Through March 1, 2006, the warrant liability was revalued at each balance sheet
      date and the change in fair value was charged to the statement of operations.
      Between November 21, 2005 and March 1, 2006, the fair value of the warrant
      decreased by $401,000 which was credited to the statement of operations.





In
      connection with the June 5, 2006 financing (see Note D), all outstanding shares
      of the Series A Preferred Stock were converted into an aggregate of 5,000,000
      shares of common stock. In addition, the exercise price of the warrants to
      purchase up to an aggregate of 2,500,000 shares of common stock issued in the
      November 2005 financing were lowered from $1.00 per share to $0.50 per share
      in
      accordance with the terms of the warrants.





11


F.  Stock-Based
      Compensation





Below
      is
      a summary of Aeolus stock option activity during the nine-month period ended
      June 30, 2006:


**Shares**
              
              **Weighted
                  Average Exercise Price**Outstanding
                  at September 30, 2005
              
              
              2,394,091
              
              $
              4.05Granted
              
              
              180,641
              
              $
              0.87Exercised
              
              
              (41,666
              )
              $
              1.00Forfeited
              
              
              (16,281
              )
              $
              13.23Outstanding
                  at June 30, 2006 (unaudited)
              
              
              2,516,785
              
              $
              3.81Exercisable
                  at June 30, 2006 (unaudited)
              
              
              2,466,917
              
              $
              3.87




For
      the
      nine months ended June 30, 2006 and 2005, all stock options were issued with
      an
      exercise price at or above the fair market value of the Company’s common stock
      on the date of grant.





Beginning
      October 1, 2005, the Company adopted Statement of Financial Accounting
      Standa rds (“SFAS”) No.
      123(R), “Share-Based Payments” (“SFAS No. 123(R)”) on a modified prospective
      transition method to account for its employee stock options. Under the modified
      prospective transition method, fair value of new and previously granted but
      unvested equity awards are recognized as compensation expense in the statement
      of operations, and prior period results are not restated. As a result of the
      adoption, the Company’s loss from continuing operations increased by $101,000
      for the nine months ended June 30, 2006.





For
      the
      nine months ended June 30, 2006, stock-based compensation expense recognized
      in
      the statement of operations is as follows (in thousands):


Research
                  and development expenses
              
              $
              31General
                  and administrative expenses
              
              
              191Total
                  stock-based compensation expense
              
              $
              222






The
      total
      deferred compensation expense for outstanding stock options was $31,000 as
      of
      June 30, 2006, which will be recognized over the next three months. The fair
      value of the options associated with the above compensation expense for the
      nine
      months ended June 30, 2006, was determined at the date of the grant using the
      Black-Scholes option pricing model with the following weighted average
      assumptions:








Dividend
                yield
            
            
            0
            %Expected
                volatility
            
            
            187
                - 190
            %Risk-free
                interest rate
            
            
            4.4%
                - 5.2
            %Expected
                option life
            
            
            10
                years





12


If
      the
      Company had accounted for stock-based compensation plans using the fair value
      based accounting method described by SFAS No. 123 for the periods prior to
      October 1, 2005, the Company’s net loss per common share-basic and diluted for
      the three and nine months ended June 30, 2005, would have approximated the
      following (in thousands, except per share data):


Three
                  Months Ended June 30, 2005
              
              Nine
                  Months Ended June 30, 2005Net
                  loss attributable to common stockholders as reported
              
              $
              (1,636
              )
              $
              (5,253
              )Pro
                  forma adjustment for stock-based compensation
              
              
              (111
              )
              
              (400
              )Pro
                  forma net loss attributable to common stockholders
              
              $
              (1,747
              )
              $
              (5,653
              )Basic
                  and diluted net loss per weighted share attributableto
                  common stockholders:As
                  reported
              
              $
              (0.12
              )
              $
              (0.38
              )Pro
                  forma - adjusted for stock-based compensation
              
              $
              (0.13
              )
              $
              (0.40
              )




The
      fair
      value of each option grant for employees and consultants was estimated on the
      date of the grant using the Black-Scholes option valuation model with the
      following weighted-average assumptions used for grants for the nine months
      ended
      June 30, 2005:





Dividend
                yield
            
            
            0
            %Expected
                volatility
            
            
            195
            %Risk-free
                interest rate
            
            
            2.9%
                - 4.3
            %Expected
                option life (in years from vesting)
            
            
            3
                years








G.  CPEC
      LLC





The
      Company uses the equity method to account for its 35.0% ownership interest
      in
      CPEC. During fiscal 2003, CPEC licensed bucindolol, a drug previously under
      development by the Company for the treatment of heart failure, to ARCA
      Discovery, Inc. in return for possible future royalty and milestone payments.
      During the three months ended March 31, 2006, CPEC agreed to modify the license
      agreement between CPEC and ARCA Discovery, Inc. and received 400,000 shares
      of
      ARCA Discovery, Inc. common stock as consideration for the amendment. In
      addition, during the three months ended March 31, 2006, CPEC received a
      milestone payment of $1,000,000 as a result of ARCA Discovery, Inc. completing
      a
      financing. During the three months ended June 30, 2006, CPEC declared and paid
      a
      dividend of which the Company received $315,000. CPEC had $360,000 of net assets
      at June 30, 2006.





13


H.  Commitments
      and Contingencies




In
      December 1999, the Company sold its anti-infectives division (“IRL”) to a
      private pharmaceutical company. The Company remains contingently liable through
      May 2007 for a lease obligation of approximately $891,000 assumed by the
      purchaser on the former IRL facility in Cranbury, New Jersey. No amounts are
      recorded in the accompanying financial statements for this contingent
      liability.








14


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





Introduction





Unless
      otherwise noted, the terms “we,” “our” or “us” refer collectively to
      Aeolus Pharmaceuticals, Inc. and our
      wholly owned subsidiary, Aeolus Sciences, Inc.





This
      report contains, in addition to historical information, statements by us with
      respect to expectations about our business and future results which are
“forward-looking” statements under the Private Securities Litigation Reform Act
      of 1995. These statements and other statements made elsewhere by us or by our
      representatives, which are identified or qualified by words such as “likely,”
“will,” “suggests,” “expects,” “might,” “believe,” “could,” “should,” “may,”
“estimates,” “potential,” “predict,” “continue,” “would,” “anticipates,”
“plans,” or similar expressions, are based on a number of assumptions that are
      subject to risks and uncertainties. Such statements include, but are not limited
      to, those relating to Aeolus’ product candidates, as well as its proprietary
      technologies and uncertainties and other factors that may cause Aeolus’ actual
      results to be materially different from historical results or from any results
      expressed or implied by such forward-looking statements. Important factors
      that
      could cause results to differ include risks associated with uncertainties of
      progress and timing of clinical trials, scientific testing, obtaining regulatory
      approval, the need to obtain funding for pre-clinical and clinical trails and
      operations, the scope and validity of intellectual property protection for
      Aeolus’ product candidates, proprietary technologies and their uses, new
      accounting and SEC requirements and competition from other biopharmaceutical
      companies. Certain of these factors and others are more fully described in
      Aeolus’ filings with the SEC, including, but not limited to, Aeolus’ Annual
      Report on Form 10-K for the fiscal year ended September 30, 2005. All
      forward-looking statements are based on information available as of the date
      hereof, and we do not assume any obligation to update such forward-looking
      statements. Readers are cautioned not to place undue reliance on these
      forward-looking statements, which speak only as of the date hereof.





Operations
      Summary





We
      are
      developing a series of catalytic antioxidant molecules to protect against the
      damaging effects of reactive oxygen derived molecules, commonly referred to
      as
      free radicals. Free radicals cause damage in a broad group of diseases and
      conditions. Our initial target applications will be the use of our catalytic
      antioxidants for amyotrophic lateral sclerosis, also known as “ALS” or “Lou
      Gehrig’s disease,” stroke, Parkinson’s disease and cancer radiation therapy. We
      have
      reported positive safety results from a completed Phase I single dose study
      of
      AEOL 10150 in patients diagnosed with ALS. In addition, in September 2005,
      we
      launched a Phase I multiple dose study of AEOL 10150 in patients diagnosed
      with
      ALS. We expect to complete this study during the first quarter of fiscal year
      2007. The
      safety data from these studies could be utilized to support subsequent efficacy
      studies of AEOL 10150 in ALS, as well as other indications for which the Company
      has developed preclinical efficacy data.





We
      do not
      have any revenue, other than grant income, and therefore we must rely on public
      or
      private equity offerings, debt financings, collaboration arrangements or grants
      to
      finance our operations.


15


Need
      for Additional Funds





We
      believe we have adequate financial resources to fund our operations through
      the
      third quarter of fiscal year 2007, but in order to fund on-going operating
      cash
      requirements beyond the third quarter of fiscal year 2007, or to accelerate
      or
      expand our programs, we will need to raise significant additional funds. Our
      need for additional financing is discussed under “Liquidity and Capital
      Resources.”





Results
      of Operations





*Three
      months ended June 30, 2006 versus three months ended June 30,
      2005*





We
      had
      net losses attributable to common stockholders of $3,178,000 for the three
      months ended June 30, 2006, versus net losses attributable to common
      stockholders of $1,636,000 for the three months ended June 30, 2005.





In
      August
      2003, we were awarded a $100,000 Small Business Innovation and Research (“SBIR”)
      Phase I grant from the National Cancer Institute, a division of the National
      Institutes of Health. In March 2004, we were awarded up to $375,000 for the
      first year of a SBIR Phase II grant and received approval for a second year
      of
      the Phase II grant program in January 2005. Pursuant to the grants, we are
      studying the antitumor and radiation-protective effects of our catalytic
      antioxidants. The study is a collaboration between us and the Department of
      Radiation Oncology at Duke University Medical Center. The grant ended in March
      2006. We recognized zero and $121,000 of grant income during the three months
      ended June 30, 2006 and 2005, respectively.





Research
      and development (“R&D”) expenses decreased $430,000, or 51%, to $419,000 for
      the three months ended June 30, 2006 from $849,000 for the three months ended
      June 30, 2005. Research and development activities were limited during the
      three
      months ended June 30, 2006 due to our limited financial resources and as we
      analyzed the results of our ongoing Phase I multiple dose clinical trial for
      the
      treatment of ALS. During the three months ended June 30, 2005, our primary
      operational focus and R&D spending was on preclinical pharmacology and
      toxicology tests on our lead compound, AEOL 10150, and our Phase I single dose
      clinical trial for the treatment of ALS. This change in focus resulted in a
      lower level of clinical trial expenses during the three months ended June 30,
      2006 compared to the three months ended June 30, 2005. Occupancy costs also
      decreased by $68,000 during the three months ended June 30, 2006 compared to
      the
      three months ended June 30, 2005 as we did not occupy the lab space during
      the
      current quarter.





16


General
      and administrative (“G&A”) expenses decreased $374,000, or 42%, to $524,000
      for the three months ended June 30, 2006 from $898,000 for the three months
      ended June 30, 2005. During the three months ended June 30, 2005, we incurred
      $219,000 of severance expenses as we did not renew the employment contract
      with
      our former Chief Financial Officer. G&A expenses were lower during the three
      months ended June 30, 2006 versus June 30, 2005 due to a lower amount of
      amortization expense related to the accelerated vesting of stock options
      following a change in the board of directors in 2004 (zero during the three
      months ended June 30, 2006 versus $271,000 during the three months ended June
      30, 2005). These lower expenses were offset by increased consulting expenses
      ($97,000) as the Company shifted its administration activities performed by
      employees during the three months ended June 30, 2005 whereas we outsourced
      these activities during the current quarter.





Effective
      October 1, 2005, we adopted SFAS No. 123(R). SFAS No. 123(R) required that
      we
      recognize the fair value of equity awards granted to our employees as
      compensation expense in the income statement over the requisite service period.
      For the three months ended June 30, 2006, we recognized $33,000 in employee
      stock-based compensation expense as a result of the adoption of SFAS No. 123(R),
      which is included in G&A expenses. Additionally, we recognized $33,000 of
      stock-based compensation charges associated with stock option grants to
      consultants.





In
      accordance with EITF 00-19, “Accounting for Derivative Financial Instruments
      Indexed To, and Potentially Settled In a Company’s Own Stock,” and the terms of
      the warrants and the transaction documents, at the closing date, June 5, 2006,
      the fair value of the warrants issued in the Common Stock private placement
      were
      accounted for as a liability until such date in which a registration statement
      registering the shares underlying the warrants was declared effective. The
      warrant liability was revalued at each balance sheet date and changes in fair
      value were charged to the statement of operations. During the period from June
      5, 2006 to June 30, 2006, the fair value of the warrant increased by $2,111,000
      which was charged to the statement of operations. The warrant liability and
      revaluations have not and will not have any impact on the Company’s working
      capital, liquidity, or business operations.





In
      connection with the Private Placement in June 2006, we were required to reduce
      the exercise price of warrants to purchase 2,500,000 shares from $1.00 per
      share
      to $0.50 per share, the purchase price of the common stock issued in the
      Financing. As a result of the change in the exercise price, these warrants
      were
      revalued resulting in an increase in their value of $105,000 which was charged
      to the statement of operations.





*Nine
      months ended June 30, 2006 versus nine months ended June 30,
      2005*





We
      had
      net losses attributable to common stockholders of $5,595,000 for the nine months
      ended June 30, 2006, versus net losses attributable to common stockholders
      of
      $5,253,000 for the nine months ended June 30, 2005.





We
      recognized $92,000 and $236,000 of grant income during the nine months ended
      June 30, 2006 and 2005, respectively from our SBIR grant from the National
      Cancer Institute. We do not expect to earn further grant revenues for the
      remainder of fiscal year 2006 as work under our SBIR grant has been
      completed.





17


Research
      and development (“R&D”) expenses decreased $944,000, or 26%, to $2,677,000
      for the nine months ended June 30, 2006 from $3,621,000 for the nine months
      ended June 30, 2005. Our primary operational focus and R&D spending during
      the nine months ended June 30, 2006 was on conducting our Phase I multiple
      dose
      clinical trial for the treatment of ALS and the advancement of the Aeolus
      Pipeline Initiative, while our primary operational focus and R&D spending
      during the nine months ended June 30, 2005 was on preclinical pharmacology
      and
      toxicology tests on our lead compound, AEOL 10150, and the launch of our Phase
      I
      single dose clinical trial for the treatment of ALS. Clinical trial expenses
      for
      the nine months ended June 30, 2006 was $908,000 compared to $1,154,000 during
      the nine months ended June 30, 2005. Preclinical expenses primarily related
      to
      the Aeolus Pipeline Initiative for the nine months ended June 30, 2006 were
      $491,000, whereas preclinical expenses related to pharmacology and toxicology
      testing of AEOL 10150 during the nine months ended June 30, 2005 were
      $1,286,000. Offsetting these declines were increased patent fees ($422,000)
      as a
      result of some of our patents entering the international validation
      phase.





R&D
      expenses for our antioxidant program have totaled $31,350,000 from inception
      through June 30, 2006. Because of the uncertainty of our research and
      development and clinical studies, we are unable to predict the level of spending
      and the anticipated program completion date, if any. However, we expect that
      R&D expenses during the remainder of fiscal year 2006 will be higher than
      those incurred in the quarter ended June 30, 2006 as we continue the clinical
      development of AEOL 10150 and expand our pre-clinical testing activities to
      further the development of other compounds in our pipeline.





General
      and administrative (“G&A”) expenses decreased $280,000, or 15%, to
      $1,571,000 for the nine months ended June 30, 2006 from $1,851,000 for the
      nine
      months ended June 30, 2005. G&A expenses were lower during the nine months
      ended June 30, 2006 versus the nine months ended June 30, 2005 due to a decline
      in employment costs and rent expenses offset by a higher level of consulting,
      legal and accounting fees. During the nine months ended June 30, 2006, the
      Company’s administration and accounting activities were outsourced while during
      the same period in 2005, employees performed these functions resulting in a
      higher level of consulting fees ($244,000) and a lower level of employment
      costs
      ($270,000) during the nine months ended June 30, 2006. Legal and accounting
      fees
      increased $141,000 during the nine months ended June 30, 2006 as a result of
      the
      Company’s increased regulatory compliance responsibilities. Rental expenses
      decreased by $97,000 during the nine months ended June 30, 2006 when compared
      to
      the same period last year as the Company closed its administrative offices
      in
      August 2005 and outsourced all of its administration functions, as a result
      of
      which we did not incur any rental expense during the nine months ended June
      30,
      2006. Also, during the three months ended June 30, 2006, we incurred $219,000
      of
      severance expenses as we did not renew the employment contract with our former
      Chief Financial Officer.





Effective
      October 1, 2005, we adopted SFAS No. 123(R). SFAS No. 123(R) required that
      we
      recognize the fair value of equity awards granted to our employees as
      compensation expense in the income statement over the requisite service period.
      For the nine months ended June 30, 2006, we recognized $101,000 in employee
      stock-based compensation expense as a result of the adoption of SFAS No. 123(R),
      which is included in G&A expenses. Additionally, we recognized $121,000 of
      stock-based compensation charges associated with stock option grants to
      consultants.


18


During
      the nine months ended June 30, 2006, CPEC LLC, received a milestone payment
      and
      equity consideration from ARCA Discovery, Inc., a privately held
      cardiovascular-focused company (“ARCA”). In 2003, CPEC LLC (“CPEC”), of which we
      own 35%, out-licensed all rights to a potential therapeutic compound referred
      to
      as “bucindolol” to ARCA. During the three months ended March 31, 2006, CPEC
      agreed to modify the license agreement between CPEC and ARCA and received
      400,000 shares of ARCA common stock as consideration for the amendment. In
      addition, during the nine months ended June 30, 2006, CPEC received a milestone
      payment of $1,000,000 as a result of ARCA completing a financing. We recorded
      $433,000 of income during the nine months ended June 30, 2006 as a result of
      our
      equity ownership of CPEC LLC.





In
      accordance with EITF 00-19, “Accounting for Derivative Financial Instruments
      Indexed To, and Potentially Settled In a Company’s Own Stock,” and the terms of
      the warrants and the transaction documents in our November 2005 and June 2006
      financings, at the closing dates, November 21, 2005 and June 5, 2006, the fair
      value of the warrants issued in the financings were initially accounted for
      as
      liabilities until such date in which a registration statement registering the
      shares underlying the warrants were declared effective. The warrant liabilities
      were revalued at each balance sheet date until the EITF 00-19 equity
      classification requirements were satisfied and changes in fair value were
      charged to the statement of operations. Between November 21, 2005 and March
      31,
      2006, the fair value of the November 2005 warrants decreased by $401,000 which
      was credited to the statement of operations. On March 1, 2006, the Securities
      and Exchange Commission declared the registration statement registering the
      shares underlying the warrants in the November 2005 financing effective and
      accordingly the warrant liability was reclassified to additional paid in
      capital. During the period from June 5, 2006 to June 30, 2006, the fair value
      of
      the warrant increased by $2,111,000 which was charged to the statement of
      operations. The warrant liability and revaluations have not and will not have
      any impact on the Company’s working capital, liquidity, or business
      operations.





In
      connection with the Private Placement in June 2006, we were required to reduce
      the exercise price of warrants to purchase 2,500,000 shares from $1.00 per
      share
      to $0.50 per share, the purchase price of the common stock issued in the
      Financing. As a result of the change in the exercise price, these warrants
      were
      revalued resulting in an increase in their value of $105,000 which was charged
      to the statement of operations.





Liquidity
      and Capital Resources





We
      do not
      have any revenue, other than grant income, and therefore we rely on investors,
      grants, collaborations and licensing of our compounds to finance our operations.
      At June 30, 2006, we had $4,003,000 of cash, an increase of $3,377,000 from
      September 30, 2005. The increase in cash was primarily due to combined net
      proceeds of $7,167,000 from the sale of the Series A Convertible Preferred
      Stock
      and common stock in November 2005 and June 2006 offset by the $4,156,000 loss
      from operations for the nine months ended June 30, 2006. We
      believe we have adequate financial resources to conduct operations through
      the
      third quarter of fiscal year 2007, but in order to fund on-going operating
      cash
      requirements beyond that point, or to further accelerate or expand our programs,
      we need to raise significant additional funds.





19


We
      incurred significant losses from operations of $4,156,000 and $6,937,000, and
      cash outflows from operations of $4,147,000 and $6,842,000, for the nine months
      ended June 30, 2006 and for the fiscal year ended September 30, 2005,
      respectively. Our ongoing future cash requirements will depend on numerous
      factors, particularly the progress of our catalytic antioxidant program and
      clinical trials and our ability to negotiate and complete collaborative
      agreements or out-licensing arrangements. In order to help fund our on-going
      operating cash requirements, we intend to seek new collaborations for our
      antioxidant research program that include initial cash payments and on-going
      research support. In addition, we might sell additional shares of our stock
      and
      explore other strategic and financial alternatives, including a merger with
      another company, the sale of stock, the establishment of new collaborations
      for
      current research programs, that include initial cash payments and ongoing
      research support and the out-licensing of our compounds for development by
      a
      third party.





There
      are
      significant uncertainties as to our ability to access potential sources of
      capital. We may not be able to enter into any collaboration on terms acceptable
      to us, or at all, due to conditions in the pharmaceutical industry or in the
      economy in general or based on the prospects of our catalytic antioxidant
      program. Even if we are successful in obtaining a collaboration for our
      antioxidant program, we may have to relinquish rights to technologies, product
      candidates or markets that we might otherwise develop ourselves. These same
      risks apply to any attempt to out-license our compounds.





Similarly,
      due to market conditions, the illiquid nature of our stock and other possible
      limitations on equity offerings, we may not be able to sell additional
      securities or raise other funds on terms acceptable to us, if at all. Any
      additional equity financing, if available, would likely result in substantial
      dilution to existing stockholders.





Our
      forecast of the period of time through which our financial resources will be
      adequate to support our operations is forward-looking information, and actual
      results could vary.








Off-Balance
      Sheet Arrangements





We
      do not
      have any off-balance sheet arrangements that have or are reasonably likely
      to
      have a current or future effect on our financial condition, changes in financial
      condition, revenues or expenses, results of operations, liquidity, capital
      expenditures or capital resources. We do have operating leases, which are
      generally for office and laboratory space. In accordance with accounting
      principles generally accepted in the United States, operating leases are not
      reflected in the accompanying consolidated balance sheets. We do not have any
      capital leases.




ITEM
      3.  Quantitative
      and Qualitative Disclosures About Market Risk.





Our
      exposure to market risk is presently limited to the interest rate sensitivity
      of
      our cash and cash equivalents, which is affected by changes in the general
      level
      of U.S. interest rates. However, we believe that we are not subject to any
      material market risk exposure and do not expect that changes in interest rates
      would have a material effect upon our financial position. A hypothetical 10%
      change in interest rates would not have a material effect on our Statement
      of
      Operations or Cash Flows for the nine months ended June 30, 2006. We do not
      have
      any foreign currency or other derivative financial instruments. Our debt bears
      interest at a fixed rate.


20


ITEM
      4.  Controls
      and Procedures .





As
      of the
      end of the period covered by this report, we carried out an evaluation, under
      the supervision and with the participation of our management, including our
      Chief Executive Officer and Chief Accounting Officer, of the effectiveness
      of
      our disclosure controls and procedures (as defined in Rule 13a-15(e)) pursuant
      to Rule 13a-15 of the Securities and Exchange Act of 1934 as amended. Based
      upon
      their evaluation, our Chief Executive Officer and Chief Accounting Officer
      have
      concluded that our disclosure controls and procedures are
      effective.





No
      change
      in our internal control over financial reporting occurred during our last fiscal
      quarter that has materially affected, or is reasonably likely to materially
      affect, our internal control over financial reporting.





Management
      is aware that there is a lack of segregation of duties due to the small number
      of employees and consultants addressing the Company’s general administrative and
      financial matters. However, management has determined that, considering the
      employees involved and the control procedures in place, risks associated with
      such lack of segregation are not significant and any potential benefits of
      adding employees or consultants to clearly segregate duties do not justify
      the
      expenses associated with such increases at this time.





**PART
      II. - OTHER INFORMATION**





ITEM
      1.  Legal
      Proceedings.





None.





ITEM
      1A. Risk
      Factors .





None.





ITEM
      2.  Unregistered
      Sales of Equity Securities and Use of Proceeds.





The
      following list sets forth information regarding all unregistered securities
      sold
      by the registrant since April 1, 2006.





(1)  On
      June
      5, 2006, the registrant sold and issued to accredited investors an aggregate
      of
      10,000,000 shares of its Common Stock at a purchase price of $0.50 per share,
      warrants to purchase up to an aggregate of 7,000,000 shares of common stock
      with
      an exercise price of $0.75 per share and warrants to purchase up to an aggregate
      of 4,000,000 shares of common stock with an exercise price of $0.50 per share,
      generating aggregate proceeds of $5,000,000. This transaction was exempt from
      registration under Section 4(2) of the Securities Act of 1933, as
      amended.





(2)  On
      May
      24, 2006, the registrant issued to accredited investors a warrant to purchase
      up
      to an aggregate of 50,000 shares of common stock with an exercise price of
      $0.50
      per share, a warrant to purchase up to an aggregate of 50,000 shares of common
      stock with an exercise price of $1.00 per share, a warrant to purchase up to
      an
      aggregate of 50,000 shares of common stock with an exercise price of $1.50
      per
      share, a warrant to purchase up to an aggregate of 50,000 shares of common
      stock
      with an exercise price of $2.00 per share, a warrant to purchase up to an
      aggregate of 50,000 shares of common stock with an exercise price of $2.50
      per
      share in accordance with the terms of a consulting agreement. This transaction
      was exempt from registration under Section 4(2) of the Securities Act of 1933,
      as amended.


21


(3)  On
      May
      22, 2006, the registrant issued to an accredited investor 25,000 shares of
      its
      Common Stock in accordance with the terms of a licensing agreement. This
      transaction was exempt from registration under Section 4(2) of the Securities
      Act of 1933, as amended.





ITEM
      3.  Defaults
      Upon Senior Securities.





None.




ITEM
      4.  Submission
      of Matters to a Vote of Security Holders.





None.





ITEM
        5.  Other
        Information.


None.




22


ITEM
      6.  Exhibits





**Exhibit
                #**
            
            **Description**10.1
            
            Subscription
                Agreement dated June 5, 2006 by and between the Company and the investors
                whose names appear on the signature pages thereof (incorporated by
                reference to Exhibit 10.1 of the Company’s Form 8-K filed dated June 6,
                2006).10.2
            
            Conversion
                Agreement dated June 5, 2006 by and among the Company, the Company’s
                Series A Preferred Stockholders, Efficacy Biotech Master Fund Ltd.
                and
                Ronin Capital, LLC (incorporated by reference to Exhibit 10.2 of
                the
                Company’s Form 8-K filed dated June 6, 2006).10.3
            
            Form
                of Warrant to Purchase Common Stock dated June 5, 2006 (incorporated
                by
                reference to Exhibit 10.3 of the Company’s Form 8-K filed dated June 6,
                2006).10.4
            
            Warrant
                to Purchase Common Stock dated June 5, 2006.by and among the Company
                and
                Efficacy Biotech Master Fund Ltd (incorporated by reference to Exhibit
                10.4 of the Company’s Form 8-K filed dated June 6, 2006).10.5
            
            Right
                of First Offer Agreement dated June 5, 2006 by and among the Company
                and
                Efficacy Biotech Master Fund Ltd (incorporated by reference to Exhibit
                10.5 of the Company’s Form 8-K filed dated June 6, 2006).10.6
            
            Board
                Observer Letter dated June 5, 2006 by and among the Company and Efficacy
                Biotech Master Fund Ltd (incorporated by reference to Exhibit 10.6
                of the
                Company’s Form 8-K filed dated June 6, 2006).10.7
            
            Employment
                Agreement dated July 14, 2006 between Aeolus Pharmaceuticals, Inc.
                and
                John L. McManus (incorporated by reference to Exhibit 10.1 of the
                Company’s Form 8-K filed dated July 14, 2006).10.8
            
            Consulting
                Agreement dated July 10, 2006 between Aeolus Pharmaceuticals, Inc.
                and
                McManus & Company, Inc. (incorporated by reference to Exhibit 10.1 of
                the Company’s Form 8-K filed dated June 14, 2006).31.1
            
            Certification
                of the Chief Executive Officer pursuant to Exchange Act Rules 13a-14(a)
                and 15d-14(a).31.2
            
            Certification
                of theChief
                Financial Officerpursuant to Exchange Act Rules 13a-14(a) and 15d-14(a).32.1
            
            Certification
                by the Chief Executive Officer and Chief Financial Officer pursuant
                to 18
                U.S.C. §1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act
                of 2002.


23


**SIGNATURES**





Pursuant
      to the requirements of the Securities Exchange Act of 1934, the registrant
      has
      duly caused this report to be signed on its behalf by the undersigned thereunto
      duly authorized.





AEOLUS
      PHARMACEUTICALS, INC.








Date:August
                11, 2006
            By:
            /s/
                John L. McManusJohn
                L. McManus
              President
                and Chief Operating Officer
              (Principal
                Executive Officer)Date:August
                11, 2006
            By:
            /s/
                Michael P. McManusMichael
                P. McManus
              Chief
                Financial Officer and Treasurer
              (Principal
                Financial and Accounting Officer)