**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTOND.C. 20549**

 

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**FORM 10-QSB/A**

 

**AmendmentNo.1**

 

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| **ý**                                        | **QUARTERLY REPORT PURSUANT TO SECTION 13  OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**                                                             |
|---------------------------------------------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                                              |                                                                                                                                                               |
| **FOR THE  PERIOD ENDED SEPTEMBER 30, 2005** |
|                                              |                                                                                                                                                               |
| **OR**                                            |
|                                              |                                                                                                                                                               |
| **o**                                             | **TRANSITION REPORT PURSUANT TO SECTION 13  OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**                                                            |
|                                              |                                                                                                                                                               |
|                                              | **FOR THE TRANSITION PERIOD  FROM            TO            .** |

 

**COMMISSION FILE NUMBER: 0-50295**

 

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**ADVANCED CELL TECHNOLOGY, INC.**

(EXACT NAME OF SMALL BUSINESS ISSUER ASSPECIFIED IN ITS CHARTER)

 
| ******DELAWARE**                                                | ** ** | **87-0656515**                       |
|-----------------------------------------------------------------|------------|--------------------------------------|
| (STATE OR OTHER JURISDICTION OF  INCORPORATION OR ORGANIZATION) |       | (I.R.S. EMPLOYER IDENTIFICATION NO.) |

 

**381 PLANTATION STREET,WORCESTER, MA 01605**

(ADDRESS, INCLUDING ZIP CODE, OF PRINCIPALEXECUTIVE OFFICES)

 

REGISTRANT’S TELEPHONE NUMBER, INCLUDING AREACODE: **(508) 756-1212**

 

SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OFTHE ACT: **NONE**

 

SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OFTHE ACT: **NONE**

 

Indicateby check mark whether the small business issuer (1) has filed all reportsrequired to be filed by Section 13 or15(d) of the Securities Exchange Act of 1934 during the preceding 12months (or for such shorter period that the small business issuer was requiredto file such reports), and (2) has been subject to such filingrequirements for the past 90 days.

 

Yesý       Noo

 

Indicateby check mark whether the registrant is a shell company (as defined in ExchangeAct Rule 12b-2).  Yes  o  No  ý

 

Indicatethe number of shares outstanding of each of the issuer’s classes of commonstock, as of the latest practicable date.

 
| **Class:**                               | ** ** | **Outstanding at September 30, 2005:** |
|------------------------------------------|------------|---------------------------------------------|
| Common Stock, $0.001 par value per share |       | 23,068,059 shares                           |

 

Transitional Small Business Disclosure format (check one)

 

Yeso       Noý

 

 

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**ADVANCED CELL TECHNOLOGY, Inc.**

**FORM 10-Q/A**

**QUARTER ENDED SEPTEMBER 30,2005**

 

**EXPLANATORY NOTE:**

 

This Amendment No. 1 onForm 10-QSB/A amends and restates in its entirety our Quarterly Report on Form10-Q for the third quarter ended September 30, 2005, as initially filed withthe Securities and Exchange Commission (the “SEC”) on November 14, 2005, and isbeing filed to reflect the restatement of our consolidated balance sheet  and consolidated statement of stockholders’s deficit, dated as of September 30, 2005 and related notes to the consolidated financialstatements.

 

As discussed in more detailin Note 2 of the notes to the consolidated financial statements, thisrestatement is  due tothe misapplication of certain accountingprinciples to the Company’s convertible debenture financing and the issuance of Notes Payable-Other both completed in September 2005. Analysis completed subsequent to our initial filing identified  embeddedderivative instruments withinthe agreements governing the debentures that required separate valuation under FAS 133 “Accountingfor Derivative Instruments and Hedging Activities.”  Our analysis identified several derivativeinstruments to be valued, and resulted in a restatement to the Company’sconsolidated balance sheet at September 30, 2005 to properly reflectconvertible debt and embedded derivative instruments. In addition, thedebenture agreements contained variable share settlement provisionsthat required theCompany to adjust the fair value of certain previously issuedwarrants and reclassify them from additional paid in capital in theconsolidated statement of stockholders’ equity to a warrant derivativeliability account in the consolidated balance sheet,  in accordance with EITF 00-19 “Accountingfor Derivative Financial Instruments Indexed to, and Potentially Settled in aCompany’s Own Stock.” Restatements for the quarter ended September 30, 2005 did not result ina change to the consolidated statement of operations or the consolidatedstatement of cash flows. The notes to the consolidated financial statements, particularlyNote 4 - Convertible Debentures, Note 6 - NotesPayable - Other and Note 8 – Reclassification of EquityTransactions  have been added or  restated to more completely describe theembedded derivative instruments,  themethodology used to establish the fair values of each and the reclassifications required.

 

In addition to the changesdescribed above, Item 6 of Part II of the original filing has been amended tocontain currently dated certifications from the Company’s Chief ExecutiveOfficer and Chief Financial Officer, as required by Sections 302 and 906 of theSarbanes-Oxley Act of 2002.  Thesecertifications are attached to this Form 10-QSB/A asExhibits 31.1, 31.2, 32.1 and 32.2, respectively. 

 

This Amendment continues tospeak as of the date of our report  on Form10-QSB.  Except as set forth above, this Amendment No. 1 toour Form 10-QSB/A for thequarter ended September 30, 2005 does not reflect events occurring afterNovember 14, 2005 or modify or update those disclosures affected by subsequentevents.  The filing of this Amendment No.1 is not a representation that any statementscontained in the original Report, or this Amendment No.1 are true and completeas of any date subsequent to the date of the original Report.  The filingof this Amendment No.1 shall not be deemed an admission that the originalfiling, when made, contained any untrue statement of a materialfact or omitted to state a material fact necessary to make the statementstherein not misleading.

 

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**AdvancedCell Technology, Inc.**

 

**INDEX**

 
| RECENT  DEVELOPMENTS OF SMALL BUSINESS ISSUER                           |   |
|-------------------------------------------------------------------------|--------|
| PART I. FINANCIAL INFORMATION                                      |   |
| ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS                               |   |
| ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OR  PLAN OF OPERATION |   |
| ITEM 3. CONTROLS AND PROCEDURES                                         |   |
| PART II. OTHER INFORMATION                                         |   |
| ITEM 1. LEGAL PROCEEDINGS                                               |   |
| ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES  AND USE OF PROCEEDS    |   |
| ITEM 3. DEFAULTS UPON SENIOR SECURITIES                                 |   |
| ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY  HOLDERS            |   |
| ITEM 5. OTHER INFORMATION                                               |   |
| ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K                           |   |
| SIGNATURE                                                               |   |

 

2

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**CAUTIONARYNOTE REGARDING FORWARD-LOOKING STATEMENTS**

 

Certain statements contained in thisQuarterly Report on Form 10-QSB and the exhibits hereto containing thewords “may,” “assumes,” “forecasts,” “positions,” “predicts,” “strategy,” “will,”“expects,” “estimates,” “anticipates,” “believes,” “projects,” “intends,” “plans,”“budgets,” “potential,” “continue” and variations thereof, and other statementscontained in this Quarterly Report on Form 10-QSB and the exhibits heretoregarding matters that are not historical facts are forward-looking statements.Because these statements involve risks and uncertainties, as well as certain assumptions,actual results may differ materially from those expressed or implied by suchforward-looking statements.  Factors thatcould cause actual results to differ materially include, but are not limitedto, risks inherent in:  our early stageof development, including a lack of operating history, lack of profitableoperations and the need for significant additional capital resources in orderto sustain our business; the development and commercialization of largely noveland unproven technologies and products; our ability to protect, maintain, anddefend our intellectual property rights; our ability to retain key members ofour management and scientific teams; and uncertainty regarding our overallability to compete effectively in a highly complex, rapidly developing, capitalintensive and competitive industry.  See *“*RISK FACTORS THAT MAY AFFECT OURBUSINESS*”* set forth in Part I,Item 2 of this Quarterly Report on Form 10-QSB for a more completediscussion of these factors.  Readers arecautioned not to place undue reliance on these forward-looking statements,which speak only as of the date that they are made.  We undertake no obligation to publicly updateor revise any forward-looking statements, whether as a result of newinformation, future events or otherwise.

 

Forward-looking statements include our plans and objectives for future operations, including plans and objectives relating to our products and our future economic performance.  Assumptions relating to the foregoing involve judgments with respect to, among other things, future economic, competitive and market conditions, future business decisions, and the time and money required to successfully complete development and commercialization of our technologies, all of which are difficult or impossible to predict accurately and many of which are beyond our control. Although we believe that the assumptions underlying the forward-looking statements contained herein are reasonable, any of those assumptions could prove inaccurate and, therefore, we cannot assure you that the results contemplated in any of the forward-looking statements contained herein will be realized. Based on the significant uncertainties inherent in the forward-looking statements included herein, the inclusion of any such statement should not be regarded as a representation by us or any other person that our objectives or plans will be achieved.

 

3

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**PART I. FINANCIAL INFORMATION**

 

## **ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS**

## ** **

## **ADVANCEDCELL TECHNOLOGY, INC. AND SUBSIDIARY**

## ** **

## **CONSOLIDATEDBALANCE SHEETS**

## ** **

| ** **                                                                                                                            | ** ** | **September 30,  2005  Restated** | ** ** | **December 31,  2004** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------|------------|-----------------------------|------------|
| ** **                                                                                                                            | ** ** | **UNAUDITED**                          | ** ** | ** **                  | ** ** |
| ASSETS                                                                                                                                |       |                                   |       |                        |       |
|                                                                                                                                  |       |                                   |       |                        |       |
| Current assets:                                                                                                                       |       |                                   |       |                        |       |
| Cash and  cash equivalents                                                                                                            |       | $                                      | 16,483,058 |                        | $          | — |   |
| Cash held in  escrow for stock subscriptions                                                                                          |       | —                                 |       | 3,676,000                   |       |
| Accounts  receivable, net of allowance for doubtful accounts of $636,399 and $128,684                                                 |       | 71,848                                 |       | 104,150                     |       |
| Prepaid  expenses                                                                                                                     |       | 147,914                                |       | 31,300                      |       |
| Deferred  royalty fees, current portion                                                                                               |       | 131,013                                |       | 119,763                     |       |
|                                                                                                                                  |       |                                   |       |                        |       |
| Total current assets                                                                                                                  |       | 16,833,833                             |       | 3,931,213                   |       |
|                                                                                                                                  |       |                                   |       |                        |       |
| Property and equipment, net                                                                                                           |       | 343,060                                |       | 98,455                      |       |
| Due from stockholder                                                                                                                  |       | —                                 |       | 394,015                     |       |
| Deferred royalty fees, less current portion                                                                                           |       | 628,752                                |       | 718,573                     |       |
| Deposits                                                                                                                              |       | 82,954                                 |       | 17,954                      |       |
| Debt issuance costs                                                                                                                   |       | 2,484,351                              |       | 12,000                      |       |
|                                                                                                                                  |       |                                   |       |                        |       |
| Total assets                                                                                                                          |       | $                                      | 20,372,950 |                        | $          | 5,172,210 |   |
|                                                                                                                                  |       |                                   |       |                        |       |
| LIABILITIES AND STOCKHOLDERS’ DEFICIT                                                                                            |       |                                   |       |                        |       |
|                                                                                                                                  |       |                                   |       |                        |       |
| Current liabilities:                                                                                                                  |       |                                   |       |                        |       |
| Accounts  payable and accrued expenses                                                                                                |       | $                                      | 2,489,457  |                        | $          | 3,867,282 |   |
| Deferred  revenue, current portion                                                                                                    |       | 332,508                                |       | 332,508                     |       |
| Interest payable  - stockholder                                                                                                       |       | —                                 |       | 296,877                     |       |
| Advances  payable - other                                                                                                             |       | 130,000                                |       | 130,000                     |       |
| Convertible  debentures  and embedded derivatives, net  of discounts of $6,343,286                                                    |       | 4,497,844                              |       | —                      |       |
| Note payable  - stockholder                                                                                                           |       | —                                 |       | 1,000,000                   |       |
| Notes  payable - other, net of discounts of $339,952                                                                                  |       | 770,249                                |       | 967,014                     |       |
|                                                                                                                                  |       |                                   |       |                        |       |
| Total current liabilities                                                                                                             |       | 8,220,058                              |       | 6,593,681                   |       |
|                                                                                                                                  |       |                                   |       |                        |       |
| Convertible  debentures and embedded derivatives net  of current portion  and discounts of $11,100,751                                |       | 7,871,228                              |       | —                      |       |
| Warrant derivatives                                                                                                                   |       | 33,443,668                             |       | —                      |       |
| Deferred revenue, net of current portion                                                                                              |       | 1,745,670                              |       | 1,995,049                   |       |
| Preferred units subscribed                                                                                                            |       | —                                 |       | 4,175,999                   |       |
|                                                                                                                                  |       |                                   |       |                        |       |
| Total liabilities                                                                                                                     |       | 51,280,624                             |       | 12,764,729                  |       |
|                                                                                                                                  |       |                                   |       |                        |       |
| Stockholders’ deficit:                                                                                                           |       |                                   |       |                        |       |
|                                                                                                                                  |       |                                   |       |                        |       |
| Common  stock, $0.001 par value; 100,000,000 shares authorized, 23,068,059 and  8,325,883 shares issued and outstanding, respectively |       | 23,068                                 |       | 8,326                       |       |
| Additional  paid-in capital                                                                                                           |       | (11,197,404                            | )     | 6,158,954                   |       |
| Deferred  compensation                                                                                                                |       | (21,585                                | )          | —                      |       |
| Accumulated  deficit                                                                                                                  |       | (19,711,753                            | )          | (13,759,799                 | )          |
|                                                                                                                                  |       |                                   |       |                        |       |
| Total stockholders’ deficit                                                                                                      |       | (30,907,674                            | )          | (7,592,519                  | )          |
|                                                                                                                                  |       |                                   |       |                        |       |
| Total liabilities and stockholders’ deficit                                                                                      |       | $                                      | 20,372,950 |                        | $          | 5,172,210 |   |
|                                                                                                                                       |            |                                        |            |                             |            |  |  |  |  |  |  |  |  |

 

The accompanying notes are an integral part of these consolidatedfinancial statements

 

4

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## **ADVANCED CELLTECHNOLOGY, INC. AND SUBSIDIARY**

## ** **

## **CONSOLIDATEDSTATEMENTS OF OPERATIONS**

## ** **

## **(Unaudited)**

 
| ** **                                              | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
|---------------------------------------------------------|------------|-------------------------------------------|------------|------------------------------------------|------------|
| ** **                                              | ** ** | **2005**                                  | ** ** | **2004**                                 | ** ** | **2005** | ** ** | **2004** | ** ** |
| Revenue:                                                |       |                                      |       |                                     |       |   |   |   |   |
| License fees  and royalties                             |       | $                                         | 83,127     |                                     | $          | 250,972 |   | $ | 311,880 |   | $ | 690,705 |   |
|                                                    |       |                                      |       |                                     |       |   |   |   |   |
| Cost of  revenue                                        |       | 41,189                                    |       | 14,868                                   |       | 145,131 |   | 185,166 |   |
|                                                    |       |                                      |       |                                     |       |   |   |   |   |
| Gross profit                                            |       | 41,938                                    |       | 236,104                                  |       | 166,749 |   | 505,539 |   |
|                                                    |       |                                      |       |                                     |       |   |   |   |   |
| Operating  expenses:                                    |       |                                      |       |                                     |       |   |   |   |   |
| Research and  development                               |       | 734,065                                   |       | 152,725                                  |       | 1,667,684 |   | 689,628 |   |
| Grant  reimbursements                                   |       | (171,980                                  | )          | (89,438                                  | )          | (597,198 | ) | (229,609 | ) |
| General and  administrative                             |       | 2,330,767                                 |       | 497,954                                  |       | 5,572,267 |   | 1,583,605 |   |
|                                                    |       |                                      |       |                                     |       |   |   |   |   |
| Total  operating expenses                               |       | 2,892,852                                 |       | 561,241                                  |       | 6,642,753 |   | 2,043,624 |   |
|                                                    |       |                                      |       |                                     |       |   |   |   |   |
| Loss from  operations                                   |       | (2,850,914                                | )          | (325,137                                 | )          | (6,476,004 | ) | (1,538,085 | ) |
|                                                    |       |                                      |       |                                     |       |   |   |   |   |
| Other income  (expense):                                |       |                                      |       |                                     |       |   |   |   |   |
| Interest  income                                        |       | 6,083                                     |       | —                                   |       | 32,042 |   | — |   |
| Gain on  settlement of debt                             |       | 966,301                                   |       | —                                   |       | 1,052,814 |   | — |   |
| Interest  expense and late fees                         |       | (432,077                                  | )          | (26,397                                  | )          | (500,806 | ) | (62,627 | ) |
| Interest  expense - stockholder                         |       | —                                    |       | (30,000                                  | )          | (60,000 | ) | (90,000 | ) |
|                                                    |       |                                      |       |                                     |       |   |   |   |   |
| Total other  income (expense)                           |       | 540,307                                   |       | (56,397                                  | )          | 524,050 |   | (152,627 | ) |
|                                                    |       |                                      |       |                                     |       |   |   |   |   |
| Net loss                                                |       | $                                         | (2,310,607 | )                                        | $          | (381,534 | ) | $ | (5,951,954 | ) | $ | (1,690,712 | ) |
|                                                    |       |                                      |       |                                     |       |   |   |   |   |
| Net loss per  share, basic and diluted                  |       | $                                         | (0.10      | )                                        | $          | (0.05 | ) | $ | (0.26 | ) | $ | (0.20 | ) |
|                                                    |       |                                      |       |                                     |       |   |   |   |   |
| Weighted  average shares outstanding, basic and diluted |       | 23,191,111                                |       | 8,325,883                                |       | 23,209,742 |   | 8,325,883 |   |

 

The accompanying notes are anintegral part of these consolidated financial statements

 

5

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## **ADVANCED CELLTECHNOLOGY, INC. AND SUBSIDIARY**

 

## **CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

 

## **CHANGE INCASH AND CASH EQUIVALENTS**

 

## **(Unaudited)**

 
| ** **                                                                       | ** ** | **Nine Months Ended  September 30,** | ** ** |
|----------------------------------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                       | ** ** | **2005**                                  | ** ** | **2004** | ** ** |
| CASH FLOWS  FROM OPERATING ACTIVITIES:                                           |       |                                      |       |   |   |
| Net loss                                                                         |       | $                                         | (5,951,954 | ) | $ | (1,690,712 | ) |
| Adjustments  to reconcile net loss to net cash provided by operating activities: |       |                                      |       |   |   |
| Depreciation  and amortization                                                   |       | 73,221                                    |       | 106,093 |   |
| Bad debt                                                                         |       | 32,715                                    |       | — |   |
| Amortization  of deferred charges                                                |       | 89,821                                    |       | 149,541 |   |
| Amortization  of debt discount                                                   |       | 413,952                                   |       | — |   |
| Amortization  of deferred revenue                                                |       | (249,379                                  | )          | (317,858 | ) |
| Gain on  settlement of accounts payable                                          |       | (1,052,814                                | )          | — |   |
| Shares  issued for services                                                      |       | 15,000                                    |       | — |   |
| Amortization  of deferred compensation                                           |       | 316,117                                   |       | — |   |
| Changes in  operating assets and liabilities:                                    |       |                                      |       |   |   |
| (Increase)  decrease in:                                                         |       |                                      |       |   |   |
| Accounts  receivable                                                             |       | (413                                      | )          | 323,547 |   |
| Prepaid  expenses                                                                |       | (116,614                                  | )          | 23,641 |   |
| Other  current assets                                                            |       | —                                    |       | 5,000 |   |
| Deferred  charges                                                                |       | (11,250                                   | )          | (108,000 | ) |
| Deposits                                                                         |       | (65,000                                   | )          | — |   |
| Increase  (decrease) in:                                                         |       |                                      |       |   |   |
| Accounts  payable and accrued expenses                                           |       | 568,013                                   |       | 1,094,702 |   |
| Interest  payable                                                                |       | 101,394                                   |       | 104,210 |   |
| Deferred  revenue                                                                |       | —                                    |       | 250,000 |   |
| Advances to  Stockholder                                                         |       | (327,235                                  | )          | (141,861 | ) |
|                                                                             |       |                                      |       |   |   |
| Net cash  used in operating activities                                           |       | (6,164,426                                | )          | (201,697 | ) |
|                                                                             |       |                                      |       |   |   |
| CASH FLOWS  FROM INVESTING ACTIVITIES:                                           |       |                                      |       |   |   |
| Proceeds  from sale of equipment                                                 |       | —                                    |       | (6,377 | ) |
| Cash  acquired in acquisition                                                    |       | 10,000                                    |       | 0 |   |
| Purchases of  property and equipment                                             |       | (317,826                                  | )          | — |   |
|                                                                             |       |                                      |       |   |   |
| Net cash  used in investing activities                                           |       | (307,826                                  | )          | (6,377 | ) |
|                                                                             |       |                                      |       |   |   |
| CASH FLOWS  FROM FINANCING ACTIVITIES:                                           |       |                                      |       |   |   |
| Proceeds  from preferred unit subscriptions, net of cost                         |       | 3,735,201                                 |       | — |   |
| Proceeds  from convertible debentures                                            |       | 16,223,713                                |       | — |   |
| Offering  costs                                                                  |       | (95,671                                   | )          | — |   |
| Payments on  notes and leases                                                    |       | (250,000                                  | )          | (23,752 | ) |
| Settlement  payment                                                              |       | (332,524                                  | )          | — |   |
| Cash  overdraft                                                                  |       | (1,409                                    | )          | — |   |
| Proceeds  from issuance of notes and loans                                       |       | —                                    |       | 230,000 |   |
|                                                                             |       |                                      |       |   |   |
| Net cash  provided by financing activities                                       |       | 19,279,310                                |       | 206,248 |   |
|                                                                             |       |                                      |       |   |   |
| Net increase  (decrease) in cash                                                 |       | 12,807,058                                |       | (1,826 | ) |
|                                                                             |       |                                      |       |   |   |
| Cash and  cash equivalents, beginning of period                                  |       | $                                         | 3,676,000  |   | $ | 3,782 |   |
|                                                                             |       |                                      |       |   |   |
| Cash and  cash equivalents, end of period                                        |       | $                                         | 16,483,058 |   | $ | 1,956 |   |
|                                                                             |       |                                      |       |   |   |
| Cash paid  for:                                                                  |       |                                      |       |   |   |
| Interest                                                                         |       | $                                         | —     |   | $ | 1,247 |   |
| Income taxes                                                                     |       | $                                         | —     |   | $ | — |   |

 

Supplementalschedule of non-cash financing activities:

 

Duringthe nine months ended September 30, 2005:

 

105,177Preferred Units, valued at $89,400, were issued in partial settlement ofaccounts payable.

 

616,124 shares of common stock, and 306,062 common stock purchasewarrants were issued upon conversion of $500,000 of notes payable and $23,708of accrued interest.

 

469,247 shares of common stock, and 234,629 common stock purchasewarrants, valued at an aggregate of $398,860, were issued in consideration ofservices related to the Preferred Unit Offering.

 

A note for $150,000 was issued as a part of a settlement of a notepayable of $339,000 and related accrued interest of $53,675.

 

9,411,778 shares of preferred stock converted to 9,411,778 shares ofcommon stock in the Merger.

 

Approximately350,000 shares of common stock were retired, and net intercompany amounts ofapproximately $600,000 due to ACT Group, Inc were extinguished, in finalsettlement of litigation between ACT Group, Inc were extinguished, in finalsettlement of litigation between ACT Group, Inc. and third parties.

 

Approximately 195,000shares of common stock were issued in settlement of accounts payable ofapproximately $1,428,000

 

Approximately260,000 warrants to purchase shares of common stock were issued to consultantsas partial compensation for consulting services.

 

In connection withthe issuance of convertible debentures, $5,747,297 was allocated to the fairvalue of warrants issued, and $9,305,014 was allocated to the beneficialconversion feature embedded in the debentures.

 

In connection withissuance of notes payable related to the ACT Group settlement, $21,818 wasallocated to the beneficial conversion feature embedded in the notes.

 

6

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## **ADVANCED CELLTECHNOLOGY, INC. AND SUBSIDIARY**

## ** **

**CONSOLIDATEDRESTATED STATEMENT OF STOCKHOLDERS’DEFICIT**

**FORTHE NINE MONTH PERIOD ENDED SEPTEMBER 30, 2005**

**(UNAUDITED)**

 
| ** **                                                                 | ** ** | **Preferred Stock** | ** ** | **Common Stock** | ** ** | **Additional  Paid-In  Capital** | ** ** | **Deferred** | ** ** | **Accumulated** | ** ** | **Total  Stockholders’  Deficit** | ** **  |
|----------------------------------------------------------------------------|------------|---------------------|------------|------------------|------------|----------------------------------|------------|--------------|------------|-----------------|------------|----------------------------------------|-------------|
| ** **                                                                 | ** ** | **Shares**          | ** ** | **Amount**       | ** ** | **Shares**                       | ** ** | **Amount**   | ** ** | **Restated**    | ** ** | **Compensation**                       | ** **  | **Deficit** | ** ** | **Restated** | ** ** |
|                                                                       |       |                |       |             |       |                             |       |         |       |            |       |                                   |        |   |   |   |   |
| Balance, December 31, 2004                                            |       | —              |       | $                | —     |                             | 8,325,883  |         | $          | 8,326           |       | $                                      | 6,158,954   |   | $ | — |   | $ | (13,759,799 | ) | $ | (7,592,519 | ) |
|                                                                       |       |                |       |             |       |                             |       |         |       |            |       |                                   |        |   |   |   |   |
| Sale of preferred units for cash                                           |       | 9,306,601           |       | 9,306            |       | —                           |       | —       |       | 7,901,294       |       | —                                 |        | — |   | 7,910,600 |   |
|                                                                       |       |                |       |             |       |                             |       |         |       |            |       |                                   |        |   |   |   |   |
| Issuance of preferred units for services provided                          |       | 105,177             |       | 105              |       | —                           |       | —       |       | 89,295          |       | —                                 |        | — |   | 89,400 |   |
|                                                                       |       |                |       |             |       |                             |       |         |       |            |       |                                   |        |   |   |   |   |
| Issuance of shares for debt conversion                                     |       | —              |       | —           |       | 616,124                          |       | 616          |       | 523,092         |       | —                                 |        | — |   | 523,708 |   |
|                                                                       |       |                |       |             |       |                             |       |         |       |            |       |                                   |        |   |   |   |   |
| Issuance of shares for services                                            |       | —              |       | —           |       | 17,647                           |       | 18           |       | 14,982          |       | —                                 |        | — |   | 15,000 |   |
|                                                                       |       |                |       |             |       |                             |       |         |       |            |       |                                   |        |   |   |   |   |
| Issuance of units for offering services                                    |       | —              |       | —           |       | 469,247                          |       | 469          |       | 398,391         |       | —                                 |        | — |   | 398,860 |   |
|                                                                       |       |                |       |             |       |                             |       |         |       |            |       |                                   |        |   |   |   |   |
| Conversion of preferred                                                    |       | (9,411,778          | )          | (9,411           | )          | 9,411,778                        |       | 9,411        |       | —          |       | —                                 |        | — |   | — |   |
|                                                                       |       |                |       |             |       |                             |       |         |       |            |       |                                   |        |   |   |   |   |
| Cost of offering                                                           |       | —              |       | —           |       | —                           |       | —       |       | (486,530        | )          | —                                 |        | — |   | (486,530 | ) |
|                                                                       |       |                |       |             |       |                             |       |         |       |            |       |                                   |        |   |   |   |   |
| Shares retained by public shareholders                                     |       | —              |       | —           |       | 4,374,007                        |       | 4,374        |       | 5,626           |       | —                                 |        | — |   | 10,000 |   |
|                                                                       |       |                |       |             |       |                             |       |         |       |            |       |                                   |        |   |   |   |   |
| Fair value of consultant options                                           |       | —              |       | —           |       | —                           |       | —       |       | 72,354          |       | (21,585                                | )           | — |   | 50,769 |   |
|                                                                       |       |                |       |             |       |                             |       |         |       |            |       |                                   |        |   |   |   |   |
| Shares cancelled                                                           |       | —              |       | —           |       | (1,474                           | )          | (1           | )          | —          |       | —                                 |        | — |   | (1 | ) |
|                                                                       |       |                |       |             |       |                             |       |         |       |            |       |                                   |        |   |   |   |   |
| Options Exercised                                                          |       | —              |       | —           |       | 12,000                           |       | 12           |       | 588             |       | —                                 |        | — |   | 600 |   |
|                                                                       |       |                |       |             |       |                             |       |         |       |            |       |                                   |        |   |   |   |   |
| Stock based compensation                                                   |       |                |       |             |       |                             |       |         |       | 62,988          |       |                                   |        |   |   | 62,988 |   |
|                                                                       |       |                |       |             |       |                             |       |         |       |            |       |                                   |        |   |   |   |   |
| Shares retired as part of settlement                                       |       | —              |       | —           |       | (352,153                         | )          | (352         | )          | (802,557        | )          | —                                 |        | — |   | (802,909 | ) |
|                                                                       |       |                |       |             |       |                             |       |         |       |            |       |                                   |        |   |   |   |   |
| Shares issued in settlement of accounts payable                            |       | —              |       | —           |       | 195,000                          |       | 195          |       | 461,230         |       | —                                 |        | — |   | 461,425 |   |
|                                                                       |       |                |       |             |       |                             |       |         |       |            |       |                                   |        |   |   |   |   |
| Settlement benefit allocated to Beneficial Conversion  Feature             |       |                |       |             |       | —                           |       | —       |       | 21,817          |       | —                                 |        | — |   | 21,817 |   |
|                                                                       |       |                |       |             |       |                             |       |         |       |            |       |                                   |        |   |   |   |   |
| Warrant issued to broker-dealer in connection with  convertible debentures |       | —              |       | —           |       | —                           |       | —       |       | 1,379,351       |       | —                                 |        | — |   | 1,379,351 |   |
|                                                                       |       |                |       |             |       |                             |       |         |       |            |       |                                   |        |   |   |   |   |
| Warrants issued in connection with ACT Group matters                       |       | —              |       | —           |       | —                           |       | —       |       | 469,966         |       | —                                 |        | — |   | 469,966 |   |
|                                                                       |       |                |       |             |       |                             |       |         |       |            |       |                                   |        |   |   |   |   |
| Warrants issued for consulting services                                    |       | —              |       | —           |       | —                           |       | —       |       | 105,907         |       | —                                 |        | — |   | 105,907 |   |
|                                                                       |       |                |       |             |       |                             |       |         |       |            |       |                                   |        |   |   |   |   |
| Reclassification of warrants to liabilities  (Restated)                    |       | —              |       | —           |       | —                           |       | —       |       | (27,670,606     | )          | —                                 |        | — |   | (27,670,606 | ) |
|                                                                       |       |                |       |             |       |                             |       |         |       |            |       |                                   |        |   |   |   |   |
| Stock-based compensation                                                   |       | —              |       | —           |       | —                           |       | —       |       | 96,454          |       | —                                 |        | — |   | 96,454 |   |
|                                                                       |       |                |       |             |       |                             |       |         |       |            |       |                                   |        |   |   |   |   |
| Net loss nine months September 30, 2005                                    |       | —              |       | —           |       | —                           |       | —       |       | —          |       | —                                 |        | (5,951,954 | ) | (5,951,954 | ) |
|                                                                       |       |                |       |             |       |                             |       |         |       |            |       |                                   |        |   |   |   |   |
| Balance, September 30, 2005                                           |       | —              |       | $                | —     |                             | 23,068,059 |         | $          | 23,068          |       | $                                      | (11,197,404 | )  | $ | (21,585 | ) | $ | (19,711,753 | ) | $ | (30,907,674 | ) |

 

Theaccompanying notes are an integral part of these consolidated financialstatements.

 

7

----

 

**ADVANCEDCELL TECHNOLOGY, INC.**

**NOTES TO RESTATED CONSOLIDATED FINANCIALSTATEMENTS**

**SPETEMBER30, 2005**

 

**(UNAUDITED)**

 

###### **1.      ORGANIZATIONAL MATTERS**

 

**Organization**

 

On January 31, 2005, Advanced CellTechnology, Inc. (formerly known as A.C.T. Holdings, Inc.) (the “Company”)completed the Merger with Advanced Cell, Inc. (formerly known as AdvancedCell Technology, Inc.), a Delaware corporation (“ACT”), pursuant to whicha wholly-owned subsidiary of the Company merged with and into ACT, with ACTremaining as the surviving corporation and a wholly-owned subsidiary of theCompany. Upon the completion of the Merger, the Company ceased all of itspre-Merger operations and adopted the business of ACT.

 

Prior to the Merger, the Company had minimalbusiness, operations, revenues and assets, and had been involved in an industryentirely unrelated to the business of ACT. Therefore, the acquisition of ACT bythe Company represented a complete change in the nature of the Company’sbusiness and operations, and changed the nature of any prior investment in theCompany.

 

The transaction has been accounted for as arecapitalization of ACT, the accounting acquirer. The historical financialstatements presented for periods prior to the merger are those of ACT. Theconsolidated accounts of the Company have been included from January 31,2005. All comparisons of financial results for periods prior to the Merger areto the financial results of ACT.

 

**Nature of Business**

 

The Company is a biotechnology companyfocused on developing and commercializing human stem cell technology in theemerging fields of regenerative medicine and stem cell therapy. Principalactivities to date have included obtaining financing, securing operatingfacilities and conducting research and development. The Company has notherapeutic products currently available for sale and does not expect to haveany therapeutic products commercially available for sale for a period of years,if at all. These factors indicate that the Company’s ability to continue itsresearch and development activities is dependent upon the ability of managementto obtain additional financing as required.

 

***Basis of Presentation —***The accompanyingunaudited financial statements as of September 30, 2005 and for the threeand nine month periods ended September 30, 2005 and 2004 have beenprepared pursuant to the rules and regulations of the Securities and ExchangeCommission (“SEC”), including Form 10-QSB and Regulation S-B. Theinformation furnished herein reflects all adjustments (consisting of normalrecurring accruals and adjustments), which are, in the opinion of management,necessary to fairly present the operating results for the respective periods.Certain information and footnote disclosures normally present in annualfinancial statements prepared in accordance with accounting principlesgenerally accepted in the United States of America have been omitted pursuantto such rules and regulations. The Company believes that the disclosuresprovided are adequate to make the information presented not misleading. Thesefinancial statements should be read in conjunction with the audited financialstatements and explanatory notes for the year ended December 31, 2004 asdisclosed in the Company’s annual report on Form 10-KSB for that year asfiled with the SEC and in conjunction with ACT’s audited financial statementsand explanatory notes for the year ended December 31, 2004 as disclosed inthe Company’s current report on Form 8-K/A as filed with the SEC on April 18,2005. Interim results of operations are not necessarily indicative ofthe results to be expected for the year ending December 31, 2005.

 

###### 2.      RESTATEMENT

 

The Company has restated its unaudited consolidatedbalance sheet and consolidated statement of stockholders’ deficit as ofSeptember 30, 2005 and for the nine months then ended, and the related notes tothe consolidated financial statements.

 

The restatement on this Form 10-QSB/A   is due tothe misapplication of certainaccounting principles to the Company’s convertible debenture financing and the issuance of Notes Payable-Other both  completedin September 2005. Analysis completed subsequent to our initial filing  identified additional embedded derivative instruments within the agreements governing the debentures that required separate valuation under FAS 133 “Accounting for Derivative Instruments and HedgingActivities.”  Ouranalysis identified several derivative instruments to be valued, and resultedin a restatement to the Company’s consolidated balance sheet at September 30,2005 to properly reflect convertible debt and embedded derivative instruments.In addition, the debenture agreementscontained variable share settlement provisions that required the Company to adjustthe fair value of certain previously issued warrants and reclassify them fromadditional paid in capital in the consolidated statement of stockholders’equity to a warrant derivative liability account in the consolidated balancesheet,  in accordance with EITF 00-19 “Accountingfor Derivative Financial Instruments Indexed to, and Potentially Settled in aCompany’s Own Stock.” Restatements for the quarter ended September 30, 2005 did not result ina change to the consolidatedstatement of operations or the consolidated statement of cash flows.  The notes to the consolidated financialstatements, particularly Note 4 - Convertible Debentures,  Note 6 - Notes Payable  -  Other and Note 8 - Reclassification of Equity Transactions  have been added or  restated to more completely describe the embeddedderivative instruments, the methodology used toestablish the fair values of each and the reclassifications required.

 

The effect of the restatement is to restate the amountsof convertible debt and related embedded derivatives, adjust fair valuesthrough the equity accounts for warrant derivatives previously classified in equitypursuant to EITF 00-19, reclassify warrant derivatives to liability accountspursuant to EITF 00-19 and restate the current and long-term classification ofrelated amounts.

 

The following table shows the impact of theserestatements on the consolidated balance sheet and consolidated statement ofstockholders’ equity at September 30, 2005:

 
| ** **                                               | ** ** | **Previously**         | ** ** | ** **     | ** ** | ** **             | ** ** |
|----------------------------------------------------------|------------|------------------------|------------|----------------|------------|------------------------|------------|
| ** **                                               | ** ** | **Reported**           | ** ** | ** **     | ** ** | **Restated**           | ** ** |
| ** **                                               | ** ** | **September 30,** | ** ** | ** **     | ** ** | **September 30,** | ** ** |
| ** **                                               | ** ** | **2005**               | ** ** | **Adjustment** | ** ** | **2005**               |       |
| **Consolidated  Balance Sheet**                          |       |                   |       |           |       |                   |       |
| Current  Liabilities:                                    |       |                   |       |           |       |                   |       |
| Convertible  debentures current portion                  |       | $                      | 988,629    |           | $          | (988,629               | )          | $ | — |   |
| Convertible  debentures and embedded derivatives         |       | —                 |       | 4,497,844      |       | 4,497,844              |       |
| Warrant  liability under convertible notes payable       |       | 5,892,665              |       | (5,892,665     | )          | —                 |       |
| Beneficial  conversion liability under convertible NP    |       | 3,101,671              |       | (3,101,671     | )          | —                 |       |
| Notes  payable - other                                   |       | 748,816                |       | 21,433         |       | 770,249                |       |
| Total  current liabilities                               |       | 13,683,746             |       | (5,463,688     | )          | 8,220,058              |       |
|                                                     |       |                   |       |           |       |                   |       |
| Long term  liabities:                                    |       |                   |       |           |       |                   |       |
| Convertible  debentures less current portion             |       | 1,977,259              |       | (1,977,259     | )          | —                 |       |
| Convertible  debentures and embedded derivatives         |       | —                 |       | 7,871,228      |       | 7,871,228              |       |
| Beneficial  conversion liability under convertible NP    |       | 6,203,343              |       | (6,203,343     | )          | —                 |       |
| Warrant  derivatives                                     |       | —                 |       | 33,443,668     |       | 33,443,668             |       |
| Total  liabilities                                       |       | 23,610,018             |       | 27,670,606     |       | 51,280,624             |       |
|                                                     |       |                   |       |           |       |                   |       |
| **Consolidated  Statement of Stockholders’ Equity** |       |                   |       |           |       |                   |       |
| Additional  paid-in capital                              |       | 16,473,202             |       | (27,670,606    | )          | (11,197,404            | )          |
| Total  stockholders’ deficit                        |       | $                      | (3,237,068 | )              | $          | (27,670,606            | )          | $ | (30,907,674 | ) |

 

###### **3.**          SIGNIFICANT ACCOUNTING POLICIES

###### ** **

***Use of Estimates—***Thesefinancial statements have been prepared in accordance with accountingprinciples generally accepted in the United States and, accordingly, requiremanagement to make estimates and assumptions that affect the reported amountsof assets and liabilities at the date of the financial statements and thereported amounts of revenues and expenses during the reporting period.  Specifically, our management has estimatedthe expected economic life and value of our licensed technology, our netoperating loss for tax purposes and our stock, option and warrant expensesrelated to compensation to employees and directors, consultants and investmentbanks and accounting related to convertible debentures.  Actual results could differ from thoseestimates.

 

***Stock Based Compensation—***SFASNo. 123, “*Accounting for Stock-Based Compensation*,”establishes and encourages the use of the fair value based method of accountingfor stock-based compensation arrangements under which compensation cost isdetermined using the fair value of stock-based compensation determined as ofthe date of the grant or the date at which the performance of the services iscompleted and is recognized over the periods in which the related services arerendered.  The statement also permitscompanies to elect to continue using the current intrinsic value accountingmethod specified in Accounting Principles Board (“*APB*”)Opinion No. 25, “*Accounting for StockIssued to Employees*,” to account for stock-based compensation toemployees.  We have elected to use theintrinsic value based method for grants to our employees and directors and havedisclosed the pro forma effect of using the fair value based method to accountfor our stock-based compensation to employees.

 

The Company uses the fair value method forequity instruments granted to non-employees and uses the Black Scholes modelfor measuring the fair value.  The stockbased fair value compensation is determined as of the date of the grant or thedate at which the performance of the services is completed (measurement date)and is recognized over the periods in which the related services are rendered.

 

8

----

 

**Pro Forma Information**

 

***Employee and Director CommonShare Purchase Options—***Pro forma informationregarding the effects on operations of employee and director common share purchaseoptions as required by SFAS No. 123 and SFAS No. 148 has beendetermined as if the Company had accounted for those options under the fairvalue method. Pro forma information is computed using the Black Scholes methodat the date of grant of the options.  Proforma information is computed using the Black Scholes method at the date ofgrant of the options based on the following assumptions ranges for the threemonth period ended September 30, 2005: (1) risk free interest rate of4.15%; (2) dividend yield of 0%; (3) expected volatility factor of65%; and (4) an expected life of the options of 2-4 years.  Theforegoing option valuation model requires input of highly subjectiveassumptions.

 

Because common share purchase options grantedto employees and directors have characteristics significantly different fromthose of traded options, and because changes in the subjective inputassumptions can materially affect the fair value of estimate, the existingmodel does not in the opinion of our management necessarily provide a reliablesingle measure of fair value of common share purchase options we have grantedto our employees and directors.

 

Pro forma information relating to employeeand director common share purchase options is as follows:

 
| ** **                                      | ** ** | **For the**** ****Three  Months Ended** | ** ** | **For The**** ****Three  Months Ended** | ** ** | **For the**** ****Nine  Months Ended** | ** ** | **For The**** ****Nine  Months Ended** | ** ** |
|-------------------------------------------------|------------|----------------------------------------------|------------|----------------------------------------------|------------|---------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                      | ** ** | **September 30,  2005**                 | ** ** | **September 30,  2004**                 | ** ** | **September 30,  2005**                | ** ** | **September 30,  2004**                | ** ** |
| Net loss as reported                            |       | $                                            | (2,310,607 | )                                            | $          | (381,534                                    | )          | $                                           | (5,951,954 | ) | $ | (1,690,712 | ) |
| Current period expense calculated under APB  25 | ** ** | **—**                                   | ** ** | **—**                                   | ** ** | **—**                                  | ** ** | **—**                                  | ** ** |
| Stock compensation calculated under SFAS  123   |       | (341,107                                     | )          | **—**                                   |       | (416,046                                    | )          | **—**                                  | ** ** |
| Pro forma net loss                              |       | $                                            | (2,651,714 | )                                            | $          | (381,534                                    | )          | $                                           | (6,368,000 | ) | $ | (1,690,712 | ) |
| Basic and diluted historical loss per share     |       | $                                            | (0.10      | )                                            | $          | (0.05                                       | )          | $                                           | (0.26      | ) | $ | (0.20 | ) |
| Pro forma basic and diluted loss per share      |       | $                                            | (0.11      | )                                            | $          | (0.05                                       | )          | $                                           | (0.27      | ) | $ | (0.20 | ) |

 

Effective January 1, 2006, the Companywill adopt the accounting proscribed in SFAS 123R for employee and directorcommon share purchase options.

 

***Net Loss Per Share—***Weuse SFAS No. 128, “Earnings Per Share” for calculating the basic anddiluted loss per share.  We compute basicloss per share by dividing net loss and net loss attributable to commonshareholders by the weighted average number of common shares outstanding.  Diluted loss per share is computed similar tobasic loss per share except that the denominator is increased to include thenumber of additional common shares that would have been outstanding if thepotential shares had been issued and if the additional shares were dilutive.Common equivalent shares are excluded from the computation of net loss pershare if their effect is anti-dilutive.

 

For the three and nine months ended September 30,2005, 40,414,204 potential shares were excluded from the shares used tocalculate diluted earnings per share as their inclusion would reduce net lossper share. There were no potentially dilutive shares at September 30,2004.

 

###### **4.**       CONVERTIBLE DEBENTURES(RESTATED)

 

###### ****

On September 15, 2005, we entered into a SecuritiesPurchase Agreement with accredited investors for the issuance of an aggregateof $22,276,250 principal amount of convertible debentures with an originalissue discount of  $4,526,250representing 20.3187%. In connection with the closing of the sale of thedebentures, we received gross proceeds of $17,750,000.  The convertible debentures are convertible atthe option of the holders into 9,685,326 shares of Common Stock at a fixedconversion price of $2.30 per share, subject to anti-dilution and othercustomary adjustments.  In connectionwith the Securities Purchase Agreement, we also issued warrants to purchase anaggregate of 4,842,663 shares of our Common Stock. The term of the warrants isfive years and the exercise price is $2.53 per share, subject to anti-dilutionand other customary adjustments.  Theinvestors have contractually agreed to restrict their ability to convert theconvertible debentures, exercise the warrants and exercise the additionalinvestment right morefully described in the following paragraph and receive shares of our Common Stock such thatthe number of shares of our Common Stock held by them and their affiliatesafter such conversion or exercise does not exceed 4.99% of our then issued andoutstanding shares of our Common Stock. 

 

The Securities Purchase Agreement provides anadditional investment right in debentures under certain conditions. If withinsix months of the effective date of the registrationstatementrelated to registration of shares underlying the initial issuance, October2005, the Company satisfies certain conditions set forth in the SecuritiesPurchase Agreement, including listing of the Company on AMEX or NASDAQ CapitalMarkets, stock trading price in excess of conversion price, and achievement ofminimum trading volumes, the Company can require the Purchasers to purchase,  at asecond closing, $11,138,125 principal amount of additional debentures for a discountedpurchase price of $8,875,000 at a price of $2.30 per share.    To the extent the Company has not exercised this right within the six month  period, the convertible debenture holders have the right topurchase additional debentures, up to their pro rata share.  Twelve months following the effective date ofthe registration statement, any debentures not yet purchased shall be availableto investors to purchase in excess of their individual pro rata share.  Additional debentures issued pursuant to theagreement will have a conversion price equal to the lesser of $2.30 per shareor the five day average of closing prices immediately prior to exercise of theright to additional investment of thedebentures purchased as additional investment.  Warrants issued pursuant to the additionalinvestment will have an exercise price equal to the lesser of $2.53 per share or 110% of the conversion price ofthe debentures purchased as additional investment. Other terms and conditions related to additionaldebentures issued will be the same as those specified for the debentures soldat the initial closing.

 

The agreements entered into provide that theCompany will pay certain cash amounts as liquidated damages in the event thatthe Company does not maintain an effective registration statement, or if theCompany fails to timely execute stock trading activity.  In addition, the agreements provide that theCompany shall meet other milestones, including settlement of ACT Grouplitigation, and liquidation of ACT Group, as described in Note 11,formation of a majority independent Board of Directors, and merger of theCompany and ACT. 

 

 

9

----

 

 

Under the terms of the agreements, principalamounts owed under the debentures become due and payable commencing six monthsfollowing closing of the transaction.  Atthat time, and each month thereafter, the Company is required to either repay1/30 of the outstanding balance owed in cash, or convert the amount due intocommon stock at the lesser of $2.30 per share or 85% of the prior ten days’closing stock price, immediately preceding the redemption. The agreements alsoprovide that the Company may force conversion of outstanding amounts owed underthe debentures into common stock, if the Company has met conditions andmilestones identified above, and, additionally, has a stock price for 20consecutive trading days that exceeds $4.60 per share.

 

In accordance with the requirements of EITF 00-19“Accounting for Derivative Financial Instruments Indexed to, and PotentiallySettled in, a Company’s Own Stock,” “EITF 00-27 “Application of Issue No. 98-5Certain Convertible Instruments” and the provisions of EITF 05-04 “The Effectof a Liquidated Damages Clause on a Freestanding Financial Instrument Subjectto EITF Issue No. 00-19, “Accounting for Derivative Financial InstrumentsIndexed to, and Potentially Settled in, a Company’s Own Stock”, the Companyconcluded that it was required to carve out the “fair value” of thefreestanding warrants associated with this debenture contract and account forthe freestanding warrant on the “combined basis” outlined in EITF 05-04 becausethe penalties associated with liquidated damages were significant and thewarrant contained a variable strike price under certain circumstances.  Of the total proceeds from the issuance of thedebentures, $5,747,297 was initially allocated to the freestanding warrantsassociated with the debentures based upon the fair value of the Warrants. Theassumptions used in the Black Scholes model for determining the fair value ofthe warrants were as follows: (1) dividend yield of 0%; (2) expected volatilityof 64%, (3) risk-free interest rate of 3.99%, and (4) expected life of 5 years.In accordance with FAS 133 “*Accounting for DerivativeInstruments and Hedging Activities*”, EITF 00-19 “*Accounting for Derivative Financial Instruments Indexed to andPotentially Settled in a Company’s Own Stock*” and EITF 05-04 “*The Effect of a Liquidated Damages Clause on a Freestanding FinancialInstrument Subject to EITF Issue No. 00-19*”, the amounts allocatedto the warrant represent a derivative liability that has been recorded in theaccompanying balance sheet.  The carryingvalue of warrant derivative at September 30, 2005 has been adjusted to reflectits “fair value” based upon a Black Scholes calculation as follows: (1)dividend yield of 0%; (2) expected volatility of 74%, (3) risk-free interestrate of 4.35%, and (4) expected remaining life of 4.75 years. During thequarter ended September 30, 2005, an increase in the fair value of the warrantliability of approximately $145,000 was initially and correctly  recorded through results of operations.

 

The Company analyzed the provisions of theconvertible debenture host contract in accordance with EITF 05-02 “The Meaningof “Conventional Convertible Debt Instrument” in Issue No. 00-19”.  Because the conversion debenture containsvariable payment terms in both its anti-dilution provisions, and certain of themonthly redemption payment features, it does not qualify as conventionalconvertible debt and the Company has concluded that the convertible debenturecontract should be analyzed under the provisions of  FAS 133 “Accounting for DerivativeInstruments and Hedging Activities”, and embedded derivative features should bebifurcated and separately measured.  Thisanalysis identified a number of  embedded derivative instruments that required separate valuation in accordance with the requirements of FAS 133,EITF 05-04 and related accounting literature. The following summarizes the fair values of embedded derivatives at thetransaction date of  September 15, 2005and  September 30, 2005, followed by a descriptionof the valuation methodology utilized to determine fair values.  Additional embedded derivatives related toliquidated damages and a company option to redeem monthly payments in stockwere also identified, found to have zero value and have been excluded from thistable.

 
| ** **                                | ** ** | **Initial Fair**  | ** ** | ** **                  | ** ** |
|-------------------------------------------|------------|------------------------|------------|-----------------------------|------------|
| ** **                                | ** ** | **Value at**      | ** ** | **Fair Value at** | ** ** |
| **Embedded Derivative Liability (Asset)** | ** ** | **September 15, 2005** | ** ** | **September 30, 2005**      | ** ** |
|                                      |       |                   |       |                        |       |
| Conversion  Feature                       |       | $                      | 7,317,206  |                        | $          | 7,234,867 |   |
| Anti-dilution  protection                 |       | 1,585,255              |       | 1,534,425                   |       |
| Default  provisions                       |       | 96,067                 |       | 96,585                      |       |
| Right to  provide future financing        |       | 159,960                |       | 169,155                     |       |
| Company  right to force conversion        |       | (1,561,618             | )          | (1,498,175                  | )          |
|                                      |       | $                      | 7,596,870  |                        | $          | 7,536,857 |   |

 

The Company analyzed the conversion feature embedded in the host debtcontract and concluded that the characteristics that would trigger theprovisions of this feature are tied primarily to future events related to theperformance of the Company’s stock, and this feature is therefore not “clearlyand closely related” to the host debt contract, thereby indicating a potentialderivative instrument under the provisions of FAS 133.  The Company further analyzed the balance ofFAS 133 requirements and concluded that the hybrid host contract was notremeasured at “fair value”, and a separate instrument with provisions similarto this embedded feature would qualify as a derivative instrument under FAS133. Accordingly, we have concluded that this embedded feature does qualify asa derivative instrument under FAS 133.  The fair value of the derivative for the conversionfeature was valued as an American call option using the binomial option pricing model with the following inputs:(1) closing stock price as of the valuation date of $2.20 at September15, 2005  and $2.21 at September 30, 2005 (2) exercise price equal to the $2.30 conversionprice (3) volatility based upon the Company’s stock trading of   64% at September 15, 2005 and 65% at September 30,2005 (4) Treasury note rateswith terms commensurate with the remaining term of the Notes of 3.9% and (5)duration of the note as an amortizing debenture of approximately 1.7 yearsbased upon present values.

 

The Companyanalyzed anti-dilution provisions embedded in the host debt contract andconcluded that the characteristics that would trigger the provisions of thisfeature are tied primarily to future events related to the performance of theCompany’s stock, and this feature is therefore not “clearly and closelyrelated” to the host debt contract, thereby indicating a potential derivativeinstrument under the provisions of FAS 133. The Company further analyzed the balance of FAS 133 requirements andconcluded that the hybrid host contract was not remeasured at “fair value”, anda separate instrument with provisions similar to this embedded feature wouldqualify as a derivative instrument under FAS 133. Accordingly, we haveconcluded that this embedded feature does qualify as a derivative instrumentunder FAS 133.  The fair value of the derivative for anti-dilutionprotection was valued using a standard put option binomial model, adjusted forthe probability of subsequent financing at prices below the principal’sconversion option with the following inputs: (1) closing stock price as of thevaluation date of $2.20 at September 15, 2005 and $2.21 at September 30, 2005 (2) exercise price equal to the $2.30 conversionprice (3) volatility based upon the Company’s stock trading of 64% at September 15, 2005 and 65% at September 30,2005 (4) Treasury note rateswith terms commensurate with the remaining term of the Notes of 3.9% and (5)duration of the note as an amortizing debenture of approximately 1.7 yearsbased upon present values.

 

The Companyanalyzed default provisions embedded in the host debt contract in accordancewith Appendix A of FAS 133. In general, provisions such as those contained inthe Company’s host contract are considered to be “clearly and closely related”and therefore not derivative instruments, unless “both” (1) the debt involves asubstantial premium or discount and (2) the put or call option is onlycontingently exercisable and generally indexed only to interest rates or creditrisk of the Company.  The companyconcluded that the convertible debentures do involve a substantial discount,given an original issue discount of approximately 20.3% and the option foraccelerated payment upon default does include provisions that relate to otherthan interest rate or credit risk of the Company. Accordingly, we have concludedthat this embedded feature does qualify as a derivative instrument under FAS133.  The fair value of the derivative for contractualdefault provisions was determined by taking the monthly amortization schedule,and multiplying the result by the contractual penalty of 120%.  The present value of this penalty was thenadjusted by the estimated probability of default for each valuation date.

 

The Companyanalyzed the investors’ option to provide future financing embedded in the hostdebt contract and concluded that the characteristics that would trigger theprovisions of this feature are tied primarily to future events related to theperformance of the Company’s stock, and this feature is therefore not “clearlyand closely related” to the host debt contract, thereby indicating a potentialderivative instrument under the provisions of FAS 133.  The Company further analyzed the balance ofFAS 133 requirements and concluded that the hybrid host contract was notremeasured at “fair value”, and a separate instrument with provisions similarto this embedded feature would qualify as a derivative instrument under FAS133. Accordingly, we have concluded that this embedded feature does qualify asa derivative instrument under FAS 133.  The fair value of the derivative for the investors’option to provide future financing was determined using a Black-Scholes OptionPricing Model with the following inputs: (1) The stock and exercise price wasbased on the maximum amount of additional investment of $8,875,000 (2) volatility of 2% was based on thehistorical volatility of government and high yield bond indices (3) risk free rate of 3.9% was basedon Treasury notes and (4) time to maturity was based upon the six month optionperiod.

 

The Companyanalyzed the right given to the Company to force conversion of the convertibledebentures into common stock that is embedded in the host debt contract andconcluded that the characteristics that would trigger the provisions of thisfeature are tied primarily to future events related to the performance of theCompany’s stock, and this feature is therefore not “clearly and closelyrelated” to the host debt contract, thereby indicating a potential derivativeinstrument under the provisions of FAS 133. The Company further analyzed the balance of FAS 133 requirements andconcluded that the hybrid host contract was not remeasured at “fair value”, anda separate instrument with provisions similar to this embedded feature wouldqualify as a derivative instrument under FAS 133. Accordingly, we haveconcluded that this embedded feature does qualify as a derivative instrumentunder FAS 133.  The fair value of the derivative asset related tothe Company’s right to force conversion was based upon a binomial option pricing model with the followinginputs: (1) closing stock price at the valuation dates of $2.20 at September 15, 2005 and $2.21 at September 30, 2005 (2) exercise price of $4.60 per share which isrequired for the forced conversion  (3)volatility based upon the Company’s stock trading of 64% at September 15, 2005 and 65% at September 30,2005 (4) Treasury note rate withterms commensurate with the remaining term of the Notes of 3.9% and (5)duration of the note as an amortizing debenture of approximately1.72 years based upon present values.

 

During thequarter ended September 30, 2005, the Company recorded approximately $426,000as Interest Expense for amortization of discounts for original issue discount,discount for warrant derivative,  andother embedded derivatives identified above.

 

In connectionwith this financing, we paid cash fees to a broker-dealer of $1,065,000 andissued a warrant to purchase 1,162,239 shares of Common Stock at an exerciseprice of $2.53 per share. The initial fair value of the warrant was estimatedat approximately $1,379,000 using the Black Scholes pricing model. Theassumptions used in the Black Scholes model are as follows: (1) dividend yieldof 0%; (2) expected volatility of 64%, (3) risk-free interest rate of 3.99%,and (4) expected life of 5 years. Cash fees paid, and the initial fair value ofthe warrant, have been capitalized as debt issuance costs and are beingamortized over 36 months, the life of the related convertible debentures. 

 

Thefollowing table summarizes Convertible Debentures and embedded derivativesoutstanding at September 30, 2005:

 
| Convertible debentures at face                    |       | $          | 22,276,250 |   |
|------------------------------------------------------------------|------------|------------|------------|--------|
| Discounts  on debentures:                                        | ** ** | ** ** | ** ** |
| Original  issue discount                                         |       | (4,417,609 | )          |
| Conversion  feature derivative                                   |       | (7,142,983 | )          |
| Warrant  derivative                                              |       | (5,610,443 | )          |
| Other  derivatives                                               |       | (273,002   | )          |
| Net  convertible debentures                                      |       | 4,832,213  |       |
| Embedded  derivatives                                            |       | 7,536,859  |       |
| Convertible  debentures and embedded derivatives                 |       | 12,369,072 |       |
| Less  current portion                                            |       | (4,497,844 | )          |
| Convertible  debentures and embedded derivatives– long term |       | $          | 7,871,228  |   |

 

###### **5.**   CONVERTIBLE NOTES PAYABLE

###### ** **

During 2004, we issued promissory notesaggregating $500,000 face value for cash proceeds of $450,000 and theassumption of $50,000 of debt owed by our parent to one of the investors. As aresult of the assumption of the $50,000 of debt, we have recorded a financingcost in that amount. The notes bear interest at 10% per year. $350,000 of notesmatured on December 31, 2004 and $150,000 matured on September 30, 2005.As outlined in Note 9, the balances outstandingrelating to these convertible notes payable were converted to common stock in January 2005.

 

As additional consideration for the purchaseof the notes, we granted to the note holders warrants entitling them topurchase 700,000 common shares at an exercise price of $0.05. Warrants for300,000 shares were exercisable immediately upon issuance and expire two yearsfrom the date of issue.  Warrants for400,000 shares are exercisable on or after February 1, 2006 and expire February 1,2008. The fair value of the warrants was estimated at $0, using the BlackScholes option pricing model. The assumptions used in the Black Scholes modelare as follows: (1) dividend yield of 0%; (2) expected volatility of0%, (3) risk-free interest rate of 2.75%, and (4) expected life of 2years. Pursuant to EITF 98-6 and EITF 00-27, there was no allocation of theproceeds of the notes to the warrants and no beneficial conversion feature,because the conversion rate at the date of issue was unknown and was presumedto be at market value.

 

During the first quarter of 2005, the$500,000 of notes, plus accrued interest of $23,708, were converted intoinvestment units consisting of 616,124 shares of common stock, plus 308,063common stock purchase warrants, exercisable at $1.27 per share and the Companydetermined that there was no beneficial conversion feature upon the conversion.

 

10

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###### **6.**                 NOTES PAYABLE-OTHER

###### ** **

###### **In September 2005, as more fully described inNote 11 – ACT Group Settlement, theCompany entered into $600,000 of convertible promissory notes payable withcertain parties in connection with settlement of various legal proceedingsrelated to ACT Group and the Company. The notes bear interest at 7.5% and are due July 2006. The notesprovide for an optional partial payment of $150,000 before July 2006.  If the Company makes such optional payment,the balance due under the notes will be extended to January 2007.  If the Company fails to make the optionalpayment, or has not paid the note in full by January 2007, the interestrate on the note increases to 12%.  Theholders of the notes have the right, but not the obligation, to convert anypart, or all of the outstanding principal and accrued interest under the notesinto shares of Common Stock at $2.20 per share. The promissory note agreements provide for a reduction in the exerciseprice in the event there is a dilutive financing event.**

######  

Weanalyzed the convertible promissory notes payable and determined that theconversion option and the anti-dilution provisions represent embeddedderivative  instruments under theprovisions of FAS 133 “Accounting for Derivative Instruments and HedgingActivities”.  Accordingly, we have separately valued theseinstruments andrecorded discounts offsetting Notes Payable – Other.

 

The Company analyzed the provisions of the NotesPayable – Other in accordance with EITF 05-02 “The Meaning of “ConventionalConvertible Debt Instrument” in Issue No. 00-19”.  Because the Notes Payable - Other containsreset pricing provisions in the event of a dilutive future financing, it doesnot qualify as conventional convertible debt,and the Company has concluded thatNotes Payable - Other should be analyzed under the provisions of  FAS 133 “Accounting for DerivativeInstruments and Hedging Activities”, and embedded derivative features should bebifurcated and separately measured.  TheCompany analyzed the conversion feature embedded in the host debt contract andconcluded that the characteristics that would trigger the provisions of thisfeature are tied primarily to future events related to the performance of theCompany’s stock, and this feature is therefore not “clearly and closelyrelated” to the host debt contract, thereby indicating a potential derivativeinstrument under the provisions of FAS 133. The Company further analyzed the balance of FAS 133 requirements andconcluded that the hybrid host contract was not remeasured at “fair value”, anda separate instrument with provisions similar to this embedded feature wouldqualify as a derivative instrument under FAS 133. Accordingly, we haveconcluded that this embedded feature does qualify as a derivative instrumentunder FAS 133.  The fair value of the derivative for the conversionfeature was valued as an American call option using the binomial option pricing model with the following inputs:(1) closing stock price as of the valuation date of $2.20 at September30, 2005 (2) exercise price equal to the $2.20 conversion price(3) volatility based upon the Company’s stock trading of 65% (4) Treasury noterates with terms commensurate with the remaining term of the Notes of 3.9% and(5) duration of the note as an amortizing debenture of approximately 1.7 yearsbased upon present values.

 

The Company analyzed anti-dilution provisions embedded in the host debtcontract and concluded that the characteristics that would trigger theprovisions of this feature are tied primarily to future events related to theperformance of the Company’s stock, and this feature is therefore not “clearlyand closely related” to the host debt contract, thereby indicating a potentialderivative instrument under the provisions of FAS 133.  The Company further analyzed the balance ofFAS 133 requirements and concluded that the hybrid host contract was notremeasured at “fair value”, and a separate instrument with provisions similarto this embedded feature would qualify as a derivative instrument under FAS133. Accordingly, we have concluded that this embedded feature does qualify asa derivative instrument under FAS 133.  The fair value of the derivative for anti-dilutionprotection was valued using a standard put option binomial model, adjusted forthe probability of subsequent financing at prices below the principal’sconversion option with the following inputs: (1) closing stock price as of thevaluation date of $2.21 at September 30, 2005 (2) exercise price equal to the $2.20 conversionprice (3) volatility based upon the Company’s stock trading of 65% (4) Treasurynote rates with terms commensurate with the remaining term of the Notes of 3.9%and (5) duration of the note as an amortizing debenture of approximately 1.7years based upon present values.

 

On July 1, 2003, we issued a promissorynote with a face amount of $339,000 to a law firm as a payment of fees duethem. The note bears interest at a rate of 10% per year. The note was due on October 1,2003. During the first quarter of 2005, the note, plus accrued interest of$53,675, was settled through (i) the issuance of 105,177 shares ofpreferred stock and 52,589 warrants pursuant to the preferred stock offeringdescribed in Note 9, valued at $89,400, (ii) acash payment of $100,000, and (iii) a new note with a face value of$150,000. The new note bears interest at 10%, is due in 3 monthly payments of50,000 each and matured on May 1, 2005. The balance of the note was paidduring the quarter ended June 30, 2005.

 

On July 8, 2003, we issued a promissorynote with a face amount of $272,108 to a law firm as a payment of fees duethem. The note bears interest at a rate of 5% per year. The note is payable inmonthly installments of $25,000, including interest. The note matured on October 1,2003. We made payments through January, 2004. At September 30, 2005 thereis a remaining principal balance of $170,249, as well as accrued interest of$10,833 and accrued late fees of $65,000, included in accrued interest. Latefees accrue at the rate of $2,500 per month.

 

###### **7.**          NOTE PAYABLE — STOCKHOLDER

###### ** **

On July 12, 2002, we issued a promissorynote with a face amount of $1,000,000 to our majority stockholder as arepayment of advances received from the stockholder. The note bears interest ata rate of 12% per year. The note matures on December 31, 2005.  As discussed more fully in Note 11– ACT Group Settlement, the balance due on this Note Payable, and relatedaccrued interest were forgiven in connection with the ACT Group Settlement.

 

###### 8.      RECLASSIFICATION OF EQUITY TRANSACTIONS (RESTATED)

 

As described more fully in Note 4 – ConvertibleDebentures, the provisions of ourconvertible debenture financing completed in September 2005 permit the Company to may makeits monthly redemption in shares rather than cash upon satisfaction of certain conditions.  Under theterms of the debenture agreement, the price per share is variable dependentupon the actual closing price of the Company’s common stock.  Accordingly, the total number of shares toretire outstanding principal is variable and the Company can not be assuredthat there are adequate authorized shares to settle all contractual obligationsunder the debenture agreement, and other option and warrant agreementsoutstanding.  As a result of the Company’s inability toensure it has unissued shares that would allow it to fully satisfy the maximumnumber of shares required to net-share settle all outstanding stockcommitments, we have concluded the previously issued warrants now qualify asderivative instruments under FAS 133 “Accounting for Derivative Instruments andHedging Activities”.

 

Accordingly, in accordance with the provisions ofEITF 00-19 “Accounting for Derivative Financial Instruments Indexed to andPotentially Settled in a Company’s Own Stock” the Company has analyzed all instruments previously recorded as permanentequity under EITF 00-19 which are described in detail in Note 9 – Stockholders’Equity Transactions.  As of September 15,2005, the closing date of the convertible debenture financing, an increase inthe fair value of instruments recorded as permanent equity of approximately$25,600,000 was recorded based upon fair values computed under a Black Scholesmodel with the following assumptions: (1) dividend yield of 0% (2) expectedvolatility of 64% (3) risk-free interest rate of 3.9% and (4) expected life andexercise prices consistent with each individual instrument.

 

At September 15, 2005 theaccumulated fair value of allwarrants  of approximately$27,700,000, after the increase tofair value described above, wasreclassified from equity to Warrant Derivative liability in accordance with therequirements of EITF 00-19. 

 

At September 30, 2005 the fair value of eachinstrument was again computed under a Black Scholes model with the followingassumptions: (1) dividend yield of 0% (2) expected volatility of 65% (3)risk-free interest rate of 4.2% and (4) expected life and exercise prices consistentwith each individual instrument. 

 

###### **9.**          STOCKHOLDERS’ EQUITY TRANSACTIONS

###### ** **

We are authorized to issue two classes ofcapital stock, to be designated, respectively, Preferred Stock and CommonStock.  The total number of shares ofcapital stock which we are authorized to issue is 55,000,000.  The total number of shares of Preferred Stockwe are authorized to issue is 50,000,000, par value $0.001 per share.  The total number of shares of Common Stock weare authorized to issue is 100,000,000, par value $0.001 per share.  We had no Preferred Stock outstanding as of September 30,2005.  We had 23,068,059 shares of CommonStock outstanding as of September 30, 2005.

 

As described more fully in Note 11– ACT Group Settlement, the Company issued warrants to purchase 422,727 sharesof common stock at $2.20 per share. The warrant agreement provides for areduction in the exercise price in the event there is a dilutive financingevent. The warrant has been valued at $469,966, using the Black Scholes pricingmodel with the following assumptions: (1) dividend yield of 0%; (2) expectedvolatility of 65%, (3) risk-free interest rate of 2.85%, and (4) expectedlife of 3.5 years.

 

In September 2005 the Company issued83,000 warrants to purchase common stock at $2.20 per share in connection withconsulting services provided during the quarter.  The warrants have been valued at $105,907,using the Black Scholes pricing model with the following assumptions: (1) dividendyield of 0%; (2) expected volatility of 65%, (3) risk-free interestrate of 4.149%, and (4) expected life of 5 years.

 

In September 2005, the Company reachedsettlement agreements and releases with two previous legal firms that theCompany owed amounts to.  Pursuant to thesettlement agreements, an aggregate of 195,000 shares of common stock wereissued as full satisfaction of amounts owed. Shares issued pursuant to this settlement were valued at fair value and thesettlement resulted in the Company recording a Gain on Settlement of Debt ofapproximately $966,000.

 

On January 31, 2005, the Company closedthe Merger described in Note 1.  As aresult of the Merger, all of the outstanding shares of the capital stock of ACTwere converted, on a pro rata basis, into approximately 18,000,000 shares ofthe Company’s Common Stock.  In addition,all outstanding options and warrants to acquire shares of the capital stock ofACT were converted into the right to receive shares of the Company’s CommonStock, and the Company has adopted the ACT stock option plans and all optionsgranted thereunder.

 

On or about January 27, 2005, theCompany issued 616,124 shares of its common stock and granted associatedwarrants to purchase 308,062 shares of common stock at a per share price of$1.27 to five holders of $500,000 aggregate principal amount of short-termpromissory notes, plus interest of $23,708 in exchange for and in retirement ofthe notes. The fair value of the warrants was estimated at $0, using the BlackScholes option pricing model. The assumptions used in the Black Scholes modelare as follows: (1) dividend yield of 0%; (2) expected volatility of0%, (3) risk-free interest rate of 3.25%, and (4) expected life of 2years.

 

On or about January 15, 2005, theCompany issued 17,647 shares of common stock, valued at then current fairmarket value of $15,000, in consideration of accounting services provided tothe Company.

 

During the period beginning January 3,2005 through January 31, 2005, ACT completed a preferred unit offering inwhich ACT sold 4,705,890 investment units to a group of accredited investors(within the meaning of Rule 501 of Regulation D) for total considerationof $8,000,000. ACT received gross cash proceeds of $7,910,600 and the balanceof $89,400 was for payment of non-Merger related legal fees.  The 

 

11

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completion of the offering resulted in theissuance of 9,411,788 shares of ACT’s Series A Preferred Stock andassociated warrants to purchase 4,705,890 shares of common stock at a per shareprice of $1.27.  In consideration ofservices rendered in connection with the preferred unit offering, ACT paid consultantsto the preferred unit offering 469,247 investment units, which resulted in theissuance by the Company of 469,247 shares of Common Stock and associatedwarrants to purchase 234,629 shares of common stock at a per share price of$1.27. All preferred shares issued pursuant to the preferred offering wereconverted into common stock prior to the Merger.

 

###### **10.**   OPTIONS OUTSTANDING

###### ** **

**Stock Plans**

** **

On January 31, 2005, the Company’s Boardof Directors approved the establishment of the 2005 Stock Incentive Plan (the “2005Plan”), subject to approval of our shareholders.  The total number of common shares availablefor grant and issuance under the plan may not exceed 9 million shares, plus anannual increase on the fist day of each of the Company’s fiscal years beginningin 2006 equal to 5% of the number of shares of our common stock outstanding onthe last day of the immediately preceding fiscal year, subject to adjustment inthe event of certain recapitalizations, reorganizations and similartransactions.  Common stock purchaseoptions may be exercisable by the payment of cash or by other means asauthorized by the Board of Directors or a committee established by the Board ofDirectors.  At September 30, 2005,we had granted 8,757,835 common stock purchase options under the 2005 Plan.

 

Pursuant to the 2005 Plan, on September 15,2005, we granted 500,000 common stock purchase options to employees. Theoptions granted have an exercise price of $2.20 per share and vest over periodsnot exceeding 4 years. The fair value of the options was estimated at $418,908for pro forma purposes using the Black Scholes option pricing model. Theassumptions used in the Black Scholes model are as follows: (1) dividendyield of 0%; (2) expected volatility of 65%, (3) risk-free interestrate of 4.149%, and (4) expected life of 4 years.

 

Pursuant to the 2005 Plan, on August 1,2005, we granted 225,000 common stock purchase options to our employees. Theoptions granted to employees have an exercise price of $2.48 per share and vestover periods not exceeding 4 years. The fair value of the options was estimatedat $293,760 for pro forma purposes using the Black Scholes option pricingmodel. The assumptions used in the Black Scholes model are as follows: (1) dividendyield of 0%; (2) expected volatility of 65%, (3) risk-free interest rateof 4.149%, and (4) expected life of 4 years.

 

Pursuant to the 2005 Plan, on August 1,2005, we granted 174,500 common stock purchase options to consultants, and50,000 common stock purchase options to a director. The options have anexercise price of $2.48 per share and vest over periods not exceeding 2 years.The fair value of the options at the date of grant was estimated at $164,806for consultant options and $47,222 for director options using the Black Scholesoption pricing model. The assumptions used in the Black Scholes model are asfollows: (1) dividend yield of 0%; (2) expected volatility of 65%, (3) risk-freeinterest rate of 4.132%, and (4) expected life of 2 years.  This initial estimate of fair value foroptions to consultants will be expensed over the option vesting period anddirector options are included in pro forma disclosure in Note 2.  In addition to this initial estimate of fairvalue, the Company calculates additional quarterly expense based upon optionswhich vest during the period.  During thequarter ended September 30, 2005, vested shares resulted in an additionalcharge of $77,830.  This amount, plusamortization of initial fair value, resulted in a total charge of $95,500 inthe quarter ended September 30, 2005, bringing total charges related tothese options to $95,500 for the nine months ended September 30,2005.  The assumptions used in the BlackScholes model for this quarterly calculation are as follows: (1) dividendyield of 0%, (2) expected volatility of 65%, (3) risk free interestrate of 4.132%, and (4) expected life of 2 years.

 

Pursuant to the 2005 Plan, on January 31,2005, we granted 7,273,335 common stock purchase options to our employees. Theoptions granted to employees have an exercise price of $0.85 per share and vestover periods not exceeding 4 years. The fair value of the options was estimatedat $385,472 for pro forma purposes using the Black Scholes option pricingmodel. The assumptions used in the Black Scholes model are as follows: (1) dividendyield of 0%; (2) expected volatility of 0%, (3) risk-free interestrate of 3.25%, and (4) expected life of 2 years.

 

Pursuant to the 2005 Plan, on January 31,2005, we granted 535,000 common stock purchase options to consultants. Theoptions have an exercise price of $0.85 per share and vest over periods notexceeding 4 years. The fair value of the options at the date of grant wasestimated at $28,354 using the Black Scholes option pricing model. Theassumptions used in the Black Scholes model are as follows: (1) dividendyield of 0%; (2) expected volatility of 0%, (3) risk-free interestrate of 3.25%, and (4) expected life of 2 years.  This initial estimate of fair value will beexpensed over the option vesting period. In addition to this initial estimate of fair value, the Companycalculates additional quarterly expense based upon options which vest duringthe period.  During the quarter ended June 30,2005, vested shares resulted in an additional charge of $61,580.  This amount, plus amortization of initialfair value, resulted in a total charge of $42,840 in the quarter ended September 30,2005, bringing total charges related to these options to $106,988 for the ninemonths ended September 30, 2005. The assumptions used in the Black Scholes model for this quarterlycalculation are as follows: (1) dividend yield of 0%, (2) expectedvolatility of 139%, (3) risk free interest rate of 3.625%, and (4) expectedlife of 2 years.

 

**Common Share Options and Warrants Issued**

 

The following table summarizes information onall common share purchase options and warrants of the Company outstanding as ofSeptember 30, 2005.

 

12

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| ** **                                                         | ** ** | **September 30, 2005** | ** ** |
|--------------------------------------------------------------------|------------|-----------------------------|------------|
| ** **                                                         | ** ** | **Number**                  | ** ** | **Weighted  Average Exercise Price** | ** ** |
| **Outstanding at beginning of the period**                         | ** ** | **10,034,036**              | ** ** | **$** | **0.51** | ** ** |
|                                                               |       |                        |       |   |   |
| **Option granted to employees and consultants  during the period** | ** ** | **8,757,835**               | ** ** | **1.01** | ** ** |
|                                                               |       |                        |       |   |   |
| **Warrants issued during the period**                              | ** ** | **11,759,210**              | ** ** | **1.95** | ** ** |
|                                                               |       |                        |       |   |   |
| **Exercise during the period**                                     | ** ** | **(12,000**                 | **)**      | **0.05** | ** ** |
|                                                               |       |                        |       |   |   |
| **Outstanding at end of the period**                               | ** ** | **30,539,081**              | ** ** | **$** | **1.00** | ** ** |

 

###### **11.**   ACT GROUP SETTLEMENT

 

On September 14, 2005, we entered into aSettlement Agreement (“Settlement Agreement”) with Gary D. Aronson and John S.Gorton (“Plaintiffs”) and our majority shareholder, A.C.T. Group, Inc., aDelaware corporation that recently filed a certificate of dissolution in thestate of Delaware (“ACT Group”), Advanced Cell, Inc., a DelawareCorporation, Michael D. West, Gunnar L. Engstrom, William M. Caldwell, IV,Anthem Venture Partners and Greg Bonfiglio (referred to collectively with theCompany as the “Defendants”).  TheSettlement Agreement resolves certain disputes relating to the litigationentitled Gary D. Aronson and John Gorton v. A.C.T. Group, Inc.,Advanced Cell Technology, Inc., Michael D. West, and Gunnar L. Engstrompending in Commonwealth of Massachusetts Superior Court, Worcester, C.A. No. 040523Band two companion Contempt Complaints filed by the Plaintiffs against certainof the Defendants, including the Company. The Settlement Agreement extinguishedin full ACT Group’s obligations and indebtedness to Plaintiffs, and Plaintiffsdismissed pending claims and actions.

 

In connection with the Settlement Agreement,the Company made a cash payment of approximately $332,000 to Plaintiffs,entered into a $600,000 Note Payable described in Note 6above, and granted a warrant to purchase 422,727 shares of the Company’s commonstock at $2.20 per share described in Note 8 above.

 

In connection with the Settlement Agreement,and as a condition to the Company’s entering into the Settlement Agreement, theCompany entered into an agreement with ACT Group compensating the Company infull for the obligations the Company incurred under the Settlement Agreementwhich extinguish in full all amounts due to and from the Company and ACTGroup.  In addition, as part of thesettlement, ACT Group returned 352,153 shares of the Company’s common stock assatisfaction in full of amounts owed to the Company by ACT Group in connectionwith the Settlement Agreement. The Settlement Agreement, and related agreemententered into with ACT Group, did not result in any charge to operations for theCompany in the period ended September 30, 2005 as costs of the settlementincurred by the Company were fully compensated by ACT Group.

 

###### **12.**                 LEGAL PROCEEDINGS

###### ** **

**Geron-Related Proceedings**

 

Campbell et al. v. Stice et al., PatentInterference Nos. 104,746 and 105,192.  These two interference proceedings wereinitiated January 30, 2002 at the request of Geron Corporation in an effortto obtain rights to U.S. Patent Nos. 5,945,577 and 6,235,970, which arelicensed by the University of Massachusetts exclusively to us.  In both proceedings, the Board of PatentAppeals and Interferences issued a decision adverse to us.  Both of these decisions are being challengedin proceedings described below.  Thisproceeding and the two proceedings discussed immediately below are referred toas the “Geron-Related Proceedings.”  Anadverse outcome in this litigation could result in our having to licensedisputed rights from other parties or require us to cease using the disputedtechnology, either of which could have a material adverse affect on ourbusiness.  An inability to use disputedtechnology could require alteration of certain of our business strategies,including our research and development strategies, and we could be preventedfrom commercializing certain products, which could have a material adverseaffect upon our business.

 

University of Massachusetts and Advanced CellTechnology, Inc. v. Roslin Institute (Edinburgh), Geron Corporation andExeter Life Sciences, Inc., U.S. District Courtfor the District of Columbia.  We filedan action on February 18, 2005 in the U.S. District Court for the Districtof Columbia.  We brought this action under35 U.S.C. 146 to reverse the decision of the Board of Patent Appeals andInterferences regarding a patent to a method of cloning non-human animals.  The patent, U.S. Patent No. 5,945,577,is licensed by the University of Massachusetts exclusively to us.   No other activities have taken place in thisaction.  The parties are actively engagedin settlement discussions.  Adversedeterminations in this proceeding would likely have a materially adverse effecton our business.

 

University of Massachusetts and Advanced CellTechnology, Inc. v. Roslin Institute (Edinburgh), Geron Corporation andExeter Life Sciences, Inc., U.S. District Courtfor the District of Columbia.  We filedan action on April 7, 2005 in the U.S. District Court for the District ofColumbia.  We brought this action under35 U.S.C. 146 to reverse the decision of the Board of Patent Appeals andInterferences regarding a patent to a method of creating embryonic stemcells.  The patent, U.S. Patent No. 6,235,970,is licensed by the University of Massachusetts exclusively to us.  The parties are actively engaged insettlement discussions.  Adversedeterminations in this proceeding would likely have a materially adverse effecton our business.

 

University of Massachusetts v. James M. Robland Phillippe Collas, Massachusetts Superior Court(Suffolk County).  The University ofMassachusetts, referred to as UMass, filed a complaint on February 22,2004 in the Superior Court (Suffolk County) for the Commonwealth ofMassachusetts.  We are not a party to thislitigation; however, a decision adverse to UMass in this litigation could havea materially adverse effect on our business. The complaint alleges the misappropriation by the defendants of valuableinventions in the fields of animal cloning and cell reprogramming, made by thedefendants at UMass and with UMass support, that are exclusively licensed toACT by UMass.  The complaint includescounts for declaratory judgment, breach of contract seeking specific performance,injunctive relief and damages, intentional interference with contract andprospective contractual relations, conversion, breach of duty, and breach ofthe covenant of good faith and fair 

 

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dealing. ACT has been cooperating with UMass in connection with the prosecutionand possible settlement of this litigation. The parties are actively engaged insettlement discussions.

 

###### **13.**                 SUBSEQUENT EVENT

###### ** **

In October 2005, the Company filed withthe Securities and Exchange Commission a Registration Statement on Form SB-2to register 20,397,296 shares of common stock, which has been declaredeffective. These registered shares represent 9,685,326 shares related toconvertible debentures described in Note 3, 4,842,663 shares related toassociated warrants issued to debenture holders, 1,162,239 shares related to awarrant issued to the broker dealer described in Note 3, and 4,707,068additional shares related to contractual obligations providing for theregistration of 130% of shares issuable pursuant to the debentures andassociated warrants.

 

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## **ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS ORPLAN OF OPERATION**

 

*As more fully described in Note 2 in the Notes toRestated Consolidated Financial Statements of this Form 10-QSB/A, theCompany has restated its unaudited consolidated balance sheet and consolidatedstatement of stockholder’s deficit as of September 30, 2005 and for the ninemonths then ended as previously reported in the Company’s Form 10-QSB  for the quarter ended September 30, 2005.  The restatement had no impact on theconsolidated statements of operations, and accordingly, there have been nochanges to the Management’s Discussion and Analysis of Financial Condition andResults of Operations.*

 

## **OVERVIEW**

 

This Quarterly Report on Form 10-QSB/A contains forward-lookingstatements that involve risks and uncertainties.****We use words such as “may,” “assumes,” “forecasts,” “positions,”“predicts,” “strategy,” “will,” “expects,” “estimates,” “anticipates,” “believes,”“projects,” “intends,” “plans,” “budgets,” “potential,” “continue” and variationsthereof, and other statements contained in quarterly report, and the exhibitshereto, regarding matters that are not historical facts and are forward-lookingstatements. Because these statements involve risks and uncertainties, as wellas certain assumptions, actual results may differ materially from thoseexpressed or implied by such forward-looking statements.  Factors that could cause actual results todiffer materially include, but are not limited to risks inherent in:  our early stage of development, including alack of operating history, lack of profitable operations and the need foradditional capital; the development and commercialization of largely novel andunproven technologies and products; our ability to protect, maintain, anddefend our intellectual property rights: uncertainties regarding our ability toobtain the capital resources needed to continue research and developmentoperations and to conduct research, preclinical development and clinical trialsnecessary for regulatory approvals; uncertainty regarding the outcome ofclinical trials and our overall ability to compete effectively in a highlycomplex, rapidly developing, capital intensive and competitive industry.  See *“*RISKFACTORS THAT MAY AFFECT OUR BUSINESS*”*set forth in Part I, Item 2 of this Quarterly Report on Form 10-QSBfor a more complete discussion of these factors.  Readers are cautioned not to place unduereliance on these forward-looking statements, which speak only as of the datethat they are made.  We undertake no obligationto publicly update or revise any forward-looking statements, whether as aresult of new information, future events or otherwise.

 

Thefollowing discussion should be read in conjunction with the consolidatedfinancial statements and notes thereto included in Part I, Item 1 of thisQuarterly Report on Form 10-QSB/A.

 

We are abiotechnology company focused on developing and commercializing human stem celltechnology in the emerging fields of regenerative medicine and stem celltherapy.

 

## **SIGNIFICANT ACCOUNTINGPOLICIES**

## ** **

## **Ourconsolidated financial statements have been prepared in accordance withaccounting principles generally accepted in the United States of America. Thepreparation of these financial statements requires management to make estimatesand assumptions that affect the reported amounts of assets, liabilities,revenues and expenses. Note 1 of the Notes to Consolidated Financial Statementsdescribes the significant accounting policies used in the preparation of theconsolidated financial statements. Certain of these significant accountingpolicies are considered to be critical accounting policies, as defined below.We do not believe that there have been significant changes to our accountingpolicies during the three months ended September 30, 2005, as compared tothose policies disclosed in the December 31, 2004 financial statementsfiled in our Current Report on Form 8-K/A with the SEC on April 18,2005.**

## ** **

## **Acritical accounting policy is defined as one that is both material to thepresentation of our financial statements and requires management to makedifficult, subjective or complex judgments that could have a material effect onour financial condition and results of operations. Specifically, criticalaccounting estimates have the following attributes: 1) we are required to makeassumptions about matters that are highly uncertain at the time of theestimate; and 2) different estimates we could reasonably have used, or changesin the estimate that are reasonably likely to occur, would have a materialeffect on our financial condition or results of operations.**

## ** **

Estimates and assumptions about future eventsand their effects cannot be determined with certainty. We base our estimates onhistorical experience and on various other assumptions believed to beapplicable and reasonable under the circumstances. These estimates may changeas new events occur, as additional information is obtained and as our operatingenvironment changes. These changes have historically been minor and have beenincluded in the consolidated financial statements as soon as they became known.Based on a critical assessment of our accounting policies and the underlyingjudgments and uncertainties affecting the application of those policies,management believes that our consolidated financial statements are fairlystated in accordance with accounting principles generally accepted in theUnited States, and present a meaningful presentation of our financial conditionand results of operations. We believe the following critical accountingpolicies reflect our more significant estimates and assumptions used in thepreparation of our consolidated financial statements:

 

***Use of Estimates -***Thesefinancial statements have been prepared in accordance with accountingprinciples generally accepted in the United States and, accordingly, requiremanagement to make estimates and assumptions that affect the reported amountsof assets and liabilities at the date of the financial statements and thereported amounts of revenues and expenses during the reporting period. Specifically, our management has estimated the expected economic life and valueof our licensed technology, our net operating loss for tax purposes and ourstock, option and warrant expenses related to compensation to employees anddirectors, consultants and investment banks.  Actual results could differfrom those estimates.

 

***Fair Value ofFinancial Instruments -***For certain of ourfinancial instruments, including accounts receivable, accounts payable, accruedexpenses, interest payable, bank overdraft, advances payable and notes payable,the carrying amounts approximate fair value due to their relatively shortmaturities.

 

***Cash and Equivalents-***Cash equivalents are comprised of certain highlyliquid investments with maturity of three months or less when purchased. We maintain our cash in bank deposit accounts, which at times, may exceedfederally insured limits.  We have not experienced any losses in suchaccount.

 

***Equipment -***Werecord our equipment at historical cost.  We expense maintenance andrepairs as incurred. Depreciation is provided for by the straight-line methodover three to six years.

 

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***Revenue Recognition-***Our revenues are generated from license andresearch agreements with collaborators. Licensing revenue is recognized ratablyover the life of the license. Deferred revenue represents the portion of thelicense and other payments received that has not been earned. Costs associatedwith the license revenue are deferred and recognized over the same term as therevenue. Reimbursements of research expense pursuant to grants are recorded asa reduction of research and development expense once the reimbursements areapproved and the Company is assured of collectibility.

 

***Intangible andLong-Lived Assets -***We follow SFAS No. 144, “*Accounting for Impairment of Disposal of Long-LivedAssets*”, which established a “primary asset” approach to determinethe cash flow estimation period for a group of assets and liabilities thatrepresents the unit of accounting for a long lived asset to be held andused.  Long-lived assets to be held and used are reviewed for impairmentwhenever events or changes in circumstances indicate that the carrying amountof an asset may not be recoverable.  The carrying amount of a long-livedasset is not recoverable if it exceeds the sum of the undiscounted cash flowsexpected to result from the use and eventual disposition of the asset. Long-lived assets to be disposed of are reported at the lower of carryingamount or fair value less cost to sell.  During the period ended September 30,2005 no impairment losses were recognized.

 

***Research andDevelopment Costs -***Research and development costsconsist of expenditures for the research and development of patents andtechnology, which are not capitalizable. Our research and development costsconsist mainly of payroll and payroll related expenses, research supplies andcosts incurred in connection with specific research grants.

 

***Stock BasedCompensation -***SFAS No. 123, “*Accounting for Stock-Based Compensation*,”establishes and encourages the use of the fair value based method of accountingfor stock-based compensation arrangements under which compensation cost isdetermined using the fair value of stock-based compensation determined as ofthe date of the grant or the date at which the performance of the services iscompleted and is recognized over the periods in which the related services arerendered.  The statement also permits companies to elect to continue usingthe current intrinsic value accounting method specified in *APB*Opinion No. 25, “*Accounting for Stock Issued to Employees*,”to account for stock-based compensation to employees.  We have elected touse the intrinsic value based method for grants to our employees and directorsand have disclosed the pro forma effect of using the fair value based method toaccount for our stock-based compensation to employees.

 

ACT uses the fair value method for equity instruments granted tonon-employees and uses the Black Scholes model for measuring the fairvalue.  The stock based fair value compensation is determined as of thedate of the grant or the date at which the performance of the services iscompleted (measurement date) and is recognized over the periods in which therelated services are rendered.

 

## **RESULTS OF OPERATIONS**

## ** **

***Revenues***

 

Revenues for the three and nine months ended September 30,2005 and September 30, 2004 were approximately $83,000, $312,000, $251,000and $691,000 respectively. These amounts relate primarily to license fees androyalties collected that are being amortized over the period of the licensegranted. The reduction in revenue in current periods was due to decreasedrevenue levels from licensees’ operations.

 

***Research and Development Expenses and GrantReimbursements***

 

Research and development expenses for thethree and nine months ended September 30, 2005 and September 30, 2004were approximately $734,000, $1,668,000, $153,000 and $690,000,respectively.  The increase in expensesin current periods, which consist mainly of payroll and payroll relatedexpenses, research supplies and costs incurred in connection with specificresearch grants, relate principally to increased staffing and spending forscientific research being done pursuant to a scientific grant from the USNational Institute of Standards and Technology (NIST) that expires in 2006.

 

Our research and development expenses consistprimarily of costs associated with basic and pre-clinical research exclusivelyin the field of human stem cell therapies and regenerative medicine, with focuson development of our technologies in cellular reprogramming, reducedcomplexity applications, and stem cell differentiation. These expensesrepresent both pre-clinical development costs and costs associated withnon-clinical support activities such as quality control and regulatoryprocesses. The cost of our research and development personnel is the mostsignificant category of expense; however, we also incur expenses with thirdparties, including license agreements, sponsored research programs and consultingexpenses.

 

We do not segregate research and developmentcosts by project because our research is focused exclusively on human stem celltherapies as a unitary field of study. Although we have three principal areas of focus for our research, theseareas are completely intertwined and have not yet matured to the point wherethey are separate and distinct projects. The intellectual property, scientists and other resources dedicated tothese efforts are not separately allocated to individual projects, but ratherare conducting our research on an integrated basis.

 

Weexpect that research and development expenses will continue to increase in theforeseeable future as we add personnel, expand our pre-clinical research, beginclinical trial activities, and increase our regulatory compliance capabilities.The amount of these increases is difficult to predict due to the uncertaintyinherent in the timing and extent of progress in our research programs, andinitiation of clinical trials. In addition, the results from our basic researchand pre-clinical trials, as well as the results of trials of similartherapeutics under development by others, will influence the number, size andduration of planned and unplanned trials. As our research efforts mature, wewill continue to review the direction of our research based on an assessment ofthe value of possible commercial applications emerging from these efforts.  Based on this continuing review, we expect toestablish discrete research programs and evaluate the cost and potential forcash inflows from commercializing products, partnering with others in thebiotechnology or pharmaceutical industry, or licensing the technologiesassociated with these programs to third parties.

 

We believe that it is not possible at this stage to providea meaningful estimate of the total cost to complete our ongoing projects andbring any proposed products to market. The use of human embryonic stem cells asa therapy is an emerging area of medicine, and it is not known what clinicaltrials will be required by the FDA in order to gain marketing approval. Coststo complete could vary substantially depending upon the projects selected for 

 

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development,the number of clinical trials required and the number of patients needed foreach study. It is possible that the completion of these studies could bedelayed for a variety of reasons, including difficulties in enrolling patients,delays in manufacturing, incomplete or inconsistent data from the pre-clinicalor clinical trials, and difficulties evaluating the trial results. Any delay incompletion of a trial would increase the cost of that trial, which would harmour results of operations. Due to these uncertainties, we cannot reasonablyestimate the size, nature nor timing of the costs to complete, or the amount ortiming of the net cash inflows from our current activities. Until we obtainfurther relevant pre-clinical and clinical data, we will not be able toestimate our future expenses related to these programs or when, if ever, and towhat extent we will receive cash inflows from resulting products.

 

Grant reimbursements for the three and ninemonths ended September 30, 2005 and September 30, 2004 wereapproximately $172,000, $597,000, $89,000 and $230,000, respectively. Theseamounts represent approved reimbursements pursuant the grant from NIST. At September 30,2005, ACT had approximately $800,000 of funds available under the grant thatcan be used to reimburse future approved research expenditures through May 2006.Under the terms of the grant, the Company will lose any unused funds upon theexpiration of the grant.  Based uponcurrent spending levels, it is likely that the Company will be unable to fullyutilize funds available under the grant, and a portion of the grant will gounused.

 

**General and Administrative Expenses**

 

General and administrative expenses for thethree and nine months ended September 30, 2005 and September 30, 2004were approximately $2,331,000, $5,572,000, $498,000 and $1,584,000,respectively.  The principal increase inexpense in the current periods versus the same periods last year is a result ofadditional salary costs related to the addition of key personnel, increasedprofessional fees related to ACT’s merger into a public company, and costs ofpreparing documents and records for various public filings with the Securitiesand Exchange Commission.

 

##### ***OtherIncome (Expense)***

 

Other income (expense) for the three and ninemonths ended September 30, 2005 and September 30, 2004 wereapproximately $540,000, $524,000, ($56,000) and ($153,000), respectively. Theincrease in other income in the three and nine months ended September 30,2005, compared to other expense in the prior periods, relates primarily to gainon settlement of debt related to favorable settlement of amounts owed toattorneys. The increase in interest expense and late fees in the three and ninemonths ended September 2005, compared to interest expense in the priorperiods relates primarily to interest recorded in connection with theconvertible debentures.

 

##### ***Net Loss***

 

Net loss for the three and nine months ended September 30,2005 and September 30, 2004 was approximately $2,311,000, $5,952,000,$382,000 and $1,691,000, respectively. The increased loss in the current periods is the result of increasedgeneral and administrative expenses, offset in part by increased interestincome and the gain on settlement of debt.

 

## ***RecentAccounting Pronouncements***

## ** **

In June 2005, the Emerging Issues TaskForce, or EITF, reached a consensus on Issue 05-6, Determining the AmortizationPeriod for Leasehold Improvements, which requires that leasehold improvementsacquired in a business combination or purchased subsequent to the inception ofa lease be amortized over the lesser of the useful life of the assets or a termthat includes renewals that are reasonably assured at the date of the businesscombination or purchase. EITF 05-6 is effective for periods beginning after July 1,2005. We do not expect the provisions of this consensus to have a materialimpact on the our financial position, results of operations or cash flows.

 

In March 2005, the FASB issued FASBInterpretation No. 47, “Accounting for Conditional Asset RetirementObligations” (“FIN 47”). FIN 47 provides guidance relating to theidentification of and financial reporting for legal obligations to perform anasset retirement activity. The Interpretation requires recognition of aliability for the fair value of a conditional asset retirement obligation whenincurred if the liability’s fair value can be reasonably estimated. FIN 47 alsodefines when an entity would have sufficient information to reasonably estimatethe fair value of an asset retirement obligation. The provision is effective nolater than the end of fiscal years ending after December 15, 2005. TheCompany will adopt FIN 47 beginning the first quarter of fiscal year 2006 anddoes not believe the adoption will have a material impact on its consolidatedfinancial position or results of operations or cash flows.

 

In May 2005, the Financial AccountingStandards Board (FASB) issued Statement of Financial Accounting Standard (SFAS)No. 154, Accounting Changes and Error Corrections - a replacement of APBOpinion No. 20 and FASB Statement No. 3.  SFAS No. 154 requires retrospectiveapplication to prior periods’ financial statements of changes in accountingprinciple, unless it is impracticable to determine either the period-specificeffects or the cumulative effect of the change. SFAS No. 154 also requires that retrospective application of achange in accounting principle be limited to the direct effects of thechange.  Indirect effects of a change inaccounting principle, such as a change in nondiscretionary profit-sharingpayments resulting from an accounting change, should be recognized in theperiod of the accounting change.  SFAS No. 154also requires that a change in depreciation, amortization or depletion methodfor long-lived, non-financial assets be accounted for as a change in accountingestimate effected by a change in accounting principle.  SFAS No. 154 is effective for accountingchanges and corrections of errors made in fiscal years beginning after December 15,2005.  Early adoption is permitted foraccounting changes and corrections of errors made in fiscal years beginningafter the date this Statement is issued. Management does not expect the implementation of this new standard tohave a material impact on our financial position, results of operations andcash flows.

 

In March 2005, the SEC released StaffAccounting Bulletin No. 107, “Share-Based Payment”(“SAB 107”), whichprovides interpretive guidance related to the interaction between SFAS 123(R)and certain SEC rules and regulations. It also provides the SEC staff’s views regarding valuation ofshare-based payment arrangements.  In April 2005,the SEC amended the compliance dates for SFAS 123(R), to allow companies to 

 

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implement the standard at the beginning of their next fiscal year,instead of the next reporting period beginning after June 15, 2005.  Management is currently evaluating the impactSAB 107 will have on our consolidated financial statements.

 

In December 2004, the FinancialAccounting Standards Board (“FASB”) issued SFAS No. 153, “Exchanges ofNonmonetary Assets, an amendment of APB Opinion No. 29, Accounting forNonmonetary Transactions.” The amendments made by Statement 153 are based onthe principle that exchanges of nonmonetary assets should be measured based onthe fair value of the assets exchanged. Further, the amendments eliminate the narrow exception for nonmonetaryexchanges of similar productive assets and replace it with a broader exceptionfor exchanges of nonmonetary assets that do not have commercial substance.  Previously, Opinion 29 required that theaccounting for an exchange of a productive asset for a similar productive assetor an equivalent interest in the same or similar productive asset should bebased on the recorded amount of the asset relinquished.  Opinion 29 provided an exception to its basicmeasurement principle (fair value) for exchanges of similar productiveassets.  The FASB believes that exceptionrequired that some nonmonetary exchanges, although commercially substantive, berecorded on a carryover basis.  Byfocusing the exception on exchanges that lack commercial substance, the FASBbelieves this statement produces financial reporting that more faithfullyrepresents the economics of the transactions. SFAS 153 is effective for nonmonetary asset exchanges occurring infiscal periods beginning after June 15, 2005.  Earlier application is permitted for nonmonetaryasset exchanges occurring in fiscal periods beginning after the date ofissuance.  The provisions of SFAS 153shall be applied prospectively.  TheCompany has evaluated the impact of the adoption of SFAS 153, and does notbelieve the impact will be significant to the Company’s overall results ofoperations or financial position.

 

In December 2004, the FASB issued SFAS No. 123(revised 2004), “Share-Based Payment”.  SFAS 123(R) will provide investorsand other users of financial statements with more complete and neutralfinancial information by requiring that the compensation cost relating toshare-based payment transactions be recognized in financial statements. That cost will be measured based on the fair value of the equity or liability instrumentsissued.  SFAS 123(R) covers a wide range of share-based compensationarrangements including share options, restricted share plans, performance-basedawards, share appreciation rights, and employee share purchase plans. SFAS 123(R) replaces FASB Statement No. 123, “Accounting for Stock-BasedCompensation”, and supersedes APB Opinion No. 25, “Accounting for StockIssued to Employees”. SFAS 123, as originally issued in 1995, established aspreferable a fair-value-based method of accounting for share-based paymenttransactions with employees.  However, that statement permitted entitiesthe option of continuing to apply the guidance in Opinion 25, as long as thefootnotes to financial statements disclosed what net income would have been hadthe preferable fair-value-based method been used.  Public entities (otherthan those filing as small business issuers) will be required to apply SFAS123(R) as of the first interim or annual reporting period that begins after June 15,2005. SFAS 123(R) is applicable for ACT effective the first interim period thatstarts after December 15, 2005. The Company has evaluated the impact ofthe adoption of SFAS 123(R), and believes that the impact may be significant tothe Company’s overall results of operations and financial position (a pro formaeffect, as estimated by management, is disclosed earlier in this note).

 

In December 2004, the FASB issued SFAS No. 152,“Accounting for Real Estate Time-Sharing Transactions, an amendment of FASBStatements No. 66 and 67 (SFAS 152)”. The amendments made by Statement 152amend FASB Statement No. 066, “Accounting for Sales of Real Estate”, toreference the financial accounting and reporting guidance for real estatetime-sharing transactions that is provided in AICPA Statement of Position (SOP)04-2, “Accounting for Real Estate Time-Sharing Transactions”. This Statementalso amends FASB Statement No. 67, “Accounting for Costs and InitialRental Operations of Real Estate Projects”, to state that the guidance for (1) incidentaloperations and (2) costs incurred to sell real estate projects does notapply to real estate time-sharing transactions. The accounting for thoseoperations and costs is subject to the guidance in SOP 04-2. This statement iseffective for financial statements for fiscal years beginning after June 15,2005, with earlier application encouraged. The Company has evaluated the impactof the adoption of SFAS 152, and does not believe the impact will besignificant to the Company’s overall results of operations or financial positionsince the Company does not enter into such transactions.

 

In December 2004, the FASB issued twoFASB Staff Positions—FSP FAS 109-1, Application of FASB Statement 109 “Accountingfor Income Taxes” to the Tax Deduction on Qualified Production Activities Providedby the American Jobs Creation Act of 2004, and FSP FAS 109-2 Accounting andDisclosure Guidance for the Foreign Earnings Repatriation Provision within theAmerican Jobs Creation Act of 2004. Neither of these affected the Company as itdoes not participate in the related activities.

 

In November 2004, the FASB issued SFAS No. 151,“Inventory Costs, an amendment of ARB No. 43, Chapter 4”. The amendmentsmade by Statement 151 clarify that abnormal amounts of idle facility expense,freight, handling costs, and wasted materials (spoilage) should be recognizedas current period charges and require the allocation of fixed productionoverheads to inventory based on the normal capacity of the productionfacilities. The guidance is effective for inventory costs incurred duringfiscal years beginning after June 15, 2005. Earlier application ispermitted for inventory costs incurred during fiscal years beginning after November 23,2004. The Company has evaluated the impact of the adoption of SFAS 151, anddoes not believe the impact will be significant to the Company’s overallresults of operations or financial position since the Company currently doesnot have any manufacturing operations or inventory.

 

In March 2004, the FASB approved theconsensus reached on the Emerging Issues Task Force (EITF) Issue No. 03-1,“The Meaning of Other-Than-Temporary Impairment and Its Application to CertainInvestments.” The objective of this Issue is to provide guidancefor identifying impaired investments. EITF 03-1 also provides newdisclosure requirements for investments that are deemed to be temporarilyimpaired. The accounting provisions of EITF 03-1 are effective for allreporting periods beginning after June 15, 2004, while the disclosurerequirements for certain investments are effective for annual periods endingafter December 15, 2003, and for other investments such disclosurerequirements are effective for annual periods ending after June 15, 2004.

 

In December 2003, the SEC issued StaffAccounting Bulletin (“SAB”) No. 104 (“SAB No. 104”), “RevenueRecognition.” SAB No. 104 supersedes SAB No. 101, “RevenueRecognition in Financial Statements.” SAB No. 104, which was effectiveupon issuance, rescinded certain guidance contained in SAB No. 101 relatedto multiple element revenue arrangements, and replaced such guidance with thatcontained in EITF 00-21, “Accounting for Revenue Arrangements with MultipleDeliverables.” Additionally, SAB No. 104 rescinded the SEC’s RevenueRecognition in Financial Statements Frequently Asked Questions and Answersissued with SAB No. 101. The revenue recognition principles of SAB No. 101remain largely 

 

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unchanged by the issuance of SAB No. 104, and therefore theadoption of SAB No. 104 did not have a material effect on the Company’sresults of operations or financial condition.

 

In January 2003, the FASB issued FASBInterpretation No. (“FIN”) 46, “Consolidation of Variable InterestEntities” (“FIN 46”). In December 2003, FIN 46 was replaced by FASBinterpretation No. 46(R) “Consolidation of Variable Interest Entities.”FIN 46(R) clarifies the application of Accounting Research Bulletin No. 51,“Consolidated Financial Statements,” to certain entities in which equityinvestors do not have the characteristics of a controlling financial interestor do not have sufficient equity at risk for the entity to finance itsactivities without additional subordinated financial support from otherparties. FIN 46(R) requires an enterprise to consolidate a variable interestentity if that enterprise will absorb a majority of the entity’s expectedlosses, is entitled to receive a majority of the entity’s expected residualreturns, or both. FIN 46(R) is effective for entities being evaluated under FIN46(R) for consolidation no later than the end of the first reporting periodthat ends after March 15, 2004. The Company does not currently have anyvariable interest entities that will be impacted by adoption of FIN 46(R).

 

##### ***LIQUIDITY ANDCAPITAL RESOURCES***

##### *** ***

We are financing our operations primarilywith $17,750,000 of proceeds of convertible debentures issued September 15,2005 and described in our Current Report on Form 8-K filed with the Securitiesand Exchange Commission on September 19, 2005, and $8,000,000 of proceeds froma January 2005 preferred unit offering. To a substantially lesser degree, financing of our operations isprovided through grant funding, payments received under license agreements, andinterest earned on cash and cash equivalents.

 

With the exception of 2002, when we soldcertain assets of a subsidiary resulting in a gain for the year, we haveincurred substantial net losses each year since inception as a result ofresearch and development and general and administrative expenses in support ofour operations. We anticipate incurring substantial net losses in the future.

 

Cash, cash equivalents, and cash held inescrow at September 30, 2005 and December 31, 2004 were approximately$16,483,000 and $3,676,000, respectively. The increase in the current period is the result of closing theconvertible debenture financing described above, net of amounts spent forpayment of notes and accounts payable, increased legal and accounting fees, andincreases in other general and administrative expenses.

 

Our cash and cash equivalents arelimited.  We expect to requiresubstantial additional funding.  Ourfuture cash requirements will depend on many factors, including the pace andscope of our research and development programs, the costs involved in filing,prosecuting, maintaining and enforcing patents and other costs associated withcommercializing our potential products. We intend to seek additional funding primarily through public or privatefinancing transactions, and, to a lesser degree, new licensing or scientific collaborations,grants from governmental or other institutions, and other relatedtransactions.   If we are unable to raiseadditional funds, we will be forced to either scale back our business effortsor curtail our business activities entirely. We anticipate that our availablecash and expected income will be sufficient to finance most of our current activitiesfor at least twelve months from the date of the financial statements, althoughcertain of these activities and related personnel may need to be reduced.  We cannot assure you that public or privatefinancing or grants will be available on acceptable terms, if at all.  Several factors will affect our ability toraise additional funding, including, but not limited to, the volatility of ourCommon Stock.

 

# **RISK FACTORS THAT MAY AFFECT OUR BUSINESS**

# ** **

*Our business is subject to various risks, included but not limited to those described below.  You should carefully consider these factors, together with all the other information disclosed in this Quarterly Report on Form 10-QSB.  Any of these risks could materially adversely affect our business, operating results and financial condition.*

 

**Risks Relating to Our Early Stage ofDevelopment**

*** ***

***We have a limitedoperating history on which potential investors may evaluate our operations andprospects for profitable operations.***  We have a limited operating history on whicha potential investor may base an evaluation of us and our prospects. If we areunable to begin and sustain profitable operations, investors may lose theirentire investment in us. We are in the pre-clinical stage, and our prospectsmust be considered speculative in light of the risks, expenses and difficultiesfrequently encountered by companies in their early stages of development,particularly in light of the uncertainties relating to the new, competitive andrapidly evolving markets in which we anticipate we will operate. To attempt toaddress these risks, we must, among other things, further develop ourtechnologies, products and services, successfully implement our research,development, marketing and commercialization strategies, respond to competitivedevelopments and attract, retain and motivate qualified personnel. Asubstantial risk is involved in investing in us because, as a development stagecompany,

 

•                  we have fewer resources than an established company,

 

•                  our management may be more likely to make mistakesat such an early stage, and

 

•                  we may be more vulnerable operationally andfinancially to any mistakes that may be made, as well as to external factorsbeyond our control.

 

These difficulties are compounded by our heavy dependence on emergingand sometimes unproven technologies. In addition, some of our significantpotential revenue sources involve ethically sensitive and controversial issueswhich could become the subject of legislation or regulations that couldmaterially restrict our operations and, therefore, harm our financialcondition, operating results and prospects for bringing our investors a returnon their investment.

 

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***We have a history ofoperating losses, and we cannot assure you that we will achieve future revenuesor operating profits.***  We have generated modest revenue to date fromour operations. Historically, we have had net operating losses each year sinceour inception. We have limited current potential sources of revenue fromlicense fees and product development revenues, and we cannot assure you that wewill be able to develop such revenue sources or that our operations will becomeprofitable, even if we are able to commercialize our technologies or any productsor services developed from those technologies. If we continue to suffer lossesas we have in the past, investors may not receive any return on theirinvestment and may lose their entire investment.

 

Although we have revenues from license fees and royalties, we have nocommercially marketable products and no immediate ability to generate revenuefrom commercial products, nor any assurance of being able to develop ourtechnologies for commercial applications. As a result, we may never be able tooperate profitably. We are just beginning to identify products available forpre-clinical trials and may not receive significant revenues from commercialsales of our products for the next several years, if at all, although we dogenerate revenues from licensing activities. We have marketed only a limitedamount of services based on our technologies and have little experience indoing so. Our technologies and any potential products or services that we maydevelop will require significant additional effort and investment prior tomaterial commercialization and, in the case of any biomedical products,pre-clinical and clinical testing and regulatory approvals. We cannot assureyou that we will be able to develop any such technologies or any products orservices, or that such technologies, products or services will prove to be safeand efficacious in clinical trials, meet applicable regulatory standards, becapable of being produced in commercial quantities at acceptable costs or besuccessfully marketed. For that reason, we may not be able to generate revenuesfrom commercial production or operate profitably.

 

We have sold the agricultural portion of our business in order tofinance operations. The agricultural applications of our technology generallyhave a more rapid realization of revenues due to more limited regulatoryrequirements and testing. Our ability to generate revenue from any agriculturalapplications of our technology is limited to existing license royalties, ifany.

 

***We will requiresubstantial additional funds to continue operating which may not be availableon acceptable terms, if at all.***  We believe our cash from all sources,including cash, cash equivalents and anticipated revenue stream from licensingfees and sponsored research contracts is sufficient for us to continueoperations through March 31, 2007, assuming the conversion of theConvertible Debentures. However, without substantial additional financingduring this period, we will need to significantly limit our capital andoperational spending and will therefore be limited in our ability to advanceour scientific efforts or further our efforts to operate profitably.

 

Management continues to evaluate alternatives and sources foradditional funding, which may include public or private investors, strategicpartners, and grant programs available through specific states or foundations.Lack of necessary funds may require us to delay, scale back or eliminate someor all of our research and product development programs and/or our capitalexpenditures or to license our potential products or technologies to thirdparties.

 

In addition, our cash requirements may vary materially from those nowplanned because of results of research and development, potential relationshipswith strategic partners, changes in the focus and direction of our research anddevelopment programs, competition, litigation required to protect ourtechnology, technological advances, the cost of pre-clinical and clinicaltesting, the regulatory process of the United States Food and Drug Administration,or FDA, and foreign regulators, whether any of our products become approved orthe market acceptance of any such products and other factors. Our current cashreserves are not sufficient to fund our operations through thecommercialization of our first products or services.

 

***We have limitedclinical testing, regulatory, manufacturing, marketing, distribution and salescapabilities which may limit our ability to generate revenues.***  Because of the relatively early stage of ourresearch and development programs, we have not yet invested significantly inclinical testing, regulatory, manufacturing, or in marketing, distribution orproduct sales resources. We cannot assure you that we will be able to developany such resources successfully or as quickly as may be necessary. Theinability to do so may harm our ability to generate revenues or operateprofitably.

 

**Risks Relating to Competition**

 

***Our competitionincludes both public and private organizations and collaborations amongacademic institutions and large pharmaceutical companies, most of which havesignificantly greater experience and financial resources than we do.***  The biotechnology and pharmaceuticalindustries are characterized by intense competition. We compete againstnumerous companies, both domestic and foreign, many of which have substantiallygreater experience and financial and other resources than we have. Several suchenterprises have initiated cell therapy research programs and/or efforts totreat the same diseases targeted by us. Companies such as Geron Corporation,Genzyme Corporation, StemCells, Inc., Aastrom Biosciences, Inc. andViacell, Inc., as well as others, many of which have substantially greaterresources and experience in our fields than we do, are well situated to competewith us effectively. Of course, any of the world’s largest pharmaceuticalcompanies represents a significant actual or potential competitor with vastlygreater resources than ours.

 

These companies hold licenses to genetic selection technologies and othertechnologies that are competitive with our technologies. These and othercompetitive enterprises have devoted, and will continue to devote, substantialresources to the development of technologies and products in competition withus.

 

Private and public academic and research institutions also compete withus in the research and development of human therapeutic or agriculturalproducts. In the past several years, the pharmaceutical industry hasselectively entered into collaborations with both public and privateorganizations to explore the possibilities that stem cell therapies may presentfor substantive breakthroughs in the fight against disease.

 

In addition, many of our competitors have significantly greaterexperience than we have in the development, pre-clinical testing and humanclinical trials of biotechnology and pharmaceutical products, in obtaining FDAand other regulatory approvals of such products and in manufacturing andmarketing such products. Accordingly our competitors may succeed in obtainingFDA approval for products more rapidly or effectively than we can. Ourcompetitors may also be the first to discover and obtain a valid patent to aparticular stem cell which may effectively block all others from doing so. Itwill be important for us or our collaborators to be the first to discover anystem cell that we are seeking to discover. Failure to be the first couldprevent us from commercializing all 

 

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of our research and development affected by that discovery.Additionally, if we commence commercial sales of any products, we will also becompeting with respect to manufacturing efficiency and sales and marketingcapabilities, areas in which we have no experience.

 

The United States is encountering tremendous competition from manyforeign countries that are providing an environment more attractive for stemcell research. The governments of numerous foreign countries are investing instem cell research, providing facilities, personnel and legal environmentsintended to attract biotechnology companies and encourage stem cell researchand development of stem cell-related technologies.

 

These efforts by foreign countries may make it more difficult toeffectively compete in our industry and may generate competitors withsubstantially greater resources than ours.

 

**Risks Relating to Our Technology**

 

**We rely onnuclear transfer and embryonic stem cell technologies that we may not be ableto successfully develop, which will prevent us from generating revenues,operating profitably or providing investors any return on their investment.**  We have concentrated our research on ournuclear transfer and embryonic stem cell technologies, and our ability tooperate profitably will depend on being able to successfully develop thesetechnologies for human applications. These are emerging technologies with, asyet, limited human applications. We cannot guarantee that we will be able tosuccessfully develop our nuclear transfer and embryonic stem cell technologiesor that such development will result in products or services with anysignificant commercial utility. We anticipate that the commercial sale of suchproducts or services, and royalty/licensing fees related to our technology,would be our primary sources of revenues. If we are unable to develop ourtechnologies, investors will likely lose their entire investment in us.

 

The outcome of pre-clinical, clinical and product testing of ourproducts is uncertain, and if we are unable to satisfactorily complete suchtesting, or if such testing yields unsatisfactory results, we will be unable tocommercially produce our proposed products. Before obtaining regulatoryapprovals for the commercial sale of any potential human products, our productswill be subjected to extensive pre-clinical and clinical testing to demonstratetheir safety and efficacy in humans. We cannot assure you that the clinicaltrials of our products, or those of our licensees or collaborators, willdemonstrate the safety and efficacy of such products at all, or to the extentnecessary to obtain appropriate regulatory approvals, or that the testing ofsuch products will be completed in a timely manner, if at all, or withoutsignificant increases in costs, program delays or both, all of which could harmour ability to generate revenues. In addition, our prospective products may notprove to be more effective for treating disease or injury than currenttherapies. Accordingly, we may have to delay or abandon efforts to research,develop or obtain regulatory approval to market our prospective products. Manycompanies involved in biotechnology research and development have sufferedsignificant setbacks in advanced clinical trials, even after promising resultsin earlier trials. The failure to adequately demonstrate the safety andefficacy of a therapeutic product under development could delay or preventregulatory approval of the product and could harm our ability to generaterevenues, operate profitably or produce any return on an investment in us.

 

While the marketing of cloned or transgenic animals does not currentlyrequire regulatory approval, such approval may be required in the future. Wecannot assure you that we would obtain such approvals or that our licensees’products would be accepted in the marketplace. This lack of approval couldreduce or preclude any royalty revenues we might receive from our licensees inthat field.

 

***We may not be ableto commercially develop our technologies and proposed product lines, which, inturn, would significantly harm our ability to earn revenues and result in aloss of investment.***   Our ability to commercially develop ourtechnologies will be dictated in large part by forces outside our control whichcannot be predicted, including, but not limited to, general economicconditions, the success of our research and pre-clinical and field testing, theavailability of collaborative partners to finance our work in pursuingapplications of nuclear transfer technology and technological or otherdevelopments in the biomedical field which, due to efficiencies, technologicalbreakthroughs or greater acceptance in the biomedical industry, may render oneor more areas of commercialization more attractive, obsolete or competitivelyunattractive. It is possible that one or more areas of commercialization willnot be pursued at all if a collaborative partner or entity willing to fundresearch and development cannot be located. Our decisions regarding theultimate products and/or services we pursue could have a significant adverseaffect on our ability to earn revenue if we misinterpret trends, underestimatedevelopment costs and/or pursue wrong products or services. Any of thesefactors either alone or in concert could materially harm our ability to earnrevenues and could result in a loss of any investment in us.

 

***If we are unable tokeep up with rapid technological changes in our field or compete effectively,we will be unable to operate profitably.***   We are engaged in activities in thebiotechnology field, which is characterized by extensive research efforts andrapid technological progress. If we fail to anticipate or respond adequately totechnological developments, our ability to operate profitably could suffer. Wecannot assure you that research and discoveries by other biotechnology,agricultural, pharmaceutical or other companies will not render ourtechnologies or potential products or services uneconomical or result inproducts superior to those we develop or that any technologies, products orservices we develop will be preferred to any existing or newly-developedtechnologies, products or services.

 

**We may notbe able to protect our proprietary technology, which could harm our ability tooperate profitably.**  The biotechnology and pharmaceutical industries place considerableimportance on obtaining patent and trade secret protection for newtechnologies, products and processes. Our success will depend, to a substantialdegree, on our ability to obtain and enforce patent protection for ourproducts, preserve any trade secrets and operate without infringing theproprietary rights of others. We cannot assure you that:

 

•                  wewill succeed in obtaining any patents in a timely manner or at all, or that thebreadth or degree of protection of any such patents will protect our interests,

 

•                  the use of our technology will not infringe on the proprietaryrights of others,

 

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•                  patent applications relating to our potentialproducts or technologies will result in the issuance of any patents or that, ifissued, such patents will afford adequate protection to us or not be challengedinvalidated or infringed, and

 

•                  patents will not issue to other parties, which maybe infringed by our potential products or technologies.

 

We are aware of certain patents that have been granted to others andcertain patent applications that have been filed by others with respect tonuclear transfer technologies. The fields in which we operate have beencharacterized by significant efforts by competitors to establish dominant orblocking patent rights to gain a competitive advantage, and by considerabledifferences of opinion as to the value and legal legitimacy of competitors’purported patent rights and the technologies they actually utilize in theirbusinesses.

 

***Our business is highly dependent uponmaintaining licenses with respect to key technology.***   Several of the key patents we utilize arelicensed to us by third parties. These licenses are subject to terminationunder certain circumstances (including, for example, our failure to makeminimum royalty payments or to timely achieve development and commercializationbenchmarks). The loss of any of such licenses, or the conversion of suchlicenses to non-exclusive licenses, could harm our operations and/or enhancethe prospects of our competitors.

 

Certain of these licenses alsocontain restrictions, such as limitations on our ability to grant sublicensesthat could materially interfere with our ability to generate revenue throughthe licensing or sale to third parties of important and valuable technologiesthat we have, for strategic reasons, elected not to pursue directly. Thepossibility exists that in the future we will require further licenses tocomplete and/or commercialize our proposed products. We cannot assure you thatwe will be able to acquire any such licenses on a commercially viable basis.

 

***We may not be ableto adequately protect against piracy of intellectual property in foreignjurisdictions.***  Considerable research in the areas of stem cells, cell therapeutics andregenerative medicine is being performed in countries outside of the UnitedStates, and a number of our competitors are located in those countries. Thelaws protecting intellectual property in some of those countries may notprovide protection for our trade secrets and intellectual property adequate toprevent our competitors from misappropriating our trade secrets or intellectualproperty. If our trade secrets or intellectual property are misappropriated inthose countries, we may be without adequate remedies to address the issue.

 

***Certain of ourtechnology is not protectable by patent.***  Certain parts of our know-how and technologyare not patentable. To protect our proprietary position in such know-how andtechnology, we intend to require all employees, consultants, advisors andcollaborators to enter into confidentiality and invention ownership agreementswith us. We cannot assure you, however, that these agreements will providemeaningful protection for our trade secrets, know-how or other proprietaryinformation in the event of any unauthorized use or disclosure. Further, in theabsence of patent protection, competitors who independently developsubstantially equivalent technology may harm our business.

 

***Patent litigationpresents an ongoing threat to our business with respect to both outcomes andcosts.***   Wehave previously been involved in patent interference litigation with Infigen, Inc.,and are currently involved in two patent disputes with Geron Corporation, andit is possible that further litigation over patent matters with one or morecompetitors could arise. We could incur substantial litigation or interferencecosts in defending ourselves against suits brought against us or in suits inwhich we may assert our patents against others. If the outcome of any suchlitigation, including our current disputes with Geron Corporation, is unfavorable,our business would likely be materially adversely affected. To determine thepriority of inventions, we may also have to participate in interferenceproceedings declared by the United States Patent and Trademark Office, whichcould result in substantial cost to us. Without additional capital, we may nothave the resources to adequately defend or pursue this litigation.

 

**Risks Relating to Our Recent Financing**

 

***If we are requiredfor any reason to repay our outstanding convertible debentures we would berequired to deplete our working capital, if available, or raise additionalfunds. Our failure to repay the convertible debentures, if required, couldresult in legal action against us, which could require the sale of substantialassets.***  Wehave outstanding $22,276,250 aggregate original principal amount of convertibledebentures with an original issue discount of 20.3187%. Beginning in March of2006 and continuing for each successive month throughout the three year term ofthe debentures, we are required to redeem, by payment with cash or with sharesof our common stock, 1/30th of the aggregate original principal amount of thedebentures. These monthly payments will impact the amount of working capitalavailable to us. The convertible debentures are due and payable in full threeyears from the date of issuance, unless sooner converted into shares of ourcommon stock. Any event of default could require the early repayment of theconvertible debentures, including the accruing of interest on the outstandingprincipal balance of the debentures if the default is not cured with thespecified grace period. We anticipate that the full amount of the convertibledebentures will be converted into shares of our common stock, in accordancewith the terms of the convertible debentures. If, prior to the maturity date,we are required to repay the convertible debentures in full, we would berequired to use our limited working capital and raise additional funds. If wewere unable to repay the notes when required, the debenture holders couldcommence legal action against us to recover the amounts due. Any such actioncould require us to curtail or cease operations.

 

***There are a largenumber of shares underlying our convertible debentures in full, and warrantsthat may be available for future sale and the sale of these shares may depressthe market price of our common stock.***  As of September 30, 2005, we had:

 

•                  outstanding convertible debentures that may beconverted into an estimated 9,685,326 shares of common stock based on aconversion price of $2.30, and

 

•                  outstanding warrants to purchase 6,004,902 shares ofcommon stock with an exercise price of $2.53, which such warrants were issuedin connection with the sale of the convertible debentures.

 

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All of the shares, including all of the shares issuable upon conversionof the debentures and upon exercise of our warrants, may be sold withoutrestriction. Sales of a substantial number of shares of our common stock in thepublic market after this offering could adversely affect the market price forour common stock and make it more difficult for you to sell shares of ourcommon stock at times and prices that you feel are appropriate.

 

***The issuance ofshares upon conversion of the convertible debentures and exercise of outstandingwarrants will cause immediate and substantial dilution to our existingstockholders.*** The issuance of shares upon conversion of the convertible debentures andexercise of warrants will result in substantial dilution to the interests ofother stockholders since the selling security holders may ultimately convertand sell the full amount issuable on conversion. Although no single sellingsecurity holder may convert its convertible debentures and/or exercise itswarrants if such conversion or exercise would cause it to own more than 4.99%of our outstanding common stock, this restriction does not prevent each sellingsecurity holder from converting and/or exercising some of its holdings and thenconverting the rest of its holdings. In this way, each selling security holdercould sell more than this limit while never holding more than this limit. Thereis no upper limit on the number of shares that may be issued which will havethe effect of further diluting the proportionate equity interest and voting powerof holders of our common stock, including investors in this offering.

 

**Risks Relating to Government Regulation**

 

***Companies such asours engaged in research using nuclear transfer and embryonic stem cells arecurrently subject to strict government regulations, and our operations could beharmed by any legislative or administrative efforts impacting the use ofnuclear transfer technology or human embryonic material.***  Our business is focused on human celltherapy, which includes the production of human differentiated cells from stemcells and involves the use of nuclear transfer technology, human oocytes, andembryonic material. Nuclear transfer technology, commonly known as therapeuticcloning, and research utilizing embryonic stem cells are controversial subjects,and are currently subject to intense scrutiny, both in the United States, theUnited Nations and throughout the world, particularly in the area of nucleartransfer of human cells and the use of human embryonic material.

 

We cannot assure you that our operations will not be harmed by anylegislative or administrative efforts by politicians or groups opposed to thedevelopment of nuclear transfer technology generally or the use of nucleartransfer for therapeutic cloning of human cells specifically. Further, wecannot assure you that legislative or administrative restrictions directly orindirectly delaying, limiting or preventing the use of nuclear transfertechnology or human embryonic material or the sale, manufacture or use ofproducts or services derived from nuclear transfer technology or humanembryonic material will not be adopted in the future.

 

***Restrictions on theuse of human embryonic stem cells, and the ethical, legal and socialimplications of that research, could prevent us from developing or gainingacceptance for commercially viable products in these areas.***  Some of our most important programs involvethe use of stem cells that are derived from human embryos. The use of humanembryonic stem cells gives rise to ethical, legal and social issues regardingthe appropriate use of these cells. In the event that our research related tohuman embryonic stem cells becomes the subject of adverse commentary orpublicity, the market price for our common stock could be significantly harmed.Some political and religious groups have voiced opposition to our technologyand practices. We use stem cells derived from human embryos that have beencreated for in vitro fertilization procedures but are no longer desired orsuitable for that use and are donated with appropriate informed consent forresearch use. Many research institutions, including some of our scientificcollaborators, have adopted policies regarding the ethical use of humanembryonic tissue. These policies may have the effect of limiting the scope ofresearch conducted using human embryonic stem cells, thereby impairing ourability to conduct research in this field.

 

Potential and actual legislation and regulation at the federal or statelevel related to our technology could limit our activities and ability todevelop products for commercial sales, depriving us of our anticipated sourceof future revenues. For example, in July 2001, the House ofRepresentatives of the United States Congress passed a bill, HR 2505, the “HumanCloning Prohibition Act of 2001.” This bill was placed on the calendar of theU.S. Senate in August 2002, where it did not pass. However, similar billscould be introduced in the future aiming to prohibit the use orcommercialization of somatic cell nuclear transfer technology or of anyproducts resulting from it, including those related to human therapeuticcloning and regenerative medicine. Such legislation could have a significantinfluence on our ability to pursue our research, development andcommercialization plans in the United States.

 

Any future or additional government-imposed restrictions in these orother jurisdictions with respect to use of embryos or human embryonic stemcells in research and development could have a material adverse effect on us,by, among other things:

 

•                  harming our ability to establish criticalpartnerships and collaborations,

 

•                  delaying or preventing progress in our research anddevelopment,

 

•                  limiting or preventing the development, sale or useof our products, and

 

•                  causing a decrease in the price of our stock.

 

***Because we or ourcollaborators must obtain regulatory approval to market our products in theUnited States and other countries, we cannot predict whether or when we will bepermitted to commercialize our products.***  Federal, state and local governments in theUnited States and governments in other countries have significant regulationsin place that govern many of our activities. We are or may become subject tovarious federal, state and local laws, regulations and recommendations relatingto safe working conditions, laboratory and manufacturing practices, theexperimental use of animals and the use and disposal of hazardous orpotentially hazardous substances used in connection with our research anddevelopment work. The preclinical testing and clinical trials of the productsthat we or our collaborators develop are subject to extensive governmentregulation that may prevent us from creating commercially viable products fromour discoveries. In addition, the sale by us or our collaborators of anycommercially viable product will be subject to government regulation fromseveral standpoints, including manufacturing, advertising and promoting,selling and marketing, labeling, and distributing.

 

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If, and to the extent that, we are unable to comply with theseregulations, our ability to earn revenues will be materially and negativelyimpacted. The regulatory process, particularly in the biotechnology field, isuncertain, can take many years and requires the expenditure of substantial resources.Biological drugs and non-biological drugs are rigorously regulated. Inparticular, proposed human pharmaceutical therapeutic product candidates aresubject to rigorous preclinical and clinical testing and other requirements bythe FDA in the United States and similar health authorities in other countriesin order to demonstrate safety and efficacy. We may never obtain regulatoryapproval to market our proposed products.

 

Our products may not receive FDA approval, which would prevent us fromcommercially marketing our products and producing revenues. The FDA andcomparable government agencies in foreign countries impose substantialregulations on the manufacture and marketing of pharmaceutical products throughlengthy and detailed laboratory, pre-clinical and clinical testing procedures,sampling activities and other costly and time-consuming procedures.Satisfaction of these regulations typically takes several years or more andvaries substantially based upon the type, complexity and novelty of the proposedproduct. We cannot yet accurately predict when we might first submit anyInvestigational New Drug, or IND, application to the FDA, or whether any suchIND application would be granted on a timely basis, if at all, nor can weassure you that we will successfully complete any clinical trials in connectionwith any such IND application. Further, we cannot yet accurately predict whenwe might first submit any product license application for FDA approval orwhether any such product license application would be granted on a timelybasis, if at all. As a result, we cannot assure you that FDA approvals for anyproducts developed by us will be granted on a timely basis, if at all. Any suchdelay in obtaining, or failure to obtain, such approvals could have a materialadverse effect on the marketing of our products and our ability to generateproduct revenue.

 

***For-profit entitiesmay be prohibited from benefiting from grant funding.***  There has been much publicity about grantresources for stem cell research, including Proposition 71 in California. Thereis ongoing litigation in California that may delay, or prevent the sale ofState bonds that would fund the activities contemplated by California voters.In addition, rules and regulations related to any funding that mayultimately be provided, the type of entity that will be eligible for funding,the science to be funded, and funding details have not been finalized. As aresult of these uncertainties regarding Proposition 71, we cannot assure youthat funding, if any, will be available to us, or any for-profit entity.

 

***The governmentmaintains certain rights in technology that we develop using government grantmoney and we may lose the revenues from such technology if we do notcommercialize and utilize the technology pursuant to established governmentguidelines.*** Certain of our and our licensors’ research has been or is being fundedin part by government grants. In connection with certain grants, the U.S.government retains rights in the technology developed with the grant. Theserights could restrict our ability to fully capitalize upon the value of thisresearch.

 

**Risks Relating to Our Reliance on ThirdParties**

 

***We depend on ourcollaborators to help us develop and test our proposed products, and ourability to develop and commercialize products may be impaired or delayed ifcollaborations are unsuccessful.***  Our strategy for the development, clinicaltesting and commercialization of our proposed products requires that we enterinto collaborations with corporate partners, licensors, licensees and others.We are dependent upon the subsequent success of these other parties inperforming their respective responsibilities and the continued cooperation ofour partners. Our collaborators may not cooperate with us or perform theirobligations under our agreements with them. We cannot control the amount andtiming of our collaborators’ resources that will be devoted to our research anddevelopment activities related to our collaborative agreements with them. Ourcollaborators may choose to pursue existing or alternative technologies inpreference to those being developed in collaboration with us.

 

Under agreements with collaborators, we may rely significantly on suchcollaborators to, among other things:

 

•                  design and conduct advanced clinical trials in theevent that we reach clinical trials,

 

•                  fund research and development activities with us,

 

•                  pay us fees upon the achievement of milestones, and

 

•                  market with us any commercial products that resultfrom our collaborations.

 

The development and commercialization of potential products will bedelayed if collaborators fail to conduct these activities in a timely manner orat all. In addition, our collaborators could terminate their agreements with usand we may not receive any development or milestone payments. If we do notachieve milestones set forth in the agreements, or if our collaborators breachor terminate their collaborative agreements with us, our business may bematerially harmed.

 

***Our reliance on theactivities of our non-employee consultants, research institutions, andscientific contractors, whose activities are not wholly within our control, maylead to delays in development of our proposed products.***  We rely extensively upon and haverelationships with scientific consultants at academic and other institutions,some of whom conduct research at our request, and other consultants withexpertise in clinical development strategy or other matters. These consultantsare not our employees and may have commitments to, or consulting or advisorycontracts with, other entities that may limit their availability to us. We havelimited control over the activities of these consultants and, except asotherwise required by our collaboration and consulting agreements to the extentthey exist, can expect only limited amounts of their time to be dedicated toour activities.

 

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In addition, we have formed research collaborations with academic andother research institutions throughout the world. These research facilities mayhave commitments to other commercial and non-commercial entities. We havelimited control over the operations of these laboratories and can expect onlylimited amounts of time to be dedicated to our research goals.

 

We also rely on other companies for certain process development orother technical scientific work. We have contracts with these companies thatspecify the work to be done and results to be achieved, but we do not havedirect control over their personnel or operations. If any of these thirdparties are unable or refuse to contribute to projects on which we need theirhelp, our ability to generate advances in our technologies and develop ourproducts could be significantly harmed.

 

**General Risks Relating to Our Business**

 

***We may be subject tolitigation that will be costly to defend or pursue and uncertain in itsoutcome.*** Our business may bring us into conflict with our licensees, licensors,or others with whom we have contractual or other business relationships, orwith our competitors or others whose interests differ from ours. If we areunable to resolve those conflicts on terms that are satisfactory to allparties, we may become involved in litigation brought by or against us. Thatlitigation is likely to be expensive and may require a significant amount ofmanagement’s time and attention, at the expense of other aspects of ourbusiness. The outcome of litigation is always uncertain, and in some casescould include judgments against us that require us to pay damages, enjoin usfrom certain activities, or otherwise affect our legal or contractual rights,which could have a significant adverse effect on our business. ACT Group filedfor dissolution on September 22, 2005 with the Secretary of State of thestate of Delaware. There can be no assurance that we will not be subject toclaims arising out of the dissolution process. 

 

***We may not be ableto obtain third-party patient reimbursement or favorable product pricing, whichwould reduce our ability to operate profitably.***  Our ability to successfully commercializecertain of our proposed products in the human therapeutic field may depend to asignificant degree on patient reimbursement of the costs of such products andrelated treatments at acceptable levels from government authorities, privatehealth insurers and other organizations, such as health maintenanceorganizations. We cannot assure you that reimbursement in the United States orforeign countries will be available for any products we may develop or, ifavailable, will not be decreased in the future, or that reimbursement amountswill not reduce the demand for, or the price of, our products with a consequentharm to our business. We cannot predict what additional regulation orlegislation relating to the health care industry or third-party coverage and reimbursementmay be enacted in the future or what effect such regulation or legislation mayhave on our business. If additional regulations are overly onerous orexpensive, or if health care related legislation makes our business moreexpensive or burdensome than originally anticipated, we may be forced tosignificantly downsize our business plans or completely abandon our businessmodel.

 

***Our products arelikely to be expensive to manufacture, and they may not be profitable if we areunable to control the costs to manufacture them.***  Our products are likely to be significantlymore expensive to manufacture than most other drugs currently on the markettoday. Our present manufacturing processes produce modest quantities of productintended for use in our ongoing research activities, and we have not developedprocesses, procedures and capability to produce commercial volumes of product.We hope to substantially reduce manufacturing costs through processimprovements, development of new science, increases in manufacturing scale andoutsourcing to experienced manufacturers. If we are not able to make these orother improvements, and depending on the pricing of the product, our profitmargins may be significantly less than that of most drugs on the market today.In addition, we may not be able to charge a high enough price for any celltherapy product we develop, even if they are safe and effective, to make aprofit. If we are unable to realize significant profits from our potentialproduct candidates, our business would be materially harmed.

 

***To be successful,our proposed products must be accepted by the health care community, which canbe very slow to adopt or unreceptive to new technologies and products.***  Our proposed products and those developed byour collaborative partners, if approved for marketing, may not achieve marketacceptance since hospitals, physicians, patients or the medical community ingeneral may decide not to accept and utilize these products. The products thatwe are attempting to develop represent substantial departures from establishedtreatment methods and will compete with a number of more conventional drugs andtherapies manufactured and marketed by major pharmaceutical companies. Thedegree of market acceptance of any of our developed products will depend on anumber of factors, including:

 

•                  our establishment and demonstration to the medicalcommunity of the clinical efficacy and safety of our proposed products;

 

•                  our ability to create products that are superior toalternatives currently on the market;

 

•                  our ability to establish in the medical communitythe potential advantage of our treatments over alternative treatment methods;and

 

•                  reimbursement policies of government and third-partypayors.

 

If the health care community does not accept our products for any ofthe foregoing reasons, or for any other reason, our business would bematerially harmed.

 

***Our current sourceof revenues depends on the stability and performance of our sublicensees.***  Our ability to collect royalties on productsales from our sublicensees will depend on the financial and operationalsuccess of the companies operating under a sublicense. We have numerouslicensees to third parties including Lifeline Cell Technology, Exeter LifeSciences and GTC Biotherapeutics, as well as others that hold licenses to ourtechnology. Revenues from those licensees will depend upon the financial andoperational success of those third parties. We cannot assure you that theselicensees will be successful in obtaining requisite financing or in developingand successfully marketing their products. These licensees may experienceunanticipated obstacles including regulatory hurdles, and scientific ortechnical challenges, which could have the effect of reducing their ability togenerate revenues and pay us royalties.

 

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***We depend on keypersonnel for our continued operations and future success, and a loss ofcertain key personnel could significantly hinder our ability to move forwardwith our business plan.***  Because of the specialized nature of ourbusiness, we are highly dependent on our ability to identify, hire, train andretain highly qualified scientific and technical personnel for the research anddevelopment activities we conduct or sponsor. The loss of one or more certainkey executive officers, or scientific officers, would be significantlydetrimental to us. In addition, recruiting and retaining qualified scientificpersonnel to perform research and development work is critical to our success.Our anticipated growth and expansion into areas and activities requiringadditional expertise, such as clinical testing, regulatory compliance,manufacturing and marketing, will require the addition of new managementpersonnel and the development of additional expertise by existing management personnel.There is intense competition for qualified personnel in the areas of ourpresent and planned activities, and there can be no assurance that we will beable to continue to attract and retain the qualified personnel necessary forthe development of our business. The failure to attract and retain suchpersonnel or to develop such expertise would adversely affect our business.

 

***Our credibility as abusiness operating in the field of human embryonic stem cells is largelydependent upon the support of our Ethics Advisory Board.***  Because the use of human embryonic stem cellsgives rise to ethical, legal and social issues, we have instituted an EthicsAdvisory Board. Our Ethics Advisory Board is made up of highly qualifiedindividuals with expertise in the field of human embryonic stem cells. Wecannot assure you that these members will continue to serve on our EthicsAdvisory Board, and the loss of any such member may affect the credibility andeffectiveness of the Board. As a result, our business may be materially harmedin the event of any such loss.

 

***Our insurancepolicies may be inadequate and potentially expose us to unrecoverable risks.***   We have limited director and officerinsurance and commercial insurance policies. Any significant insurance claimswould have a material adverse effect on our business, financial condition andresults of operations. Insurance availability, coverage terms and pricingcontinue to vary with market conditions. We endeavor to obtain appropriateinsurance coverage for insurable risks that we identify, however, we may failto correctly anticipate or quantify insurable risks, we may not be able toobtain appropriate insurance coverage, and insurers may not respond as weintend to cover insurable events that may occur. We have observed rapidlychanging conditions in the insurance markets relating to nearly all areas oftraditional corporate insurance. Such conditions have resulted in higherpremium costs, higher policy deductibles, and lower coverage limits. For somerisks, we may not have or maintain insurance coverage because of cost oravailability.

 

***We have no productliability insurance, which may leave us vulnerable to future claims we will beunable to satisfy.***   The testing, manufacturing, marketing andsale of human therapeutic products entail an inherent risk of product liabilityclaims, and we cannot assure you that substantial product liability claims willnot be asserted against us. We have no product liability insurance. In theevent we are forced to expend significant funds on defending product liabilityactions, and in the event those funds come from operating capital, we will berequired to reduce our business activities, which could lead to significantlosses.

 

We cannot assure you that adequate insurance coverage will be availablein the future on acceptable terms, if at all, or that, if available, we will beable to maintain any such insurance at sufficient levels of coverage or thatany such insurance will provide adequate protection against potential liabilities.Whether or not a product liability insurance policy is obtained or maintainedin the future, any product liability claim could harm our business or financialcondition.

 

***We need to improveour financial control procedures.***  Since the merger, we have determined thatthere are deficiencies in the operating effectiveness of our internal controlsover financial reporting that we believe would collectively constitutesignificant deficiencies and material weaknesses under standards established bythe American Institute of Certified Public Accountants, resulting in more thana remote likelihood that a material misstatement of our annual or interimfinancial statements will not be prevented or detected. Since the merger,additional management processes and procedures have been added to supplementthe underlying systems of internal accounting control to allow timelypreparation and filing of required financial reports.

 

In our opinion, we have not established and did not maintain effectiveinternal control over financial reporting as of September 30, 2005. Wealso believe that because of the effect of the material weakness we haveidentified, we have not maintained effective internal control over financialreporting as of September 30, 2005, based on criteria established inInternal Control—Integrated Framework issued by the Committee of SponsoringOrganizations of the Treadway Commission. We have taken initial remedial steps,and will continue our on-going evaluation of internal controls and expect toimprove our internal controls over financial reporting as necessary to assuretheir effectiveness, but there can be no assurance that we will succeed or thatother deficiencies will not be identified.

 

***We presently havemembers of management and other key employees located in various locationsthroughout the country which adds complexities to the operation of thebusiness.***  Presently, we have members of management and other key employees locatedin both California and Massachusetts, which adds complexities to the operationof our business. We intend to maintain our research facilities in Massachusettsand establish corporate offices and an additional research facility inCalifornia. We will likely incur significant costs associated with maintainingmultiple locations.

 

***We face risksrelated to compliance with corporate governance laws and financial reportingstandards.*** The Sarbanes-Oxley Act of 2002, as well as related new rules andregulations implemented by the Securities and Exchange Commission and thePublic Company Accounting Oversight Board, require changes in the corporategovernance practices and financial reporting standards for public companies.These new laws, rules and regulations, including compliance with Section 404of the Sarbanes-Oxley Act of 2002 relating to internal control over financialreporting, referred to as Section 404, have materially increased our legaland financial compliance costs and made some activities more time-consuming andmore burdensome. Section 404 requires that our management assess ourinternal control over financial reporting annually and include a report on itsassessment in our annual report. Our independent registered public accountingfirm is required to audit both the design and operating effectiveness of ourinternal controls and management’s assessment of the design and the operatingeffectiveness of our internal controls. There exist material weaknesses anddeficiencies at this time in our internal controls. These weaknesses anddeficiencies could have a material adverse effect on our business andoperations.

 

**Risks Relating to Our Common Stock**

 

***Stock prices forbiotechnology companies have historically tended to be very volatile.***  Stock prices and trading volumes for manybiotechnology companies 

 

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fluctuate widely for a number of reasons, including but not limited tothe following factors, some of which may be unrelated to their businesses orresults of operations:

 

•                  clinical trial results

 

•                  the amount of cash resources and ability to obtainadditional funding

 

•                  announcements of research activities, businessdevelopments, technological innovations or new products by companies or theircompetitors

 

•                  entering into or terminating strategic relationships

 

•                  changes in government regulation

 

•                  disputes concerning patents or proprietary rights

 

•                  changes in revenues or expense levels

 

•                  public concern regarding the safety, efficacy orother aspects of the products or methodologies being developed

 

•                  reports by securities analysts

 

•                  activities of various interest groups or organizations

 

•                  media coverage

 

•                  status of the investment markets

 

This market volatility, as well as general domestic or internationaleconomic, market and political conditions, could materially and adverselyaffect the market price of our common stock and the return on your investment.

 

***A significant numberof shares of our common stock will become available for sale and their salecould depress the price of our common stock.***  On January 31, 2006, a significantnumber of our outstanding securities (not including the shares underlying thedebentures and warrants issued in the recent financing) that are currentlyrestricted will become eligible for sale under Rule 144 of the SecuritiesAct.

 

Not including the shares of common stock underlying the convertibledebentures and the warrants issued in connection with our recent financing, asof September 30, 2005, there are presently approximately 22,000,000outstanding options, warrants and other securities convertible or exercisableinto shares of our common stock.

 

We may also sell a substantial number of additional shares of ourcommon stock in connection with a private placement or public offering ofshares of our common stock (or other series or class of capital stock to bedesignated in the future). The terms of any such private placement would likelyrequire us to register the resale of any shares of capital stock issued orissuable in the transaction. We have also issued common stock to certainparties, such as vendors and service providers, as payment for products andservices. Under these arrangements, we may agree to register the shares forresale soon after their issuance. We may also continue to pay for certain goodsand services with equity, which would dilute your interest in the company.

 

Sales of a substantial number of shares of our common stock under anyof the circumstances described above could adversely affect the market pricefor our common stock and make it more difficult for you to sell shares of ourcommon stock at times and prices that you feel are appropriate.

 

***We do not intend topay cash dividends on our common stock in the foreseeable future.***  Any payment of cash dividends will dependupon our financial condition, results of operations, capital requirements andother factors and will be at the discretion of our board of directors. We donot anticipate paying cash dividends on our common stock in the foreseeablefuture. Furthermore, we may incur additional indebtedness that may severelyrestrict or prohibit the payment of dividends.

 

***Our securities arequoted on the OTC Bulletin Board, which may limit the liquidity and price ofour securities more than if our securities were quoted or listed on the NasdaqStock Market or a national exchange.***  Our securities are currently quoted on theOTC Bulletin Board, an NASD-sponsored and operated inter-dealer automatedquotation system for equity securities not included in the Nasdaq Stock Market.Quotation of our securities on the OTC Bulletin Board may limit the liquidityand price of our securities more than if our securities were quoted or listedon The Nasdaq Stock Market or a national exchange. Some investors may perceiveour securities to be less attractive because they are traded in theover-the-counter market. In addition, as an OTC Bulletin Board listed company,we do not attract the extensive analyst coverage that accompanies companieslisted on Nasdaq or any other regional or national exchange. Further,institutional and other investors may have investment guidelines that restrictor prohibit investing in securities traded in the over-the-counter market.These factors may have an adverse impact on the trading and price of oursecurities.

 

**Our common stock is subject to “penny stock”regulations and restrictions on initial and secondary broker-dealer sales.**  The Securities and Exchange 

 

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Commission has adopted regulations which generally define “penny stock”to be any listed, trading equity security that has a market price less than$5.00 per share or an exercise price of less than $5.00 per share, subject tocertain exemptions. Penny stocks are subject to certain additional oversightand regulatory requirements. Brokers and dealers affecting transactions in ourcommon stock in many circumstances must obtain the written consent of a customerprior to purchasing our common stock, must obtain information from the customerand must provide disclosures to the customer. These requirements may restrictthe ability of broker-dealers to sell our common stock and may affect yourability to sell your shares of our common stock in the secondary market.

 

## **ITEM 3. CONTROLS AND PROCEDURES**

## ** **

(a) *Evaluationof disclosure controls and procedures.*  The Company’s management, with the participation of ourprincipal executive officer, has evaluated the effectiveness of our disclosurecontrols and procedures (as defined in Rules 13a-15(e) and15d-15(e) under the Securities Exchange Act of 1934, as amended (the “ExchangeAct”)), as of the end of the period covered by this Quarterly Report on Form 10-QSB.Based on such evaluation, due to the material weaknesses in our internalcontrols over financial reporting further described below, our principalexecutive officer has concluded that such disclosure controls and procedureswere not effective in providing reasonable assurance that information requiredto be disclosed by us in the reports we file or submitted by us under theExchange Act is recorded, processed, summarized and reported, within the timeperiods specified in the SEC’s rules and forms.  The Company has implemented, and is in theprocess of implementing, new disclosure controls and procedures to ensure thatinformation required to be disclosed by us in reports that we file or submitunder the Exchange Act is recorded, processed, summarized and reported with thetime periods specified in applicable SEC rules and forms are effective.

 

(b) *Changes in internal controls*.  The Company’s management is responsiblefor establishing and maintaining adequate internal control over financialreporting.  Our internal control systemis intended to provide reasonable assurance to the Company’s management andboard of directors regarding the preparation and fair presentation of publishedfinancial statements.  The Company’smanagement assessed the effectiveness of the Company’s internal control overfinancial reporting as of September 30, 2005. In making its assessment ofinternal control over financial reporting, management used the criteria setforth by the Committee of Sponsoring Organizations of the Treadway Commission(COSO) in Internal Control — Integrated Framework.

 

Management’s assessment identified materialdeficiencies in the Company’s internal control over financial reporting.  These deficiencies include lack ofsegregation of duties, limited capability to interpret and apply United Statesgenerally accepted accounting principles, lack of adequate documentation of oursystem of internal controls, lack of formal accounting policy and proceduresand related documentation, deficiencies in our information technology systems andlack of a formal budgeting process. We also have not yet instituted newinternal control processes related to our identified material weaknesses,significant deficiencies and deficiencies, as has been characteristic ofcompanies that have completed their review of internal controls and have had toreport on the effect or such review. Accordingly, our internal control overfinancial reporting may be subject to additional material weaknesses anddeficiencies that we have not identified. Management has determined that these significant deficiencies, in theaggregate, constituted a material weakness in the design and operation of theCompany’s internal controls in effect prior to September 30, 2005. TheCompany hired a chief financial officer on April 1, 2005, and the Companyis in the process of implementing new controls; however, these controls werenot fully in operation during the quarter ended September 30, 2005.  As a result of the material weaknessesdescribed in the preceding paragraph, we believe that, as of September 30,2005, the Company’s internal control over financial reporting was not effectivebased on the COSO criteria.

 

# **PART II. OTHERINFORMATION**

# ** **

## **ITEM 1. LEGAL PROCEEDINGS**

 

Reference is made to our Quarterly Report on Form 10-QSB for theperiod ended March 31, 2005, as filed with the Securities and ExchangeCommission on May 23, 2005, as amended by Amendment No. 1 to ourQuarterly Report on Form 10-QSB/A filed with the Securities and ExchangeCommission on September 7, 2005, and to our Quarterly Report on Form 10-QSBfor the period ended June 30, 2005, as filed with the Securities andExchange Commission on August 15, 2005, for a description of pending legalproceedings.  There have been no materialdevelopments with respect to legal proceedings, except as set forth immediatelybelow.

 

Gary D. Aronson and John Gorton v. A.C.T. Group, Inc., AdvancedCell Technology, Inc., Michael D. West, and Gunnar L. Engstrom. Commonwealth ofMassachusetts Superior Court. Worcester. C.A. No. 040523B.  On September 14, 2005, we, together withcertain other defendants, entered into a settlement agreement with Gary D.Aronson and John S. Gorton, referred to as the plaintiffs. The settlementagreement resolved certain disputes relating to the litigation entitled Gary D.Aronson and John Gorton v. A.C.T. Group, Inc., Advanced Cell Technology, Inc.,Michael D. West, and Gunnar L. Engstrom formerly pending in Commonwealth ofMassachusetts Superior Court, Worcester, C.A. No. 040523B and twocompanion Contempt Complaints filed by the plaintiffs against certain of thedefendants, including us. The specific terms of the settlement are described inmore detail in our Form 8-K filed on September 15, 2005.

 

William A. Brandt, Jr. as Assignee for the Benefit of theCreditors of Avian Farms, Inc. v. Advanced Cell Technology, Inc. andA.C.T. Group, Inc.  U.S. DistrictCourt for the District of Massachusetts, C.A. No. 01-40227-NMG.  This proceeding was settled by virtue of asettlement agreement and release entered into between our largest stockholder,ACT Group, Inc., referred to as ACT Group and the plaintiffs in thisaction, which agreement satisfied in full all ACT Group’s obligations andindebtedness to the plaintiffs and provided a complete release of all claims byplaintiffs against ACT Group and all other defendants.

 

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## **ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIESAND USE OF PROCEEDS**

 

The disclosure set forth below describes ourunregistered sales of equity securities for the period July 1, 2005through September 30, 2005.  Theissuances of the equity securities described below were made in reliance uponthe exemption from registration under Section 4(2) of the SecuritiesAct of 1933, as amended, relating to sales by an issuer not involving a publicoffering, and/or pursuant to the requirements of one or more of the safeharbors provided in Regulation D under the Securities Act or, in the caseof equity compensation to employees, directors and eligible consultants, Rule 701therewith.

 

On September 18, 2005, we issued 20,000shares of common stock to Torkildson Katz Fonseca Moore & Hetheringtonin settlement of accounts payable for services provided to the company on apre-merger basis.

 

On September 16, 2005, we issued 175,000shares of common stock to Pillsbury Winthrop Shaw & Pittman insettlement of accounts payable for services provided to the company on apre-merger basis.

 

On September 15, 2005, we entered into asecurities purchase agreement with certain accredited investors for theissuance of an aggregate of $22,276,250 principal amount convertible debentureswith an original issue discount of 20.3187%. In connection with the closing ofthe sale of convertible debentures, we received gross proceeds of $17,750,000.The convertible debentures are due and payable three years from the date ofissuance, unless sooner converted into shares of our common stock. Theconversion price of the debentures is $2.30, subject to anti-dilution and othercustomary adjustments. In connection with the securities purchase agreement, wealso issued warrants to purchase an aggregate of 4,842,663 shares of our commonstock. The term of the warrants is five years and the exercise price is $2.53per share, subject to anti-dilution and other customary adjustments.  The debentures contain covenants that willlimit the ability of the Company to, among other things: incur or guaranteeadditional indebtedness; incur or create liens; amend its certificate ofincorporation, bylaws or other charter documents so as to adversely affect anyrights of the holders of the debentures; and repay or repurchase more than a deminimis number of shares of common stock other than as permitted in thedebentures and other documents executed in connection with the issuance of thedebentures. The debentures include customary default provisions and an event ofdefault includes, among other things, a change of control of the Company, thesale of all or substantially all of the Company’s assets, the failure to havethe registration statement declared effective on or before the 180th day afterthe initial closing date, and the lapse of the effectiveness of theregistration statement for more than 30 consecutive trading days or 60non-consecutive days during any 12-month period (with certain exceptions), thefailure of the Company to timely deliver certificates to holders uponconversion and a default by the Company in any obligations under anyindebtedness of at least $150,000 which results in such indebtedness beingaccelerated. Upon the occurrence of an event of default, each debenture maybecome immediately due and payable, either automatically or by declaration ofthe holder of such debenture. The aggregate amount payable upon an accelerationby reason of an event of default shall be equal to the greater of 120% of the principalamount of the debentures to be prepaid or the principal amount of thedebentures to be prepaid, divided by the conversion price on the date specifiedin the debenture, multiplied by the closing price on the date set forth in thedebenture.  Reference is made to ourCurrent Report on Form 8-K, as filed with the Securities and ExchangeCommission on September 19, 2005, for a complete description of thistransaction.

 

On September 15, 2005, in connectionwith the issuance of the debentures and warrants, described above, we issued awarrant to purchase 1,162,239 shares of common stock at an exercise price of$2.53 per share, to T.R. Winston & Company, LLC.

 

On September 14, 2005, as part of thesettlement agreement relating to the litigation entitled *Gary D. Aronson and John Gorton v. A.C.T. Group, Inc.,Advanced Cell Technology, Inc., Michael D. West, and Gunnar L. Engstrom*pending in Commonwealth of Massachusetts Superior Court, Worcester, C.A. No. 040523B,we issued to Gary Aronson and John Gorton unsecured convertible promissorynotes in the aggregate amount of $600,000, bearing interest at the rate of 7.5%per annum and maturing July 1, 2006, referred to as the settlement note.The settlement note may be prepaid at any time without penalty. The holders ofthe settlement note have the right to convert the settlement note, in whole orin part, into our common stock at the price specified in the settlementwarrants. We also issued to Aronson and Gorton warrants to purchase 422,727shares of our common stock, preferred stock or other non-debt securities issuedby us at an exercise price of $2.20 per share of common stock or per share ofcommon stock underlying any preferred stock or other non-debt securities.  Reference is made to our Current Report on Form 8-K,as filed with the Securities and Exchange Commission on September 19,2005, for a complete description of this transaction.

 

On September 14, 2005, we issued awarrant to purchase 50,000 shares of common stock at an exercise price of $2.20per share to Reinaldo Diaz in connection with consulting services provided tous.

 

On September 14, 2005, we issued awarrant to purchase 33,000 shares of common stock at an exercise price of $2.20per share to William Woodward in connection with consulting services providedto us.

 

## **ITEM 3. DEFAULTS UPON SENIOR SECURITIES**

## ** **

None.

 

## **ITEM 4. SUBMISSION OF MATTERS TO A VOTE OFSECURITY HOLDERS**

## ** **

A special meeting of our stockholders was held on July 6, 2005,for the purposes described below.  Thevoting record for each matter presented to the stockholders is as set forthimmediately following each description.

 

1.                                       To amend the Company’sArticles of Incorporation to increase the number of authorized shares of theCompany’s common stock, par value $0.001 per share (“Common Stock”), to100,000,000, and to increase the number of authorized shares of the Company’sundesignated preferred stock, par value $0.001 per share (“Preferred Stock”),to 50,000,000, in each case with no change in the par value.

 

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Number of Votes FOR: 12,774,522

Number of Votes AGAINST: 1,000

Number of Votes ABSTAINING: 25

 

2.                                       To adopt the Company’s 2005Stock Incentive Plan (the “2005 Stock Plan”) which provides for equity basedawards to the Company’s employees, directors and consultants, and to reserve upto 18,000,000 shares of Common Stock for issuance pursuant to the grant ofawards thereunder.

 

Number of Votes FOR: 12,775,197

Number of Votes AGAINST: 225

Number of Votes ABSTAINING: 125

 

## **ITEM 5. OTHER INFORMATION**

## ** **

## **On October 14, 2005, theCompany filed with the Securities and Exchange Commission a RegistrationStatement on Form SB-2 to register 20,397,296 shares of common stock inaccordance with the requirements of the Registration Rights Agreement enteredinto in connection with the issuance on September 15, 2005 of debenturesand warrants described in Part II, Item 2 of this Form 10-QSB.  The shares registered pursuant to theRegistration Statement on Form SB-2 represent 9,685,326 shares of commonstock underlying the convertible debentures, 4, 6,004,902 shares of commonstock issuable upon exercise of the warrants, and up to 4,707,068 additionalshares issuable upon conversion of the debentures and exercise of the warrantsin accordance with our contractual obligations related thereto.  The Registration Statement on Form SB-2  became effective October 28, 2005.  Reference is made to our RegistrationStatement on Form SB-2, as filed with the Securities and ExchangeCommission on October 14, 2005.**

## ** **

## **ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K**

## ** **

(a)                                  Please see the Exhibit Indexwhich follows the signature pages to this Quarterly Report on Form 10-QSBand which is incorporated by reference herein.

 

(b)                                 During the quarter for whichthis report is filed, we made the following reports on Form 8-K:

 
| **Date of  Report**      | ** ** | **Item Reported**                                                                           | ** ** | **Financial Statements Filed** |
|--------------------------|------------|---------------------------------------------------------------------------------------------|------------|--------------------------------|
| ** **               | ** ** | ** **                                                                                  | ** ** | ** **                     |
| July 6, 2005        |       | Amendment to  Articles of Incorporation                                                     |       | None                           |
|                     |       |                                                                                        |       |                           |
| August 5,  2005     |       | Appointment of  New Director; Adoption of Code of Ethics; Entry into Material Agreements    |       | None                           |
|                     |       |                                                                                        |       |                           |
| September 19,  2005 |       | Entry into  Material Agreement - Issuance of Unregistered Debentures and Warrants           |       | None                           |
|                     |       |                                                                                        |       |                           |
| September 22,  2005 |       | Entry into  Material Agreement – Amendments to Employments and Stock Option Agreements |       | None                           |

 

**SIGNATURE**

 

Pursuant to therequirements of the Securities Exchange Act of 1934, the Registrant has dulycaused this report to be signed on its behalf by the undersigned hereunto dulyauthorized.

 
| ** **            | **ADVANCED CELL TECHNOLOGY, INC.** |
|-----------------------|------------------------------------|
| ** **            | ** **                         | ** ** |
| ** **            | ** **                         | ** ** |
|                  | By:                                | /s/ William M.  Caldwell, IV |   |
|                  |                               | William M.  Caldwell, IV |
|                  |                               | Chief Executive  Officer |
|                  |                               |   |
| Dated: March 29, 2006 |                               |   |

 

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**EXHIBIT INDEX**

 
| **Exhibit********Number** | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                 |
|---------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.1                       |       | Certificate of Amendment to Articles of  Incorporation dated July 6, 2005 (previously filed as Exhibit 3.1  to the Registrant’s Current Report on Form 8-K filed on July 7,  2005 (File No. 000-50295) and incorporated by reference herein).                                                                     |
| 10.1                      |       | Amendment No. 1 to Employment  Agreement between ACT and Michael D. West dated August 1, 2005  (previously filed as Exhibit 10.1 to the Registrant’s Current Report on Form 8-K  filed on August 5, 2005 (File No. 000-50295) and incorporated by  reference herein).                                        |
| 10.2                      |       | Amendment to Employment Agreement between  the Registrant and James G. Stewart dated September 16, 2005 (previously  filed as Exhibit 10.1 to the Registrant’s Current Report on Form 8-K  filed on September 22, 2005 (File No. 000-50295) and incorporated  by reference herein).                               |
| 10.3                      |       | Securities Purchase Agreement dated September 15,  2005 (previously filed as Exhibit 10.1 to the Registrant’s Current  Report on Form 8-K filed on September 19, 2005 (File No. 000-50295)  and incorporated by reference herein).                                                                                |
| 10.4                      |       | Registration Rights Agreement dated September 15,  2005 (previously filed as Exhibit 10.2 to the Registrant’s Current  Report on Form 8-K filed on September 19, 2005 (File No. 000-50295)  and incorporated by reference herein).                                                                                |
| 10.5                      |       | Form of Common Stock Purchase Warrant  (previously filed as Exhibit 10.3 to the Registrant’s Current Report on Form 8-K  filed on September 19, 2005 (File No. 000-50295) and incorporated  by reference herein).                                                                                                 |
| 10.6                      |       | Form of Amortizing Convertible  Debenture (previously filed as Exhibit 10.4 to the Registrant’s Current  Report on Form 8-K filed on September 19, 2005 (File No. 000-50295)  and incorporated by reference herein).                                                                                              |
| 10.7                      |       | Form of Lock-up Agreement (previously  filed as Exhibit 10.5 to the Registrant’s Current Report on Form 8-K  filed on September 19, 2005 (File No. 000-50295) and incorporated  by reference herein).                                                                                                             |
| 10.8                      |       | Settlement Agreement dated September 14,  2005 (previously filed as Exhibit 10.6 to the Registrant’s Current  Report on Form 8-K filed on September 19, 2005 (File No. 000-50295)  and incorporated by reference herein).                                                                                         |
| 10.9                      |       | Form of Convertible Promissory Note  (Unsecured) (previously filed as Exhibit 10.7 to the Registrant’s  Current Report on Form 8- K filed on September 19, 2005 (File No. 000-50295)  and incorporated by reference herein).                                                                                      |
| 10.10                     |       | Form of Warrant to Purchase Securities  (previously filed as Exhibit 10.8 to the Registrant’s Current Report on Form 8-K  filed on September 19, 2005 (File No. 000-50295) and incorporated  by reference herein).                                                                                                |
| 10.11                     |       | Agreement between Advanced Cell Technology, Inc.,  Advanced Cell, Inc. and A.C.T. Group, Inc. dated September 15,  2005 (previously filed as Exhibit 10.9 to the Registrant’s Current  Report on Form 8-K filed on September 19, 2005 (File No. 000-50295)  and incorporated by reference herein). |
| 31.1                      |       | Certification of the Chief Executive  Officer pursuant to Rule 13a-14(a) and 15d-14(a) of the  Securities Exchange Act of 1934, as adopted pursuant to Section 302 of  the Sarbanes-Oxley Act of 2002.                                                                                                                      |
| 31.2                      |       | Certification  of the Chief Financial Officer pursuant to Rule 13a-14(a) and 15d-14(a) of  the Securities Exchange Act of 1934, as adopted pursuant to Section 302  of the Sarbanes-Oxley Act of 2002.                                                                                                                      |
| 32.1                      |       | Certification of the Chief Executive  Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906  of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                              |
| 32.2                      |       | Certification of the Chief Financial  Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906  of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                              |

 

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