UNITED
STATES


SECURITIES AND EXCHANGE
COMMISSION


WASHINGTON,
D.C. 20549


FORM
10-KSB


(Mark
One)


[X]
ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934


For
the fiscal year ended December 31, 2007





[  ]
TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934


For the
transition
period   from        to





Commission
File Number 001-13835





APPLIED NEUROSOLUTIONS,
INC.


(Name of
small business issuer in its Charter)





Delaware
            39-1661164(State
      of Other Jurisdiction of Incorporation or Organization)
            (IRS
      Employer Identification No.)





50 Lakeview Parkway, Suite
111, Vernon Hills, IL  60061


(Address
of Principal Executive Offices and Zip Code)





(847)
573-8000


(Issuer’s
Telephone Number, Including Area Code)





Securities
registered under Section 12 (b) of the Act:  None





Securities
registered under Section 12 (g) of the Act:





Common
Stock, $0.0025 par value


(Title of
Class)





Check
whether the issuer (1) filed all reports required to be filed by section 13 or
15(d) of the Exchange Act during the past 12 months (or for such shorter period
that the registrant was required to file such reports), and (2) has been subject
to such filing requirements for the past 90 days.Yes X  No
__





Check if
there is no disclosure of delinquent filers in response to Item 405 of
Regulation S-B contained in this form, and no disclosure will be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-KSB or any
amendment to this Form 10-KSB.  [  ]





Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act).


Yes__   No  X





State
issuer's revenues for its most recent fiscal
year:  $1,083,333





As of
March 17, 2008, the aggregate market value of voting common stock held by
non-affiliates of the Registrant (99,769,426 shares) was approximately
$9,976,943. The aggregate market value was computed by reference to the "Close"
price of such common equity as of that date.





As of
March 17, 2008, the issuer had 130,217,808 shares of Common Stock
outstanding.





Documents
Incorporated by
Reference:                                                                           None





Transitional
Small Business Disclosure Format (check
one):                                                                                                           Yes____
No X





INDEX





PagePART
      IItem
      1.
            Description
      of business
            1Item
      2.
            Description
      of property
            22Item
      3.
            Legal
      proceedings
            22Item
      4.
            Submission
      of matters to a vote of security holders
            22PART
      IIItem
      5.
            Market
      for common equity and related stockholder matters
            23Item
      6.
            Management’s
      discussion and analysis or plan of operation
            24Item
      7.
            Financial
      statements
            34Item
      8.
            Changes
      in and disagreements with accountants on accounting and financial
      disclosure
            62Item
      8a.
            Controls
      and procedures
            62Item
      8b.
            Other
      information
            63PART
      IIIItem
      9.
            Directors,
      executive officers, promoters, control persons and corporate governance;
      compliance with section 16(a) of the exchange act
            63Item
      10.
            Executive
      compensation
            66Item
      11.
            Security
      ownership of certain beneficial owners and management and related
      stockholder matters
            70Item
      12.
            Certain
      relationships and related transactions, and director
      independence
            72Item
      13.
            Exhibits
            72Item
      14.
            Principal
      accountant fees and services
            76SIGNATURES
            
            77CERTIFICATIONS
            
            78


i


PART
I





This Form 10-KSB contains
forward-looking statements.  For this purpose, any statements
contained in this Form 10-KSB that are not statements of historical fact may be
deemed to be forward-looking statements.  You can identify
forward-looking statements by those that are not historical in nature,
particularly those that use terminology such as “may,” “will,” “should,”
“could,” “expects,” “anticipates,” “contemplates,” “estimates,” “believes,”
“plans,” “projected,” “predicts,” “potential,” or “continue” or the negative of
these similar terms.  In evaluating these forward-looking statements,
you should consider various factors, including those listed below under the
heading “Item 1.  Risk factors related to our
business”.  The Company’s actual results may differ significantly from
the results projected in the forward-looking statements.  The Company
assumes no obligation to update forward-looking statements.





As used in this Form 10-KSB, references
to “APNS,” the “Company,” the “Registrant,” “we,” “our,” or “us” refer to
Applied NeuroSolutions, Inc. unless the context otherwise
indicates.





ITEM
1.                      DESCRIPTION
OF BUSINESS





Applied NeuroSolutions, Inc. (“APNS” or
“the Company”) is a development stage biopharmaceutical company primarily
engaged in the research and development of novel therapeutic targets for the
treatment of Alzheimer's disease (“AD”) and diagnostics to detect
AD.





Alzheimer’s disease is the most common
cause of dementia among people age 65 and older.  Dementia is the loss
of memory, reason, judgment and language to such an extent that it interferes
with a person’s daily life and activities.  Currently it is estimated
that over five million people in the U.S. have Alzheimer’s disease and the
national cost of caring for people with Alzheimer’s is estimated to exceed $148
billion annually.  The market for AD therapy is expected to grow to 21
million patients by 2010 in the seven major pharmaceutical markets (USA, France,
Germany, Italy, Spain, U.K. and Japan), according to BioPortfolio,
Ltd.





Our core technology in the AD field is
based on exclusive licenses with AECOM covering all diagnostic and therapeutic
applications in the field of neurodegenerative disease discovered in Dr. Peter
Davies’ laboratories at Albert Einstein College of Medicine
(“AECOM”).  Dr. Davies’ research has focused on AD and the roll of
certain proteins; primarily hyperphosphorylated tau, which are involved in the
formation of neurofibrillary tangles within neurons (nerve
cells).  Excessive phosphorylation of tau (the addition of one or more
phosphate groups, which are comprised of phosphorous and oxygen, to a molecule)
prevents it from stabilizing microtubules, thereby causing the breakdown of the
transit system of the nerve cell.  This internal neuronal damage leads
to the development of the paired helical filaments and neurofibrillary tangles
which are contributing factors to the eventual death of the neurons related to
Alzheimer’s disease.  Tau in this abnormally phosphorylated form is
the building block for the paired helical filaments and the neurofibrillary
tangles (“NFTs”); one of the hallmark pathologies associated with
AD.  There is a high correlation among the presence of
hyperphosphorylated tau, NFTs and AD.  Thus, it is believed that the
hyperphosphorylated tau represents an early abnormality in the progression of
Alzheimer’s disease.





Articles published in the scientific
journals Nature(co-authored by Dr. Peter Davies)andProceedings of the National Academy
of Sciences have described research showing that a mutation in the gene
that codes for tau is associated with dementia.  The research
described in the articles demonstrates that abnormal tau represents an
appropriate target for research on neurodegenerative diseases, such as
Alzheimer’s disease.  Dr. Davies has been applying his expertise in
research directed towards abnormal tau for many years and, together with Applied
NeuroSolutions scientists, has developed a large number of proprietary
antibodies which are being used in the development of our diagnostic pipeline to
detect AD, and targets directed at AD therapeutic solutions.





In a collaboration with Eli Lilly and
Company (“Lilly”), we are involved in the discovery and development of novel
therapeutics for the development of treatments for Alzheimer’s disease based
upon a concept developed by Peter Davies, Ph.D., the Company’s founding
scientist and the Burton P. and Judith Resnick Professor of Alzheimer’s Disease
Research at AECOM.  As a result of Dr. Davies’ research, we and Lilly
are focused on discovery of unique therapeutics that may be involved in a common
intracellular phosphorylation pathway leading to the development of the
abnormal, destructive brain structures, amyloid plaques and neurofibrillary
tangles, that are characteristic of Alzheimer’s disease.We
have identified various biomarkers that we believe will aid in the development
of diagnostics and drug specific markers that could also play a role in the
development of new AD treatments.





1




In November
2006, we entered into an agreement with Eli Lilly and Company (“Lilly”) to
develop therapeutics to treat AD.  Pursuant to the terms of the
agreement, we received $2 million in cash, including an equity investment of
$500,000, from Lilly, plus we will receive annual research and development
support for the duration of the collaboration agreement.  In addition,
Lilly will, based on the achievement of certain defined milestones, provide us
over time with up to $20 million in milestone payments for advancing our
proprietary target to a therapeutic compound.  The collaboration has
also made progress on other targets that are part of the collaboration that
could provide milestone payments to us over time of up to $10 million for
advancing each of these other targets to a therapeutic
compound.  There is no limit to the number of targets that we could
receive milestone payments from Lilly.  Royalties are to be paid to us
for AD drug compounds brought to market that result from the
collaboration.  There is no limit on the number of drug compounds for
which royalty payments may be due to us.  Lilly received the exclusive
worldwide rights to the intellectual property related to our expertise in
understanding the molecular neuropathology of AD as it pertains to the formation
of neurofibrillary tangles in the development of AD
therapeutics.  Lilly will fund the vast majority of all pre-clinical
research and development and will fully finance the clinical testing,
manufacturing, sales and marketing of AD therapeutics developed from our
collaboration.





Since the start of our collaboration
with Lilly, the collaboration management structure, working teams and external
resources have become fully operational.  The key assets and
proprietary tools have been appropriately transferred to support work being
undertaken by each of Dr. Davies, Lilly and APNS.  The first internal
milestone on the proprietary tau-related APNS target was reached in the second
quarter of 2007 and the next internal milestone is scheduled to be achieved by
the end of the first quarter of 2008.  Key in-vivo models have been
established with the goal to validate our tau-based target.  Our
collaboration with Lilly has made good progress on the milestones established by
the program management for the proprietary tau-related APNS
target.  Our first paid milestone is targeted for achievement in late
2008 to early 2009.  Our collaboration with Lilly continues to make
good progress toward additional tau-based targets with an additional target
being screened and validation studies underway for other targets.





We have also been working on both a
cerebrospinal fluid (“CSF”) based test and serum based tests to detect AD at an
early stage.  In a research setting, our CSF-based test has
demonstrated an ability to differentiate AD patients from those with other
diseases that have similar symptoms.





We are
utilizing the knowledge gained during the development of our CSF-based
diagnostic test to aid in the development of serum-based diagnostic tests to
detect Alzheimer’s disease, specifically a screening test to rule out AD as well
as the detection of our ptau biomarker to support the diagnosis of
AD.  In January 2006, we entered into a research agreement with
Nanosphere, Inc., a nanotechnology-based molecular diagnostics company, to
assist us in the development of a serum-based diagnostic test for
AD.  Work performed during the research agreement resulted in
Nanosphere and APNS scientists achieving a better understanding (in January
2007) of the tools necessary to advance the development of a serum-based AD
diagnostic test with our scientifically accepted biomarkers.  We
established a project plan and began developing these key tools in early 2007,
and targeted to have the first of these tools developed during the first quarter
of 2008 to enable us to continue to advance our serum diagnostic development
work.





We sought
additional expertise and resources by conducting a scientific advisory board
meeting that brought together APNS scientists, Dr. Davies and three outside
diagnostic experts to assist us in assessing the most effective approaches and
resources to advance our diagnostic development programs.  Through
2007, we followed our work plans to develop antibody tools and we achieved a key
milestone in the first quarter of 2008 by identifying several high affinity
antibodies that meet our requirements.  These tools will support
advancing development of a “rule out” serum based test for
AD.  Additional back up tool options to support a “rule out” test are
also in development.  In addition, tools directed toward the
development of a ptau biomarker based test in serum that could support the early
identification of AD are targeted for completion in the  second
quarter 2008.  Throughout the tool development process we have been
identifying specialized technologies that may enable us to advance our
diagnostic development programs.  Technology assessments have been
initiated.  In order to maximize the value, and minimize the time to
market, of our diagnostic programs, we may seek some form of partnering, such as
collaborations, strategic alliances and/or licensing
arrangements.  Currently there is no FDA-approved diagnostic test to
detect AD.




2




Our
product farthest along in development is a CSF-based diagnostic test to detect
whether a person has AD.  This diagnostic test, based upon the
detection of a certain AD associated protein found in the CSF of AD patients,
has achieved, based on published research validation studies, overall
sensitivity and specificity in the range of 85% to 95%.  This is based
on extensive testing in our lab, utilizing in excess of 2,000 CSF samples to
differentiate patients diagnosed with AD from patients diagnosed with other
forms of dementia and relevant neurological diseases, including major
depression, as well as healthy controls.  We are alsodeveloping antibodies
that may allow for a reduction in the tests incubation time.  Our most
recent research has sought to further substantiate the utility of the test in
the mild cognitive impairment (“MCI”) population, as evidenced by reports
published inNeurobiology
of Agingin
September 2007 andNeurologyin December 2007.





In order to maximize the value, and
minimize the time to commercialization, of our diagnostic programs, we are
exploring additional partnerships, including collaborations, strategic and
technical alliances and/or licensing arrangements.  We are having
discussions with experts and companies regarding various approaches,
technologies and opportunities for collaboration and to assist us in advancing
the development of our diagnostic tests towards commercialization.





History


On September 10, 2002, Hemoxymed, Inc.
and Molecular Geriatrics Corporation (“MGC”) established a strategic alliance
through the closing of a merger (the “Merger”).  The Merger Agreement
provided that the management team and Board of Directors of MGC took over
control of the merged company.  The transaction was tax-free to the
shareholders of both companies.  In October 2003, we changed our name
to Applied NeuroSolutions, Inc.  The Merger transaction has been
accounted for as a reverse merger.  For financial reporting purposes,
MGC is continuing as the primary operating entity under the Company’s name, and
its historical financial statements have replaced those of the
Company.  Thus, all financial information prior to the Merger date is
the financial information of MGC only.





After the Merger, we had two
wholly-owned operating subsidiaries, which we dissolved during
2004.  The assets of these dissolved subsidiaries were transferred to
us.





One of the wholly-owned operating
subsidiaries we dissolved was MGC, a development stage biopharmaceutical company
incorporated in November 1991, with operations commencing in March 1992, to
develop diagnostics to detect AD, and therapeutic targets directed at AD
solutions.





The other wholly-owned operating
subsidiary we dissolved was Hemoxymed Europe, SAS, a development stage
biopharmaceutical company incorporated in February 1995 to develop therapies
aimed at improving tissue oxygenation by increasing oxygen release from
hemoglobin to provide therapeutic value to patients with serious, medical
needs.  We are not currently funding the development of this
technology.





We are subject to risks and
uncertainties common to small-cap and micro-cap biotech companies, including
competition from larger, well capitalized entities, patent protection issues,
availability of funding and government regulations.  We have
experienced significant operating losses since our inception.  As of
December 31, 2007, we had an accumulated deficit of approximately $48.0
million.  Notwithstanding payments that we may receive under our
collaboration agreement with Eli Lilly and Company, we expect to incur operating
losses over the next several years as our research and development efforts
continue.  We need to raise additional capital prior to the end of the
first quarter 2009 to continue our operations.





We currently have no regulatory
approved therapeutic or diagnostic products on the market and have not received
any commercial revenues from the sale or license of any such
products.





Alzheimer's
Disease Background





Alzheimer’s disease is the most common
cause of dementia among people age 65 and older.  Dementia is the loss
of memory, reason, judgment and language to such an extent that it interferes
with a person’s daily life and activities.  Currently it is estimated
that over five million people in the U.S. have Alzheimer’s disease and the
national cost of caring for people with Alzheimer’s is estimated to exceed $100
billion annually.  The market for AD therapy is expected to grow,
based on the aging demographic of the seven major pharmaceutical markets (USA,
France, Germany, Italy, Spain, U.K. and Japan).  Currently there are
only five drugs approved in the U.S. to treat AD.  All of these drugs
are primarily acetylcholinesterase inhibitors and are only beneficial in
treating symptoms associated with AD in a minority of AD patients for a very
limited time period.





3




Alzheimer’s
disease is an intractable, chronic and progressively incapacitating disease
characterized by the degeneration and death of several types of neurons in
certain regions of the brain.  Patients affected by the disease
initially suffer loss of memory, then a decline of intellectual abilities severe
enough to interfere with work and activities of daily living, followed by severe
dementia and, finally, death.  This illness, currently estimated to
affect over five million people in the United States, and as many as twenty-four
million people worldwide, is a leading cause of death behind cardiovascular
disease and cancer.  While the disease is most common in the elderly,
affecting nearly 10% of people age 65 and older and up to 50% of people age 85
and older, it has been diagnosed in patients in their 40’s and
50’s.  Alzheimer’s disease, at present, can be conclusively diagnosed
only by histological examination of the brain by biopsy or
autopsy.  The diagnosis of patients suspected of having AD is
therefore typically made through a process of elimination, by conducting
neurological and psychiatric examinations, extensive laboratory tests and brain
imaging to rule out other conditions (such as stroke, brain tumor, or
depression) that may exhibit similar symptoms.





Alzheimer’s disease was first described
in 1907 by Dr. Alois Alzheimer, a German psychiatrist who discovered large
numbers of unusual microscopic deposits in the brain of a demented patient upon
autopsy.  These deposits, called amyloid plaques and neurofibrillary
tangles, are highly insoluble protein aggregates that form in the brains of AD
patients in particular regions, including those involved with memory and
cognition.  Generally, amyloid plaques are deposited on the surface of
neurons, whereas neurofibrillary tangles are formed within
neurons.  The plaques and tangles are associated with degeneration and
loss of neurons.  The actual loss of neurons, as well as the impaired
function of surviving neurons, is generally believed to be the key
neuropathological contributors to the memory loss and dementia that
characterizes Alzheimer’s disease.








Therapeutic
Program





We are working to discover and develop
novel therapeutic targets for the development of treatments for
AD.  The basis for this work is Dr. Davies discovery of a novel
initiation point that we believe is common to the ultimate development of both
the neurofibrillary tangles and amyloid plaques.  A patent application
was filed in 2005 covering Dr. Davies work relative to this area.  In
November 2006, we entered into an agreement with Eli Lilly and Company to
develop therapeutics to treat AD.  In conjunction with Lilly, we are
developing novel therapeutics for the treatment of Alzheimer’s disease based
upon a concept developed by Dr. Davies.  The agreement forms a
collaboration that will combine the expertise, research tools and tau-based
approach advanced by Dr. Davies and our team at APNS with the scientists,
therapeutic development expertise and financial resources at Eli Lilly and
Company.  Lilly has an exclusive world-wide license to manufacture,
market and sell any AD therapeutic that comes to market from our collaboration
agreement.





The market potential for a drug to
effectively treat Alzheimer’s disease is extremely large.  Currently
there are only five drugs approved in the U.S. to treat AD.  All of
these drugs are primarily acetylcholinesterase inhibitors and are only
beneficial in treating symptoms associated with AD in a minority of AD
patients.  Despite the problems with the currently approved
therapeutics, market research data indicate that these drugs sold nearly $4.5
billion in the U.S during 2007.  The therapeutic market has been
estimated to be in excess of $6 billion for effective therapeutics by 2010 in
the U.S.








Diagnostic
Program





Alzheimer’s disease, at present, can be
conclusively diagnosed only by histological examination of the brain by biopsy
or autopsy.  The diagnosis of patients suspected of having AD is
therefore typically made through a process of elimination, by conducting
neurological and psychiatric examinations, extensive laboratory tests and brain
imaging to rule out other conditions (such as stroke, brain tumor, or
depression) with similar symptoms.  The AD predictive accuracy of such
exams is generally in the range of 80%-90% in some of the larger AD centers, but
is usually closer to 60%, on average, when diagnosed outside of the larger AD
centers.  Costs to patients for such testing can range from $1,000 -
$4,000, including imaging procedures.  A simple, predictive, accurate
and cost effective diagnostic test would therefore address a large unmet medical
need.  If the test was a serum based test, it could potentially be
utilized as a routine screening test.





4




Our approach
to meeting this need for a diagnostic test is based on Dr. Davies’ research of
the tau pathology, and revolves around developing a pipeline of diagnostic tests
that could include: (i) the detection of hyperphosphorylated tau in CSF, (ii) a
screening test to rule out AD in serum, and (iii) the detection of
hyperphosphorylated tau in serum.  Competitive diagnostics in
development, as well as some that are marketed through reference laboratories,
include approaches which attempt to identify AD patients by measuring: (i)
normal tau, total tau or phosphorylated tau in CSF, either individually, or as
part of a panel, (ii) beta amyloid, (iii) neural thread protein in CSF and/or
urine, (iv) amyloid derived diffusible ligands (ADDL’s) in CSF, (v) imaging
plaques in the brain, or (vi) employing proteomic or genetic markers for
AD.





We have developed a prototype
diagnostic test utilizing cerebrospinal fluid (“CSF”).  To date, with
our diagnostic test, we have conducted numerous validation studies utilizing in
excess of 2,000 CSF samples.  These studies were performed in our
laboratory and were designed using human CSF, in blinded samples, to determine
our test’s ability to differentiate patients diagnosed with AD from patients
diagnosed with other forms of dementia and relevant neurological diseases,
including major depression, as well as healthy controls.  Published
studies have shown the ability of our test to correctly identify the patients
diagnosed with AD with an overall sensitivity and specificity in the 85% to 95%
range.  The studies have been published in peer reviewed scientific
journals such as Neuroscience
Letters, Archives of
Neurology, and American
Journal of Psychiatry.  We currently have 20 peer-reviewed
publications that report the performance of our CSF-based test in various
patient populations, including AD, mild cognitive impairment (“MCI”),
depression, other neurological disorders and normal controls.  We have
shown with our test that phosphotau concentrations in CSF correlate well with
the degree of cognitive impairment.  A study published in 2001 in
Annals of Neurology
addressed the relationship between phosphotau levels in CSF and natural AD
progression.  In addition, a report published in the November 2006
edition of Brain
describes a study utilizing our CSF-based test that importantly shows
statistically significant correlations of phosphotau 231 levels from 26 living
patients with the neurofibrillary pathology subsequently observed in those 26
patients upon autopsy.





A study published in the January 2004
edition of Archives of General
Psychiatry has shown that detecting phosphorylated tau (“ptau”) proteins
in CSF comes closest to fulfilling the criteria of a biological marker for
AD.  This publication reported that our CSF-based test exceeded
standards for an AD diagnostic test established by the National Institute of
Aging and the Ronald and Nancy Reagan Research Institute of the Alzheimer’s
Association in a 1998 published “Consensus Report”.  It was determined
by that group that a successful biological marker would be one that had a
sensitivity level and specificity level of at least 80%.  A Position
Paper, “Research Criteria for the Diagnosis of Alzheimer’s Disease: Revising the
NINCDS-ADRDA Criteria”, was published in the August 2007 edition of Lancet Neurology that
describes suggested revisions to the criteria for the diagnosis of Alzheimer’s
disease, including the use of CSF biomarkers, specifically referencing our
CSF-based p-tau 231 test.





Studies published in the December 2005
edition of Neuroscience
Letters and in the March 2006 journal Neurobiology of Aging support
the use of our CSF-based diagnostic test in identifying individuals with mild
cognitive impairment (“MCI”) who, over time, are most likely to develop
AD.  Two studies published in 2007 show the ability of our CSF-based
test to be a strong predictor of the decline from MCI to AD.  The
September 2007 online edition of Neurobiology of Aging
presented a study comparing five of the best-known CSF biomarkers for
AD.  Our ptau biomarker was the strongest predictor of the decline
from MCI to AD.  The December 2007 issue of Neurology published an
internationally based multi-center study that demonstrated our ptau biomarker
was a significant predictor of the decline from MCI to AD in a clinically useful
time period of 1.5 years.





We are utilizing the knowledge gained
during the development of our CSF-based diagnostic test to aid in the
development of serum-based diagnostic tests to detect Alzheimer’s disease,
specifically a screening test to rule out AD as well as the detection of our
ptau biomarker to support the diagnosis of AD.  In January 2006, we
entered into a research agreement with Nanosphere, Inc., a nanotechnology-based
molecular diagnostics company, to assist us in the development of a serum-based
diagnostic test for AD.  Work performed during the research agreement
resulted in Nanosphere and APNS scientists achieving a better understanding (in
January 2007) of the tools necessary to advance the development of a serum-based
AD diagnostic test with our scientifically accepted biomarkers.  We
established a project plan and began developing these key tools in early 2007,
and targeted to have the first of these tools developed during the first quarter
of 2008 to enable us to continue to advance our serum diagnostic development
work.




5




We sought
additional expertise and resources by conducting a scientific advisory board
meeting that brought together APNS scientists, Dr. Davies and three outside
diagnostic experts to assist us in assessing the most effective approaches and
resources to advance our diagnostic development programs.  Through
2007, we followed our work plans to develop antibody tools and we achieved a key
milestone in the first quarter of 2008 by identifying several high affinity
antibodies that meet our requirements.  These tools will support
advancing development of a “rule out” serum based test for
AD.  Additional back up tool options to support a “rule out” test are
also in development.  In addition, tools directed toward the
development of a ptau biomarker based test in serum that could support the early
identification of AD are targeted for completion in the  second
quarter 2008.  Throughout the tool development process we have been
identifying specialized technologies that may enable us to advance our
diagnostic development programs.  Technology assessments have been
initiated.  In order to maximize the value, and minimize the time to
market, of our diagnostic programs, we may seek some form of partnering, such as
collaborations, strategic alliances and/or licensing
arrangements.  Currently there is no FDA-approved diagnostic test to
detect AD.





Before approval by the FDA for general
sale, under certain conditions, companies can supply either “investigational use
only” or “research use only” assay kits under the Clinical Laboratory
Improvement Amendment (“CLIA”) of 1988.  As part of our plan to seek
commercialization opportunities for our proposed diagnostic products, we may
pursue some form of agreement with a reference lab.





Transgenic
Mice Model





To date, no widely accepted animal
model that exhibits both AD pathologies has been developed.   Dr.
Peter Davies, through collaboration with a researcher at Nathan Klein Institute
(“NKI”), has developed a transgenic mouse containing the human tau (“htau”) gene
that develops human paired helical filaments, the building blocks of the
neurofibrillary tangles, which are known to be involved in the pathology of
Alzheimer’s disease.  The pathology in these mice is Alzheimer-like,
with hyperphosphorylated tau accumulating in cell bodies and dendrites as
neurofibrillary tangles.  In addition, these transgenic mice have
exhibited extensive neuronal death, which accompanies the tau
pathology.  These transgenic mice could be used for testing the
efficacy of therapeutic compounds.  AECOM and the New York State
Office of Mental Health, the agency that oversees NKI, each have an interest in
these transgenic mice.  Through our license agreements with AECOM, we
have the license rights to AECOM’s interest in these transgenic
mice.  In 2006, we entered into additional license agreements that
provide us with the exclusive rights to sell these mice.  The mice are
currently available through Jackson Laboratories.  In December 2006,
we entered into an agreement to sell a breeding pair of these mice.





Research
and Product Development





During the next twenty-four (24)
months, we expect to spend a significant amount of our financial resources on
research and development activities.  We incurred costs of
approximately $1,659,000 in 2007 and $2,119,000 in 2006 on research and
development activities.  Since we are not yet engaged in the
commercial distribution of any diagnostic or therapeutic products and we have no
revenues from the sale of any such products, these research and development
costs must be funded through equity or debt financing or payments received from
collaborators.  Throughout our collaboration with Eli Lilly and
Company, Lilly will provide annual research and development support that
partially offsets these expenses.  We estimate that we will incur
costs of approximately $150,000 to $180,000 per month on research and
development activities over the next twenty-four months.  This
excludes the non-cash charges resulting from accounting for equity instruments
included in such monthly expenditures.  These expenditures, however,
may fluctuate from quarter-to-quarter and year-to-year depending upon the
resources available and our development schedule.  Lilly will fund the
vast majority of all pre-clinical research and development and will fully
finance the clinical testing, manufacturing, sales and marketing of AD
therapeutics developed from our collaboration.  If we were to conduct
diagnostic validation and proof of concept work, and/or diagnostic clinical
trials, our research and development expenditures would most likely increase
significantly.  In addition, regulatory decisions and competitive
developments may significantly influence the amount of our research and
development expenditures.





Sales
and Marketing





We do not have marketing and sales
expertise or personnel.  As we currently do not intend to develop a
marketing and sales force, we will depend on arrangements with corporate
partners or other entities for the marketing and sale of our proposed
products.  Under our agreement with Eli Lilly and Company, Lilly has
an exclusive world-wide license to market and sell any AD therapeutic that comes
to market from our collaboration agreement.  We do not currently have
any agreements with partners or other entities to provide sales and marketing
services for our proposed diagnostic products, but would seek those arrangements
at the appropriate time.





6




Manufacturing





We currently do not have any facilities
suitable for manufacturing on a commercial scale basis any of our proposed
products nor do we have any experience in volume manufacturing.  We
will either find our own manufacturing facilities, rely upon third-party
manufacturers to manufacture our proposed products in accordance with these
regulations, or we will most likely utilize the capabilities of our partners
and/or collaborators.  Under our agreement with Eli Lilly and Company,
Lilly has an exclusive world-wide license to manufacture any therapeutic for AD
that comes to market from our collaboration agreement.





Competition





Companies in the pharmaceutical,
diagnostic and biotechnology fields are subject to intense
competition.  We compete with numerous larger companies that have
substantially greater financial and other resources and more
experience.  The principal factors affecting our competitive markets
include scientific and technological factors, the availability of patent and
other protection for technology and products, the ability, length of time and
cost required to obtain governmental approval for testing, manufacturing and
marketing and physician acceptance.  Companies that complete clinical
trials, obtain regulatory approvals and commence commercial sales of their
products before us may achieve a significant competitive
advantage.  In addition, such companies may succeed in developing
products that are more effective and less costly than products that may be
developed by us.  There can be no assurance that developments by other
companies will not render our products or technologies obsolete or
noncompetitive or that we will be able to keep pace with the technological
developments of our competitors.





We believe that some of our competitors
are in the process of developing technologies that are, or in the future may be,
the basis for competitive products.  Some of these products may have
an entirely different approach or means of accomplishing the desired therapeutic
or diagnostic effect than products being developed by us.  These
competing products may be more effective and less costly than the products
developed by us.





Significant levels of research within
our fields of interest occur at universities, non-profit institutions, and
for-profit organizations.  These entities compete with us in
recruiting skilled scientific talent.





We believe that our ability to compete
successfully will depend upon our ability to create and maintain scientifically
advanced technology, obtain adequate funding, develop proprietary products,
attract and retain scientific personnel, obtain patent or other protection for
our products, develop strategic alliances to enhance the likelihood of success,
obtain required regulatory approvals and manufacture and successfully market our
products either directly by us or through our collaboration with Eli Lilly and
Company and other collaborations or partnerships we may enter into.





Diagnostics





There is currently no FDA-approved
diagnostic to detect Alzheimer's disease ("AD"), although there are tests
available under the CLIA exemption through reference labs.  If any of
our current diagnostic programs are ultimately successfully marketed, they would
compete against, or augment, the most widely used current practice of detecting
AD through a battery of tests, namely neurological and psychiatric examinations,
extensive laboratory tests and brain imaging to rule out other conditions (such
as stroke, brain tumor, or depression) with similar symptoms.  The AD
predictive accuracy of such a battery of exams is generally in the range of
80%-90% in some of the larger AD centers, but is usually closer to 60% when
diagnosed outside of the AD centers.  Costs to patients for such
testing can range from $1,000 - $4,000, including imaging
procedures.  A simple, predictive, accurate and cost effective
diagnostic test could, therefore, be an attractive alternative for medical
practitioners and insurers to the current practice to detect AD.  If
the test was a serum-based test it could potentially be utilized as a routine
screening test.





7




We are aware
of other companies and academic institutions pursuing the development of
biochemical markers to be utilized in the diagnosis of AD.  Potential
competitors include Nymox Pharmaceutical Corp. and Innogenetics, who have
developed diagnostic tests for AD.  Athena Diagnostics has “research
use only” type CSF-based tests available, and others (Satoris, Power 3 Medical,
Proteosome Science, Acumen and Bio-Rad/Cyphergen) have programs directed toward
identifying proteomic or genetic markers for AD.  Competitive
diagnostics in development, as well as some that are marketed through reference
laboratories, include approaches which attempt to identify AD patients by
measuring: (i) normal tau, total tau or phosphorylated tau in CSF, either
individually, or as part of a panel, (ii) beta amyloid, (iii) neural thread
protein in CSF and/or urine, (iv) amyloid derived diffusible ligands (ADDL’s) in
CSF, (v) imaging plaques in the brain, or (vi) employing proteomic or genetic
markers for AD.  Much of our knowledge of potential competitors and
their diagnostic tests comes from our review of published articles in scientific
journals.  Publications and other information publicly available
indicate that tests being developed by these companies and others are unable to
adequately distinguish AD from other brain disorders or are in too early a
development stage to be evaluated.  At this time, we believe our
CSF-based diagnostic test exhibits a unique ability to recognize early stage AD
and to differentiate patients diagnosed with AD from patients diagnosed with
other forms of dementia and relevant neurological diseases, including major
depression, as well as healthy controls.  In addition, our CSF-based
diagnostic test has shown to be a strong predictor of the decline from MCI to
AD.





Therapeutics





The only products with FDA approved
label claims for pharmaceutical management of AD in the U.S. provide symptomatic
treatment through the use of acetylcholinesterase (“AchE”) inhibitors, of which
there are five currently marketed by some of the largest pharmaceutical
companies, including; Aricept (Pfizer), Exelon (Novartis), Reminyl (Johnson
& Johnson), Tacrine (Pfizer), and Memantine (Forest
Labs).  Despite limited clinical effectiveness and a poor safety and
side effect profile, sales of these drugs in 2007 were nearly $4.5 billion,
according to CNN.com.





The market for AD therapy is expected
to grow, based on the aging demographic of the seven major pharmaceutical
markets (USA, France, Germany, Italy, Spain, U.K. and Japan).  AchE
inhibitors remain the largest class of drugs within the late stage development
pipeline.  However, their apparent limited efficacy would seem to
provide an opportunity for other promising compounds.  It is estimated
that over 100 potential compounds are currently being developed by both major
pharmaceutical companies as well as small biotech companies.  The lack
of current effective pharmacological therapy for an increasing AD population
provides an attractive opportunity for therapeutics we may discover utilizing
our novel therapeutic approach in our collaboration with Eli Lilly and
Company.





Patents,
licenses, trade secrets and proprietary rights





Our success depends and will continue
to depend, in part, upon our ability to retain our exclusive licenses, to
maintain patent protection for our products and processes, to preserve our trade
secrets and proprietary information and to operate without infringing the
proprietary rights of third parties.  We believe in securing and
supporting a strong competitive position through the filing and prosecution of
patents where available, and through trade secrets, when patenting is
precluded.





We have filed patent applications in
the U.S. for composition of matter and use of compounds to treat AD, method of
use, as well as aspects of our diagnostic test technologies for use in MCI and
methods for developing novel therapeutic screens for the discovery of compounds
useful in the treatment of AD, novel approaches to therapeutic intervention,
transgenic mouse production and a novel gene.  Patent Cooperation
Treaty (P.C.T.) applications have been filed abroad, when
applicable.





In March 2004 we were notified by email
from Innogenetics, a Belgian biopharmaceutical company involved in specialty
diagnostics and therapeutic vaccines, that it believes the CSF diagnostic test
we have been developing uses technology that is encompassed by the claims of
their U.S. patents.  Innogenetics also informed us that it could be
amenable to entering into a licensing arrangement or other business deal with
APNS regarding its patents.  We had some discussions with Innogenetics
concerning a potential business relationship, however no further discussions
have been held since the second quarter of 2006.





8




We have
reviewed these patents with our patent counsel on several occasions prior to
receipt of the email from Innogenetics and subsequent to receipt of the
email.  Based on these reviews, we believe that our CSF diagnostic
test does not infringe the claims of these Innogenetics patents.  If
we were unable to reach a mutually agreeable arrangement with Innogenetics, we
may be forced to litigate the issue.  Expenses involved with
litigation may be significant, regardless of the ultimate outcome of any
litigation.  An adverse decision could prevent us from possibly
marketing a future diagnostic product and could have a material adverse impact
on our business.








Alzheimer's
disease technology license





We have various License and
Collaborative Research Agreements (the "Agreements") with Albert Einstein
College of Medicine ("AECOM").  These Agreements grant us the
exclusive rights to neurodegenerative disease technology, primarily Alzheimer's
disease technology for diagnostic and therapeutic applications from Dr. Peter
Davies’ lab at AECOM.  These Agreements were amended in March 2002, in
September 2002, and again in October 2006 and remain effective on an evergreen
basis.  The minimum annual payments to be made to AECOM, which consist
of payments due for support of research conducted in Dr. Davies' lab and for
annual license maintenance, are as follows:





Year
            
            Amount2008
      and each subsequent year
            
            $500,000





We are obligated to continue to pay
AECOM $500,000 for each year after 2007 in which the Agreements are still in
effect.  In addition, we are obligated to pay AECOM a percentage of
all revenues we receive from selling and/or licensing aspects of the AD
technology licensed under the Agreements that exceeds the minimum obligations
reflected in the annual license maintenance payments.





Confidentiality
and assignment of inventions agreements





We require our employees, consultants
and advisors having access to our confidential information to execute
confidentiality agreements upon commencement of their employment or consulting
relationships with us.  These agreements generally provide that all
confidential information we develop or make known to the individual during the
course of the individual's employment or consulting relationship with us must be
kept confidential by the individual and not disclosed to any third
parties.  We also require all of our employees and consultants who
perform research and development for us to execute agreements that generally
provide that all inventions conceived by these individuals will be our
property.





Government
regulation





The research, development, manufacture,
and marketing of our potential products are subject to substantial regulation by
the U.S. Food and Drug Administration (“FDA”) in the United States and by
comparable authorities in other countries.  These national agencies
and other federal, state, and local entities regulate, among other things,
research and development activities and the testing, manufacture, safety,
effectiveness, labeling, storage, record keeping, approval, advertising, and
promotion of our potential products.





Therapeutics





As an initial step in the FDA
regulatory approval process for a prospective therapeutic product, preclinical
studies are typically conducted in animals to identify potential safety
problems.  For certain diseases, animal models may exist which are
believed to be predictive of human efficacy.  For these diseases, a
drug candidate is tested in an animal model.  The results of the
studies are submitted to the FDA as a part of an Investigational New Drug
Application (“IND”), which is filed to comply with FDA regulations prior to
beginning human clinical testing.





Clinical trials for new therapeutics
are typically conducted in three sequential phases, although the phases may
overlap.  In Phase I, the compound is tested in healthy human subjects
for safety (adverse effects), dosage tolerance, absorption, biodistribution,
metabolism, excretion, clinical pharmacology and, if possible, to gain early
information on effectiveness.  Phase II typically involves studies in
a small sample of the intended patient population to assess the efficacy of the
drug for a specific indication, to determine dose tolerance and the optimal dose
range, and to gather additional information relating to safety and potential
adverse effects.  Phase III trials are comparative clinical studies
undertaken to further evaluate clinical safety and efficacy in an expanded
patient population at geographically dispersed study sites in order to determine
the overall risk-benefit ratio of the drug and to provide an adequate basis for
physician labeling.  Each trial is conducted in accordance with
certain standards under protocols that detail the objectives of the study, the
parameters to be used to monitor safety and efficacy criteria to be
evaluated.  Each protocol must be submitted to the FDA as part of the
IND.  Further, each clinical study must be evaluated by an independent
Institutional Review Board (IRB) at the institution at which the study will be
conducted.  The IRB will consider, among other things, ethical
factors, the safety of human subjects and the possible liability of the
institution.





9




Data from
preclinical testing and clinical trials are submitted to the FDA in a New Drug
Application (“NDA”) for marketing approval.  Preparing an NDA involves
considerable data collection, verification, analysis and expense, and there can
be no assurance that any approval will be granted on a timely basis, if at
all.  The approval process is affected by a number of factors,
including the severity of the disease, the availability of alternative
treatments and the risks and benefits demonstrated in clinical
trials.  The FDA may deny an NDA if applicable regulatory criteria are
not satisfied or require additional testing or information.  Among the
conditions for marketing approval is the requirement that the prospective
manufacturer's quality control and manufacturing procedures conform to the FDA's
good manufacturing practices (“GMP”) regulations, which must be followed at all
times.  In complying with standards set forth in these regulations,
manufacturers must continue to expend time, monies and effort in the area of
production and quality control to ensure full technical
compliance.  Manufacturing establishments serving the U.S. markets,
both foreign and domestic, are subject to inspections by, or under the authority
of, the FDA and by other federal, state or local agencies.





The process of completing clinical
testing and obtaining FDA approval for a new drug is likely to take a number of
years from the commencement of the clinical trial and require the expenditure of
substantial resources.  We would require significant additional funds
in the future to finance the clinical testing process if we developed any
therapeutic products on our own.  Under our agreement with Eli Lilly
and Company, however, Lilly will finance the clinical testing process of any AD
therapeutic developed from our collaboration.





Diagnostic





In vitro diagnostic products have a
different path to regulatory approval, i.e., the Premarket Approval Application
(“PMA”) process regulated by the Office of In Vitro Diagnostic Device and Safety
(“OIVD”) of the FDA.  The regulatory process leading to a submission
of an in vitro diagnostic device PMA for FDA approval to market involves a
multistage process including: (1) a Pre-Investigational Device Exemption
(“Pre-IDE”) program in which preliminary information is submitted to the FDA for
review and guidance on, and acceptance of, the test protocol and proposed
clinical trial to evaluate the safety and effectiveness of an in vitro
diagnostic product followed by, (2) an Investigational Device Exemption (“IDE”)
submission for approval to allow the investigational diagnostic device to be
used in a clinical study in order to (3) collect safety and effectiveness data
required to support a PMA to receive FDA approval to market a
device.      Data from a clinical trial is used to
evaluate the clinical performance of the diagnostic test.  Before FDA
approval for general sale, under certain conditions, companies can supply either
“investigational use only” or “research use only” assay kits under the Clinical
Laboratory Improvement Amendment (“CLIA”) of 1988.  Whether we will be
able to market kits under these regulatory categories, or obtain final approval
for a kit for specific claims, is uncertain given changing regulatory
environments in most major markets.





Whether or not FDA approval has been
obtained, regulatory authorities in foreign countries must grant approval prior
to the commencement of commercial sales of the product in such
countries.  The requirements governing the conduct of clinical trials
and market entry vary widely from country to country, and the time required for
clearance may be longer or shorter than that required by the
FDA.  Although there are some procedures for unified filings for
certain European countries, in general, each country at this time has its own
procedures and requirements.  We would require significant additional
funds in the future to finance the clinical testing process if we developed any
diagnostic products on our own.  As funds permit, we will continue
advancing the development of our diagnostic program, while pursuing appropriate
partnering and/or out-licensing opportunities.








10





Environmental
regulation





In connection with our research and
development activities, our business is, and will in the future continue to be,
subject to regulation under various state and federal environmental
laws.  These laws and regulations govern our use, handling and
disposal of various biological and chemical substances used in our
operations.  Although we believe that we have complied with these laws
and regulations in all material respects and we have not been required to take
any action to correct any noncompliance, there can be no assurance that we will
not be required to incur significant costs of comply with health and safety
regulations in the future.





Employees





As of February 29, 2008 we had six
full-time employees, two of whom have advanced scientific
degrees.  None of our employees are covered by a collective bargaining
agreement and we believe all relations with our employees are
satisfactory.  In addition, to complement our internal expertise, we
have license agreements with AECOM that provide access to Dr. Peter Davies and
the academic researchers in his lab and we may contract with other academic
research laboratories, outside organizations with specific expertise and
scientific consultants that provide pertinent expertise with therapeutic and
diagnostic development.  In the future, we may hire additional
research, development and other personnel in addition to utilizing outside
organizations and consultants.





Risk
factors related to our business





Factors that could cause or contribute
to differences in our actual results include those discussed in the following
section, as well as those discussed in other parts of this Annual Report on Form
10-KSB.  You should consider carefully the following risk factors,
together with all of the other information included in this Annual Report on
Form 10-KSB.  Each of these risk factors could adversely affect our
business, operating results and financial condition, as well as adversely affect
the value of our common stock.





Our
cash balances, coupled with our annual R & D support from Eli Lilly and
Company, should be sufficient to fund our current planned development activities
through the first quarter of 2009.  We will need to raise funds prior
to the end of the first quarter of 2009 in order to continue operations and we
may have to amend our charter to increase our authorized shares of common stock
in order to raise adequate capital which would be costly for us to do and may
not be successful in which event we may have difficulty raising
capital.





As of December 31, 2007, we had cash of
$2,960,141.  We anticipate that our cash balances at December 31,
2007, coupled with our annual R & D support from Eli Lilly and Company,
should be sufficient to fund operations through the first quarter of
2009.  We will need additional funding prior to the end of the first
quarter of 2009 in order to continue our research, product development and our
operations.  The cash on hand will be used for ongoing research and
development, working capital, general corporate purposes and possibly to secure
appropriate partnerships and expertise.  Since we do not expect to
generate significant revenues from operations in 2008 and 2009, we will be
required to raise additional capital in financing transactions or through some
form of collaborative partnership in order to satisfy our expected cash
expenditures after the first quarter of 2009.  We expect to raise such
additional capital by selling shares of our capital stock, proceeds from
exercises of existing warrants and/or stock options and/or by borrowing
money.  However, such additional capital may not be available to us at
acceptable terms or at all.  As of February 29, 2008, we have
6,121,392 authorized shares of common stock available for
issuance.  In order to raise funds through the sale of capital stock,
we will need to increase our authorized common stock, which will require the
time and expense of obtaining stockholder approval.  Because most of
our stockholders hold their shares in street name and a charter amendment is not
a discretionary item for which brokers can cast a vote without instruction from
their clients, we would have to hire a solicitation firm to assist us in getting
sufficient stockholder votes to increase our authorized common
stock.  If we are unable to increase the number of authorized shares
of common stock, we will have significant difficulty in raising sufficient
additional capital to support operations.  Further, if we sell
additional shares of our capital stock, current ownership positions in our
Company will be subject to dilution. In the event that we are unable to obtain
additional capital, we may be forced to reduce our operating expenditures or to
cease operations altogether.





We have had net losses for each of the
years ended December 31, 2007 and 2006, and we have an accumulated deficit of
approximately $48.0 million as of December 31, 2007.  Since the
financial statements for each of these periods were prepared assuming that we
would continue as a going concern, in the view of our independent registered
public accountants, these conditions raise substantial doubt about our ability
to continue as a going concern.  We anticipate that our cash balances
at December 31, 2007, coupled with our annual R & D support from Eli Lilly
and Company, should be sufficient to fund operations through the first quarter
of 2009.  We will need additional funding prior to the end of the
first quarter of 2009 in order to continue our research, product development and
our operations.  Since we do not expect to generate any material
revenues for the foreseeable future, our ability to continue as a going concern
depends, in large part, on our ability to raise additional capital prior to the
end of the first quarter 2009, either through some form of partnership or debt
or equity financing, including exercise of outstanding stock options and/or
warrants.  If we are unable to raise additional capital, we may be
forced to discontinue our business.





11




We
are a development stage company without any products currently in clinical
trials





We are a development stage
company.  Our product furthest along is a diagnostic test which
detects Alzheimer’s disease utilizing cerebrospinal fluid (CSF).  Our
other potential diagnostic and therapeutic products and technologies are early
in the research and development phase, and product revenues may not be realized
from the sale of any such products for at least the next several years, if at
all.  Our proposed products will require significant additional
research and development efforts prior to any commercial use, including
extensive preclinical and clinical testing as well as lengthy regulatory
approval.  There can be no assurances that our research and
development efforts will be successful, that our potential products will prove
to be safe and effective in clinical trials or that we will develop any
commercially successful products.  We currently have no approved
products on the market and have not received any commercial revenues from the
sale or license of any diagnostic or therapeutic products.





We
have a history of operating losses and expect to sustain losses in the
future





We have experienced significant
operating losses since our inception.  As of December 31, 2007, we had
an accumulated deficit of approximately $48.0 million.  We expect to
incur operating losses over the next several years as our research and
development efforts continue.  Our ability to achieve profitability
depends in part upon our ability, alone or with or through others, to raise
additional capital to execute our business plan, to advance development of our
proposed products, to obtain required regulatory approvals, to manufacture and
market our products, and to successfully commercialize our approved
products.





We
need to raise additional capital by the end of the first quarter of 2009,
however, we may not be able to raise such capital, or we may only be able to
raise capital on unfavorable terms





Our operations to date have consumed
substantial amounts of cash.  Our development of our technologies and
potential products will require substantial funds to conduct the costly and
time-consuming activities necessary to research, develop and optimize our
technologies, and ultimately, to establish manufacturing and marketing
capabilities.  Our future capital requirements will depend on many
factors, including:





·
            continued
      scientific progress in the research and development of our
      technologies;


·
            our
      ability to establish and maintain collaborative arrangements with others
      for product development;


·
            progress
      with validation testing, pre-clinical and clinical
  trials;


·
            the
      time and costs involved in obtaining regulatory
  approvals;


·
            the
      costs involved in preparing, filing, prosecuting, maintaining and
      enforcing patent claims;


·
            competing
      technological and market
developments;


·
            changes
      in our existing research relationships;
and


·
            effective
      product commercialization activities and
  arrangements.





We anticipate that our cash balances at
December 31, 2007, coupled with our annual R & D support from Eli Lilly and
Company, should be sufficient to fund operations through the first quarter of
2009.  We will need additional funding prior to the end of the first
quarter of 2009 in order to continue our research, product development and our
operations.  The cash on hand will be used for ongoing research and
development, working capital, general corporate purposes and possibly to secure
appropriate partnerships and expertise.  If additional funding is not
obtained, we will not be able to continue funding the costs of any programs, and
we may have to significantly minimize or eliminate our programs, and possibly
discontinue all our product development and/or our operations.  We are
currently evaluating our options to maximize the value of our diagnostic
technology, including seeking partnerships and licensing
arrangements.




12




We
face extensive governmental regulation and any failure to comply could prevent
or delay product approval or cause the disallowance of our products after
approval





The U.S. Food and Drug Administration,
and comparable agencies in foreign countries, impose many requirements on the
introduction of new therapeutics through lengthy and detailed clinical testing
procedures, and other costly and time consuming compliance procedures relating
to the manufacture, distribution, advertising, pricing and marketing of
pharmaceutical products.  These requirements make it difficult to
estimate when any of our products in development will be available commercially,
if at all.





The regulatory process takes many years
and requires the expenditure of substantial resources.  Clinical
trials for diagnostic products, including the FDA submission and approval
process, generally take less time than for therapeutic products.  Data
obtained from pre-clinical and clinical activities are subject to varying
interpretations that could delay, limit or prevent regulatory agency approval.
We may also encounter delays or rejections based on changes in regulatory agency
policies during the period in which we develop our products and/or the period
required for review of any application for regulatory agency approval of a
particular product. Delays in obtaining regulatory agency approvals will make
the projects more costly and adversely affect our business.





Diagnostic products have a different
path to regulatory approval than the path for pharmaceutical
products.  In vitro diagnostic products have a different path to
regulatory approval, i.e., the Premarket Approval Application (PMA) process
regulated by the Office of In Vitro Diagnostic Device and Safety (OIVD) of the
FDA.  The regulatory process leading to a submission of an in vitro
diagnostic device PMA for FDA approval to market involves a multistage process
including: (1) a Pre-Investigational Device Exemption (Pre-IDE) program in which
preliminary information is submitted to the FDA for review and guidance on, and
acceptance of, the test protocol and proposed clinical trial to evaluate the
safety and effectiveness of an in vitro diagnostic product followed by, (2) an
Investigational Device Exemption (IDE) submission for approval to allow the
investigational diagnostic device to be used in a clinical study in order to (3)
collect safety and effectiveness data required to support a PMA to receive FDA
approval to market a device.





Even if we successfully enroll patients
in clinical trials for our diagnostic or therapeutic products, setbacks are a
common occurrence in clinical trials.  These setbacks often
include:





·
            Failure
      to comply with the regulations applicable to such testing may delay,
      suspend or cancel our clinical
trials,


·
            The
      FDA might not accept the test
results,


·
            The
      FDA, or any comparable regulatory agency in another country, may suspend
      clinical trials at any time if it concludes that the trials expose
      subjects participating in such trials to unacceptable health
      risks


·
            Human
      clinical testing may not show any current or future product candidate to
      be safe and effective to the satisfaction of the FDA or comparable
      regulatory agencies


·
            The
      data derived from clinical trials may be unsuitable for submission to the
      FDA or other regulatory agencies.





In 2005 we filed with the FDA a
Pre-Investigational Device Exemption (“Pre-IDE”) application with respect to our
CSF-based diagnostic test and we had our Pre-IDE meeting with the FDA in
November 2005.    Subsequent to our meeting with the FDA, we
worked with our clinical consultants to refine our clinical
protocol.  At that time, work was suspended until such time that we,
along with our consultants, could identify a cost effective protocol that would
be acceptable to the FDA and offer the opportunity to obtain desired claims and
indications.  It is uncertain when we will file a Pre-IDE for any of
our diagnostic programs in development. We have not filed any Investigation New
Drug (“IND”) with respect to our AD therapeutic, and the timing of such filing
in the future is uncertain, and subject to the progress of our collaboration
with Eli Lilly and Company.  We cannot predict with certainty when we
might submit any of our proposed products currently under development for
regulatory review.  Once we submit a proposed product for review, the
FDA or other regulatory agencies may not issue their approvals on a timely
basis, if at all.  If we are delayed or fail to obtain such approvals,
our business may be adversely affected.   If the FDA grants
approval for a drug or device, such approval may limit the indicated uses for
which we may market the drug or device and this could limit the potential market
for such drug or device. Furthermore, if we obtain approval for any of our
products, the marketing and manufacture of such products remain subject to
extensive regulatory requirements. Even if the FDA grants approval, such
approval would be subject to continual review, and later discovery of unknown
problems could restrict the products future use or cause their withdrawal from
the market. If we fail to comply with regulatory requirements, either prior to
approval or in marketing our products after approval, we could be subject to
regulatory or judicial enforcement actions.  Failure to comply with
regulatory requirements could, among other things, result in:





13


·
            product
      recalls or seizures;


·
            fines
      and penalties;


·
            injunctions;


·
            criminal
      prosecution;


·
            refusals
      to approve new products and withdrawal of existing approvals;
      and/or


·
            enhanced
      exposure to product liabilities.





In order to
market our products outside of the United States, we must comply with numerous
and varying regulatory requirements of other countries regarding safety and
quality. The approval procedures vary among countries and can involve additional
product testing and administrative review periods. The time required to obtain
approval in other countries might differ from that required to obtain FDA
approval. The regulatory approval process in other countries includes all of the
risks associated with obtaining FDA approval detailed above. Approval by the FDA
does not ensure approval by the regulatory authorities of other
countries.





In addition, many countries require
regulatory agency approval of pricing and may also require approval for the
marketing in such countries of any drugs or devices we develop. We cannot be
certain that we will obtain any regulatory approvals in other countries and the
failure to obtain such approvals may materially adversely affect our
business.





Under our agreement with Eli Lilly and
Company, however, all aspects of our therapeutic collaboration will be largely
funded by Lilly.





We
may not identify a cost effective protocol for obtaining FDA approval that could
yield desired claims for any of our proposed products





Prior to beginning the clinical testing
process required to obtain FDA approval for any of our proposed products, we
must determine if there is a cost effective protocol that would be acceptable to
the FDA and offer the opportunity to obtain desired claims and
indications.  If a cost effective clinical testing protocol cannot be
structured in a time appropriate duration for a specific proposed product, we
will not attempt to obtain FDA approval for that proposed
product.  This may reduce or eliminate any potential revenues we would
receive from the proposed product.





Our
technologies are subject to licenses and termination of any of those licenses
would seriously harm our business





We have exclusive licenses with Albert
Einstein College of Medicine ("AECOM") covering virtually all of our Alzheimer's
disease technology, including all our AD related diagnostic and therapeutic
products currently in development.  We depend on these licensing
arrangements to maintain rights to our products under
development.  These agreements require us to make payments in order to
maintain our rights.  The agreements also generally require us to pay
royalties on the sale of products developed from the licensed technologies, fees
on revenues from sublicensees, where applicable, and the costs of filing and
prosecuting patent applications.  We are currently in compliance with
our license agreements, however, we will need to raise additional capital prior
to the end of the first quarter of 2009 in order to meet our ongoing obligations
to AECOM.  If we fail to raise sufficient funds, and consequently
default on our obligations to AECOM, our licenses could terminate, and we could
lose the rights to our proprietary technologies. Such a loss would have a
material adverse effect on our operations and prospects.





Our
collaboration agreement with Eli Lilly and Company may not provide the future
payments we anticipate over the course of the agreement which could result in
the termination of our operations





In November 2006, we entered into an
agreement with Eli Lilly and Company to develop therapeutics to treat
AD.  Lilly received the exclusive worldwide rights to the intellectual
property related to our expertise in understanding the molecular neuropathology
of AD as it pertains to the formation of neurofibrillary
tangles.  Lilly may not advance any of the technology under the
agreement as fast, or as far, as we would anticipate, if at all, to provide us
with the milestone and royalty payments we expected when we signed the
agreement.  In addition, Lilly may decide to allocate internal
resources to other projects and slow down, or stop the work, under our
collaboration agreement for a period of time, which could cause our technology
under the agreement not to be advanced at the rate we expected, or not be
advanced at all.  Such a situation could have a material adverse
effect on our operations and prospects and we may have to shut down, or scale
back, our operations unless we could enter into a new partnership arrangement or
raise capital.





14




The
demand for diagnostic products for Alzheimer’s disease may be limited because
there is currently no cure or effective therapeutic products to treat the
disease





Since there is currently no cure or
therapy that can stop the progression of Alzheimer’s disease, the market
acceptance and financial success of a diagnostic technology capable of detecting
Alzheimer’s disease may be limited.  As a result, even if we
successfully develop a safe and effective diagnostic technology for identifying
this disease, its commercial value might be limited.





The
value of our research could diminish if we cannot protect, enforce and maintain
our intellectual property rights adequately





The pharmaceutical and diagnostic
industries place considerable importance on obtaining patent and trade secret
protection for new technologies, products and processes, and where possible, we
actively pursue both domestic and foreign patent protection for our proprietary
products and technologies. Our success will depend in part on our ability to
obtain and maintain patent protection for our technologies and to preserve our
trade secrets. When patent protection is available, it is our policy to file
patent applications in the United States and selected foreign jurisdictions.
During our review of our patent portfolio in 2007, we stopped maintaining some
older method patents that we determined did not have the potential for any
future benefit. We currently hold and maintain 8 issued United States patents
and various related foreign patents.  Two of the issued United States
patents are for our Alzheimer's diagnostic technology, three of the issued
United States patents are for our Alzheimer's therapeutic technology and one of
the issued United States patents relates to transgenic animals.  One
of the patents, issued in October 2007, relates to a gene that is nested within
the tau gene that in turn creates the tau protein.  One of the issued
AD patents is assigned to AECOM and is licensed to us, and four of the issued AD
patents are assigned to us.  We currently have three patent
applications filed, one has Alzheimer's diagnostic applications, one has
Alzheimer's therapeutic applications, and one has both Alzheimer's diagnostic
and therapeutic applications.    The issued United States
Alzheimer's technology patents expire between 2014 and 2023.  No
assurance can be given that our issued patents will provide competitive
advantages for our technologies or will not be challenged or circumvented by
competitors. With respect to already issued patents, there can be no assurance
that any patents issued to us will not be challenged, invalidated, circumvented
or that the patents will provide us proprietary protection or a commercial
advantage. We also rely on trade secrets and proprietary know-how, which we seek
to protect, in part, through confidentiality agreements with employees,
consultants, collaborative partners and others. There can be no assurance that
these agreements will not be breached.





The ability to develop our technologies
and to commercialize products will depend on avoiding the infringement of
patents of others.  While we are aware of patents issued to
competitors, we are not aware of any claim of patent infringement against us,
except as described in the following two paragraphs.  Any potential
patent infringement may require us to acquire licensing rights to allow us to
continue the development and commercialization of our products.  Any
such future claims concerning us infringing patents and proprietary technologies
could have a material adverse effect on our business. In addition, litigation
may also be necessary to enforce any of our patents or to determine the scope
and validity of third-party proprietary rights. There can be no assurance that
our patents would be held valid by a court of competent
jurisdiction.  We may have to file suit to protect our patents or to
defend use of our patents against infringement claims brought by
others.  Because we have limited cash resources, we may not be able to
afford to pursue or defend against litigation in order to protect our patent
rights.





In March 2004 we were notified by email
from Innogenetics, a Belgian biopharmaceutical company involved in specialty
diagnostics and therapeutic vaccines, that it believes the CSF diagnostic test
we have been developing uses technology that is encompassed by the claims of
its’ U.S. patents.    Innogenetics also informed
us


that it
could be amenable to entering into a licensing arrangement or other business
deal with APNS regarding its patents.  We had some discussions with
Innogenetics concerning a potential business relationship, however no further
discussions have been held since the second quarter of 2006.





15




We have
reviewed these patents with our patent counsel on several occasions prior to
receipt of the email from Innogenetics and subsequent to receipt of the
email.  Based on these reviews, we believe that our CSF diagnostic
test does not infringe the claims of these Innogenetics
patents.    If we were unable to reach a mutually agreeable
arrangement with Innogenetics, we may be forced to litigate the
issue.  Expenses involved with litigation may be significant,
regardless of the ultimate outcome of any litigation.  An adverse
decision could prevent us from possibly marketing a future diagnostic product
and could have a material adverse impact on our business.





We also rely on trade secrets to
protect our proprietary technologies, especially where we do not believe patent
protection is appropriate or obtainable.  However, trade secrets can
be difficult to protect.  We rely in part on confidentiality
agreements with our employees, consultants, outside scientific collaborators,
sponsored researchers and others to protect our trade secrets and other
proprietary information.  These agreements may not effectively prevent
disclosure of confidential information and may not provide an adequate remedy if
unauthorized disclosure of confidential information occurs.  In
addition, others may independently discover our trade secrets and proprietary
information.  Costly and time-consuming litigation could be necessary
to enforce and determine the scope of our proprietary rights, and failure to
obtain or maintain trade secret protection could adversely affect our
competitive position.  None of our employees, consultants, scientific
researchers or collaborators has any rights to publish scientific data and
information generated in the development or commercialization of our products
without our approval, with the exception of Eli Lilly and Company’s rights under
our collaboration agreement.  Under the license agreements with us,
AECOM has a right to publish scientific results relating to the diagnosis of AD
and precursor or related conditions in scientific journals, provided, that AECOM
must give us pre-submission review of any such manuscript to determine if it
contains any of our confidential information or patentable
materials.





We
face large competitors and our limited financial and research resources may
limit our ability to develop and market new products





The biotechnology, diagnostic and
pharmaceutical markets generally involve rapidly changing technologies and
evolving industry standards.  Many companies, both public and private,
are developing products to diagnose and to treat Alzheimer’s
disease.  Most of these companies have substantially greater
financial, research and development, manufacturing and marketing experience and
resources than we do.  As a result, our competitors may more rapidly
develop effective diagnostic products as well as therapeutic products that are
more effective or less costly than any product that we may
develop.  Under our agreement with Eli Lilly and Company, however, all
aspects of our therapeutic collaboration will be largely funded by
Lilly.





We also face competition from colleges,
universities, governmental agencies and other public and private research
institutions.  These competitors are becoming more active in seeking
patent protection and licensing arrangements to collect royalties for use of
technology that they have developed.  Some of these technologies may
compete directly with the technologies being developed by us.  Also,
these institutions may also compete with us in recruiting highly qualified
scientific personnel.





We
do not have manufacturing capability and we must rely on third party
manufacturers to produce our products, giving us limited control over the
quality of our products and the volume of products produced





While we have internally manufactured
some of the reagents and materials necessary to conduct our activities related
to research and development of our diagnostic products, we do not currently have
any large scale manufacturing capability, expertise or personnel and expect to
rely on outside manufacturers to produce material that will meet applicable
standards for clinical testing of our products and for larger scale production
if marketing approval is obtained.





We will either find our own
manufacturing facilities, rely upon third-party manufacturers to manufacture our
proposed products in accordance with appropriate regulations, or we will most
likely utilize the capabilities of our partners and/or
collaborators.  Under our agreement with Eli Lilly and Company, Lilly
has an exclusive world-wide license to manufacture, market and sell any AD
therapeutic that comes to market from our collaboration agreement. We do not
have any outside manufacturing agreements for our proposed diagnostic
products.  If we, or Lilly, choose to utilize an outside manufacturer,
we cannot assure that any outside manufacturer that we, or Lilly, select will
perform suitably or will remain in the contract manufacturing business, in which
instances we (or Lilly) would need to find a replacement manufacturer or we
would have to develop our own manufacturing capabilities.  If we are
unable to do so, our ability to obtain regulatory approval for our products
could be delayed or impaired.  Our ability, and Lilly’s ability, to
market our products could also be affected by the failure of our third party
manufacturers or suppliers to comply with the good manufacturing practices
required by the FDA and foreign regulatory authorities.





16


We
do not have marketing and sales staff to sell our products and we must rely on
third parties to sell and market our products, the cost of which may make our
products less profitable for us





We do not have marketing and sales
experience or personnel.  As we currently do not intend to develop a
marketing and sales force, we will depend on arrangements with partners or other
entities for the marketing and sale of our proposed products.  Under
our agreement with Eli Lilly and Company, Lilly has an exclusive world-wide
license to market and sell any AD therapeutic that comes to market from our
collaboration agreement.  We do not currently have any agreements with
corporate partners or other entities to provide sales and marketing services for
our proposed diagnostic products.  We may not succeed in entering into
any satisfactory third-party arrangements for the marketing and sale of our
proposed products, or we may not be able to obtain the resources to develop our
own marketing and sales capabilities.  We may never have an AD
therapeutic come to market under the Lilly agreement, or we may never have a
diagnostic product come to market.  The failure to develop those
capabilities, either externally or internally, may adversely affect future sales
of our proposed products.





We
must rely on third party relationships to develop, manufacture and market our
products without which we may fail





We do not possess all the resources
necessary to complete the development, clinical testing, regulatory process,
manufacturing, marketing and commercialization of our diagnostic and therapeutic
products and we will need to obtain such resources from third
parties.  In order to obtain such resources, we will need to enter
into collaborations with corporate partners, licensors, licensees and possibly
relationships with third parties from whom we will outsource the necessary
expertise and resources.  Our success may depend on securing such
relationships.  This business strategy would utilize the expertise and
resources of third parties in a number of areas including:





·
            performing
      various activities associated with pre-clinical studies and clinical
      trials;


·
            preparing
      submissions seeking regulatory
approvals;


·
            manufacture
      of kits and solutions; and


·
            sales
      and marketing of our products.





This strategy
of reliance on third party relationships creates risks to us by placing critical
aspects of our business in the hands of third parties, whom we may not be able
to control as effectively as our own personnel.  For example, under
our agreement with Eli Lilly and Company, Lilly has an exclusive world-wide
license to manufacture, market and sell any AD therapeutics that comes to market
from our collaboration agreement.  We cannot be sure that the Lilly
agreement or any future collaborative agreements will be
successful.   If these third parties, such as Eli Lilly and
Company, do not perform in a timely and satisfactory manner, we may incur
additional costs and lose time in our development and clinical programs as well
as the commercialization our products.  To the extent we choose not
to, or are not able to, establish such arrangements, we could experience
increased risk and capital requirements.





We do not have the ability to conduct
clinical trials independently. We intend to rely on our partners, clinical
investigators and third-party clinical research organizations to perform a
significant portion of these functions. There can be problems with using third
party clinical research organizations such as:





·
            we
      are not able to locate acceptable contractors to run this portion of our
      clinical trials;


·
            we
      can not enter into favorable agreements with
  them;


·
            third
      parties may not successfully carry out their contractual duties;
      and/or


·
            third
      parties may not meet expected
deadlines.







If any of these problems occur, we will
be unable to obtain required regulatory approvals and will be unable to
commercialize our products on a timely basis, if at all.







17







We
are dependent on our key employees and consultants, who may not readily be
replaced





We are highly dependent upon the
principal members of our management team, especially Ellen R. Hoffing, Chairman,
President and Chief Executive Officer, and Peter Davies, Ph.D., our founding
scientist, as well as our other officers and directors.  Ms. Hoffing’s
employment agreement is effective through August 29, 2009.  Our
consulting agreements with Dr. Davies are effective through November
2008.  We do not have employment agreements with John DeBernardis,
Ph.D., Chief Scientific Officer, and David Ellison, Chief Financial Officer and
Corporate Secretary.  We do not currently maintain key-man life
insurance and the loss of any of these persons' services, and the resulting
difficulty in finding sufficiently qualified replacements, could adversely
affect our ability to develop and market our products and obtain necessary
regulatory approvals.





Our success also will depend in part on
the continued service of other key scientific personnel, and our ability to
identify, hire and retain additional staff, if necessary.  We face
intense competition for qualified employees and consultants.  Large
pharmaceutical companies and other competitors, which have greater resources and
experience than we have, can, and do, offer superior compensation packages to
attract and retain skilled personnel.  As a result, we may have
difficulty retaining such employees and consultants because we may not be able
to match the packages offered by such competitors and large pharmaceutical
companies, and we may have difficulty attracting suitable
replacements.





We expect that our potential expansion
into areas and activities requiring additional expertise, such as clinical
trials, governmental approvals, contract and manufacturing and sales and
marketing, will be done by working with outside contractors who have the
appropriate expertise or by utilizing collaborators / partners.  The
management of these processes may require an increase in management and
scientific personnel and the development of additional expertise by existing
management personnel.  The failure to attract and retain such
personnel or to develop such expertise could materially adversely affect
prospects for our success.





If
our current research collaborators, scientific advisors, and specifically our
founding scientist, Dr. Peter Davies, terminate their agreements with us, or
develop relationships with competitors, our ability to advance existing programs
and add new tools and technologies could be adversely impacted.





We derive significant support and
benefit from research collaborators and other expertise that we
utilize.  These collaborators are not our employees and operate under
consulting agreements that are subject to termination provisions.  Our
core technology in the AD field is based on exclusive licenses with AECOM
covering all of our diagnostic and therapeutic applications in the field of
neurodegenerative diseases.  We therefore cannot control the explicit
amount of time or output that is derived from our collaborators through our
agreements.  Dr. Davies is currently actively deploying the time and
resources at his lab at AECOM that is necessary to advance our collaboration
agreement with Eli Lilly and Company.  We may not derive any new or
additional tools or technologies from our relationship with Dr. Davies at AECOM,
that would be appropriate for us to develop, or that fall outside of the rights
of the Lilly collaboration.





We
use hazardous materials in our research and that may subject us to liabilities
in excess of our resources





Our research and development involves
the controlled use of hazardous materials such as acids, caustic agents,
flammable solvents and carcinogens.  Although we believe that our
safety procedures for handling and disposing of hazardous materials comply in
all material respects with the standards prescribed by government regulations,
the risk of accidental contamination or injury from these materials cannot be
completely eliminated.  In the event of an accident, we could be held
liable for any damages that result.  Although we have insurance
coverage for third-party liabilities of this nature, such liability beyond this
insurance coverage could exceed our resources.  Our insurance for
hazardous materials liabilities has a deductible of $5,000 and a cap on coverage
for damages of $250,000.  There can be no assurance that current or
future environmental or transportation laws, rules, regulations or policies will
not have a material adverse effect on us.





If
we have any products used in clinical trials or products sold commercially,
potential product liability claims against us could result in reduced demand for
our products or extensive damages in excess of insurance coverage





The use of our products in clinical
trials or from commercial sales will expose us to potential liability claims if
such use, or even their misuse, results in injury, disease or adverse
effects.  We intend to obtain product liability insurance coverage
before we initiate clinical trials for any of our
products.   This insurance is expensive and insurance companies
may not issue this type of insurance when needed.  Any product
liability claim resulting from the use of our diagnostic test in a clinical
study, even one that was not in excess of our insurance coverage or one that is
meritless, could adversely affect our ability to complete our clinical trials or
obtain FDA approval of our product, which could have a material adverse effect
on our business.





18




The
healthcare reimbursement environment is uncertain and our customers may not get
significant insurance reimbursement for our products, which could have a
materially adverse affect on our sales and our ability to sell our
products





Recent efforts by governmental and
third-party payors, including private insurance plans, to contain or reduce the
costs of health care could affect the levels of revenues and profitability of
pharmaceutical, diagnostic and biotechnology products and
companies.  For example, in some foreign markets, pricing or
profitability of prescription pharmaceuticals is subject to government
control.  In the United States, there have been a number of federal
and state proposals to implement similar government control.  Pricing
constraints on our potential products could negatively impact revenues and
profitability.





In the United States and elsewhere,
successful commercialization of our products will depend in part on the
availability of reimbursement to the consumer using our products from
third-party health care payors.  Insufficient reimbursement levels
could affect demand for our products, and therefore, our ability to realize an
appropriate return on our investment in product
development.  Third-party health care payors are increasingly
challenging the price and examining the cost-effectiveness of medical products
and services.  If we succeed in bringing one or more products to
market, and the government or third-party payors fail to provide adequate
coverage or reimbursement rates for those products, it could reduce our product
revenues and profitability.





Current
proposed regulations for reference laboratory developed diagnostic tests may
impact our ability to sell our proposed diagnostic tests under the Clinical
Laboratory Improvement Amendment (“CLIA”) exemption





Governmental agencies are currently
reviewing additional regulations to be imposed on reference laboratory developed
diagnostic tests, so called “homebrew” tests, including evidence of analytic and
clinical validity and enhanced labeling requirements.  In addition,
there have been discussions concerning lower Medicare reimbursement for non-FDA
approved tests.  Increased FDA regulation of reference laboratory
developed diagnostic tests could significantly increase the costs and
significantly reduce the demand for such tests.





We
must enroll a sufficient number of participants in our clinical trials and
generate clinical data that shows our products are safe and effective in order
to obtain the necessary regulatory approval to market our products





In order to sell our products, we must
receive regulatory approval to market our products.  Before obtaining
regulatory approvals for the commercial sale of any of our products under
development, we must demonstrate through all necessary regulatory studies,
including pre-clinical and clinical trials, that the product is safe and
effective for use in each target indication. If our products fail in research,
development and/or clinical trials, this may have a significant negative impact
on us.





In addition, the results from
pre-clinical testing and early clinical trials may not be predictive of results
obtained in late stage clinical trials. There can be no assurance that our
clinical trials will demonstrate sufficient safety and efficacy to obtain
regulatory approvals. The completion rate of our clinical trials is dependent
on, among other factors, the patient enrollment rate. Patient enrollment is a
function of many factors including:





·
            patient
      population size;


·
            access
      to patients;


·
            competitive
      trials;


·
            the
      nature of the protocol to be used in the
trial;


·
            patient
      proximity to clinical sites; and


·
            eligibility
      criteria for the study





Delays in
patient enrollment would increase costs and delay ultimate sales, if any, of our
products.





19




Our
stock price may fluctuate significantly due to reasons unrelated to our
operations, our products or our financial results.  Our stock price
may decrease if we have to issue a large number of shares of common stock in
order to raise the additional funds needed in the first quarter of
2009.





Stock prices for many technology
companies fluctuate widely for reasons which may be unrelated to operating
performance or new product or service announcements.  Broad market
fluctuations, earnings and other announcements of other companies, general
economic conditions or other matters unrelated to us or our operations and
outside our control also could affect the market price of the Common
Stock.  During the 2006 and 2007 fiscal years, the highest interday
price of our stock was $0.50 and the lowest interday price of our stock during
the same period was $0.08.  We have sufficient cash to last through
the first quarter of 2009, and we will need to raise additional funds prior to
the end of the first quarter of 2009.  In order to raise additional
funds, we may have to sell a significant number of shares of our common stock
and/or issue warrants exercisable to purchase shares of our common
stock.  While the inflow of additional funds may cause our stock price
to increase, the prospect of issuing, or the actual issuance of, a substantial
number of additional shares of common stock may cause our stock price to
decrease.





We
will need to increase the number of our authorized shares of common stock in
order to raise a meaningful amount of capital through the sale of equity
securities.  Such increase will require approval of our
stockholders.  If our stockholders do not approve the increase in
authorized common stock, we will be limited in our ability to raise a
significant amount of capital through the sale of equity
securities.




We have 200,000,000 authorized shares
of common stock.  As of December 31, 2007, we had 130,217,808 shares
of common stock issued and outstanding, and we have reserved (i) 44,418,453
shares of common stock for issuance upon the exercise of outstanding warrants
and (ii) 19,242,347 shares of common stock for issuance upon the exercise of
outstanding options.  We currently have 6,121,392 shares of common
stock available for issuance in any capital raising
transaction.  Because we may have to issue warrants in any equity deal
to raise capital, we could have significantly less than 6.1 million shares to
sell, which reduces the amount of capital we could raise.  In order to
be able to raise a significant amount of capital for future operations, we will
need to increase our authorized common stock to at least 300 million shares, or
more.  To increase our authorized common stock, we will need to secure
stockholder approval.  Because of the large number of shares held in
street name, we expect to incur significant expenses in order to obtain such
approval.  Most of our stockholders hold their shares in street name
and a charter amendment is not a discretionary item for which brokers can cast a
vote without instruction from their clients.  We would have to hire a
solicitation firm to assist us in getting sufficient stockholder votes to
increase our authorized common stock.





Our
share price may decline due to a large number of shares of our common stock
eligible for sale in the public markets and a large number of shares of our
common stock that could be issued upon the exercise of warrants and options that
are “in the money”





As of December 31, 2007, we had
outstanding 130,217,808 shares of Common Stock, without giving effect to shares
of Common Stock issuable upon exercise of (i) warrants issued to SF Capital,
exercisable for 6,214,286 shares of or common stock, (ii) warrants issued in the
February 2004 Offering, exercisable for 31,547,489 shares of our common stock
(at an exercise price of $0.30 per share), (ii) the Placement Agent's warrants,
exercisable for 3,143,335 shares of our common stock (at an exercise price of
$0.30 per share), (iii) 10,575,680 options granted under our stock option plan,
(iv) 8,666,667 options granted outside of our stock option plan, and (iv)
3,513,343 other warrants previously issued.  Of such outstanding
shares of common stock, all are freely tradable, except for any shares not yet
registered, shares underlying stock options that are not yet vested, and any
shares held by our "affiliates" within the meaning of the Securities Act
(officers, directors and 10% security holders), which shares will be subject to
the resale limitations of Rule 144 promulgated under the Securities
Act.  We will need to raise capital prior to the end of the first
quarter of 2009 and this may cause us to issue additional shares of our common
stock in 2009.





The
holders of our outstanding warrants and stock options may not exercise them, or
they may expire before we are able to receive any proceeds from the exercise of
these warrants and stock options





As of December 31, 2007, we had
44,418,453 outstanding warrants and 19,242,347 outstanding stock
options.  34,690,824 of these warrants, with an exercise price of
$0.30, expire on February 6, 2009.  The remaining 9,727,629
outstanding warrants have an average exercise price of $0.18 and have expiration
dates between 2008 and 2012.  The outstanding stock options have
exercise prices ranging from $0.15 to $0.285 and have expiration dates between
2008 and 2017.  We may not receive any significant proceeds from the
exercise of these outstanding warrants and stock options due to market
conditions and/or the expiration of the warrants and stock options prior to
exercise.  This could impact our future fund raising
options.





20




We
have not paid any dividends and do not anticipate paying dividends in the
foreseeable future





A predecessor of Applied NeuroSolutions
liquidated most of its assets and paid a dividend to its shareholders in August
2001.  We have not paid cash dividends on our common stock, and we do
not anticipate paying cash dividends on our common stock in the foreseeable
future.  Investors who require dividend income should not rely on an
investment in our common stock to provide such dividend
income.  Potential income to investors in our common stock would only
come from any rise in the market price of our common stock, which is uncertain
and unpredictable.





A
limited market for our common stock and “Penny Stock” rules may make buying or
selling our common stock difficult




Our common stock presently trades in
the over-the-counter market on the OTC Bulletin Board. As a result, an investor
may find it difficult to sell, or to obtain accurate quotations as to the price
of, our securities.  In addition, our common stock is subject to the
penny stock rules that impose additional sales practice requirements on
broker-dealers who sell such securities to persons other than established
customers and accredited investors.  The SEC regulations generally
define a penny stock to be an equity that has a market price of less than $5.00
per share, subject to certain exceptions.  Unless an exception is
available, those regulations require the delivery, prior to any transaction
involving a penny stock, of a disclosure schedule explaining the penny stock
market and the risks associated therewith and impose various sales practice
requirements on broker-dealers who sell penny stocks to persons other than
established customers and accredited investors (generally institutions and high
net worth individuals).  In addition, the broker-dealer must provide
the customer with current bid and offer quotations for the penny stock, the
compensation of the broker-dealer and its salesperson in the transaction and
monthly account statements showing the market value of each penny stock held in
the customer's account.  Moreover, broker-dealers who recommend such
securities to persons other than established customers and accredited investors
must make a special written suitability determination for the purchaser and
receive the purchaser's written agreement to transactions prior to
sale.  Regulations on penny stocks could limit the ability of
broker-dealers to sell our common stock and thus the ability of purchasers of
our common stock to sell their shares in the secondary market.





Our
disclosure controls and procedures and our internal controls over financial
reporting are not adequate and may result in our failure to disclose items that
we may be required to disclose under the Securities Act or the Securities
Exchange Act or may result in financial statements that are incomplete or
subject to restatement





Section 404 of the Sarbanes Oxley Act
of 2002 (“Section 404”) requires significant additional procedures and review
processes of our system of internal controls.  Section 404 requires
that we evaluate and report on our system of internal controls over financial
reporting beginning with this Annual Report on Form 10-KSB for this year ended
December 31, 2007.  In addition, our independent auditors must report
on management’s evaluation of those controls for the year ending December 31,
2008.  The additional costs associated with this process may be
significant.  Our internal controls under Section 404 may not be
adequate.  After documenting and testing our system, we have
identified the following material weaknesses:




·
            We
      lack segregation of duties in the period-end financial reporting process,
      and


·
            Our
      accounting software has inherent control
  deficiencies.





Additionally,
our chief executive officer and chief financial officer concluded that as of
December 31, 2007, our disclosure controls and procedures were not
effective to ensure that information required to be disclosed by us in reports
that we file or submit under the Exchange Act is recorded, processed, summarized
and reported within the time periods specified in SEC rules and
forms.  Consequently, we may fail to disclose items that we are
required to report in our SEC filings, including registration statements, proxy
statements and periodic reports.  If we are required to amend prior
reports as a result of failing to disclose required information, investors may
react adversely to such amendments and our stock price may
decrease.





Our
Independent Registered Public Accountants have substantial doubt about our
ability to continue as a going concern





21




We have
had net losses for each of the years ended December 31, 2007 and 2006, and we
have an accumulated deficit as of December 31, 2007.  Since the
financial statements for each of these periods were prepared assuming that we
would continue as a going concern, in the view of our independent registered
public accountants, these conditions raise substantial doubt about our ability
to continue as a going concern.  We anticipate that our cash balances
at December 31, 2007, coupled with our annual R & D support from Eli Lilly
and Company, should be sufficient to fund operations through the first quarter
of 2009.  We will need additional funding prior to the end of the
first quarter of 2009 in order to continue our research, product development and
our operations.  Since we do not expect to generate any material
revenues for the foreseeable future, our ability to continue as a going concern
depends, in large part, on our ability to raise additional capital prior to the
end of the first quarter 2009, either through some form of collaboration or
joint venture or debt or equity financing, which may include the exercise of
outstanding stock options and/or warrants.  If we are unable to raise
additional capital, we may be forced to discontinue our business.





ITEM
2.                      DESCRIPTION
OF PROPERTY





We lease approximately 7,500 square
feet of office and laboratory space in Vernon Hills, Illinois at an annual
rental of approximately $125,000.Our
current lease agreement expired in May 2007 and was renewed for a three-year
period ending May 2010 at a slightly reduced base rent.  We believe
that we can acquire additional space, if needed, on acceptable
terms.





ITEM
3.                      LEGAL
PROCEEDINGS





We are not currently involved in any
legal proceedings.





ITEM
4.                      SUBMISSION
OF MATTERS TO A VOTE OF SECURITY HOLDERS





None


22


PART
II





ITEM
5.                      MARKET
FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS





Our common stock is quoted on the OTC
(Over-the-Counter) Bulletin Board and traded under the symbol,
"APNS".  Prior to November 25, 2003, our common stock was traded on
the OTC Bulletin Board under the symbol “HMYD”.  Our common stock was
previously traded on the OTC Bulletin Board under the symbol “OPHD” until
February 5, 2002.





The following table sets forth the
range of high and low closing bid prices for our common stock, from January 1,
2006 through December 31, 2007, and for each of the quarterly periods indicated
as reported by the OTC Bulletin Board.  The bid prices represent
prices between broker-dealers and don’t include retail mark-ups and mark-downs
or any commissions to the dealer.  These bid prices may not reflect
actual transactions.







High
            Low2006:First
      quarter
            $0.33
            $0.17Second
      quarter
            0.24
            0.11Third
      quarter
            0.32
            0.16Fourth
      quarter
            0.42
            0.262007:First
      quarter
            $0.31
            $0.23Second
      quarter
            0.32
            0.20Third
      quarter
            0.24
            0.15Fourth
      quarter
            0.22
            0.11





As of February 29, 2008, we had
approximately 3,000 record holders of our common stock.  We estimate
that as of such date, there were more than 2,500 beneficial holders of our
common stock.





No dividends were paid in 2006 and
2007.  There are no restrictions on the payment of
dividends.  We do not intend to pay dividends for the foreseeable
future.





All of our securities that were issued
or sold by us since March 15, 2001, have been registered with the SEC, except
8,666,667 stock options issued outside our Stock Option Plan in 2006 and 926,316
shares of restricted  common stock.  All of these issuances
were made in reliance upon the exemption set forth in Section 4(2) of the
Securities Act of 1933.  We filed an SB-2 registration statement in
July 2004, an S-8 registration statement in December 2004, and an SB-2
registration statement in November 2007. An S-8 registration statement is
expected to be filed in the second quarter of 2008 to register the stock options
and restricted stock noted above.





23


ITEM
6.                      MANAGEMENT’S
DISCUSSION AND ANALYSIS OR PLAN OF OPERATION





General





Our business strategy is to build on
our strong scientific research, and commitment to develop a range of solutions
to meet the unmet needs of the growing number of Alzheimer patients. Through our
tau based approach we continue to develop proprietary technology, know-how and
tools. We are seeking to offer options for early diagnosis and high impact
therapeutic solutions that will enhance the physicians’ ability to effectively
manage their patient’s treatment.





Our unique science, stemming from the
work of our founding scientist, Dr. Peter Davies, is focused on developing a
range of diagnostic tests.  In addition, through our collaboration
with a top tier Pharmaceutical company, Eli Lilly and Company, our tau-based
science is the foundation of the development and commercialization of novel
therapeutics to modify the course of AD.  Our principal development
programs, and plan of operation for each, are as follows:





·
            AD Therapeutic Program– We are involved in the discovery and development of novel
      therapeutic targets for the development of treatments for Alzheimer’s
      disease based upon a concept developed by Peter Davies, Ph.D., the
      Company’s founding scientist and the Burton P. and Judith Resnick
      Professor of Alzheimer’s Disease Research at AECOM.  As a result
      of Dr. Davies’ research, and the Company’s expertise, we are focused on
      discovery of unique therapeutics that may be involved in a common
      intracellular phosphorylation pathway leading to the development of the
      abnormal, destructive brain structures, amyloid plaques and
      neurofibrillary tangles, that are characteristic of Alzheimer’s
      disease.  A patent application was filed in 2005 covering Dr.
      Davies work relative to the therapeutic work.  In November 2006,
      we entered into an agreement with Eli Lilly and Company to develop
      therapeutics to treat AD.  The agreement forms a collaboration
      that combines the expertise, research tools and tau-based approach
      advanced by Dr. Davies and our team at APNS, with the scientists,
      therapeutic development expertise and financial resources at Eli Lilly and
      Company.  The agreement calls for Lilly to receive the exclusive
      worldwide rights to the intellectual property related to our expertise in
      understanding the molecular neuropathology of AD as it pertains to the
      formation of neurofibrillary tangles.  Lilly will fund the vast
      majority of all pre-clinical research and development and will fully
      finance the clinical testing, manufacturing, sales and marketing of AD
      therapeutics developed from our collaboration.  Since the start
      of the collaboration, the collaboration management structure, working
      teams and external resources have become fully operational.  The
      key assets and proprietary tools have been appropriately transferred to
      support work being undertaken by each of Dr. Davies, Lilly and
      APNS.  The first internal milestone on the proprietary
      tau-related APNS target was reached in the second quarter of 2007 and the
      next internal milestone is scheduled for the first quarter of
      2008.  Key in-vivo models have been established with the goal to
      validate our tau-based target.  The collaboration has made good
      progress on the milestones established by the program management for the
      proprietary tau-related APNS target.  APNS’s first paid
      milestone is targeted for achievement in late 2008 to early
      2009.  The collaboration continues to make good progress toward
      additional tau-based targets with an additional target being screened and
      validation studies underway for other
targets.




·
            AD Diagnostic Program–
      Our diagnostic program is based on Dr. Davies’ research of the tau
      pathology, and revolves around developing a pipeline of diagnostic tests
      that could include: (i) the detection of hyperphosphorylated tau in CSF,
      (ii) a screening test to rule out AD in serum, and (iii) the detection of
      hyperphosphorylated tau in serum.  Our product farthest along in
      development is a CSF-based diagnostic test to detect whether a person has
      AD.  This diagnostic, based upon the detection of a certain AD
      associated protein found in the CSF of AD patients, has achieved, based on
      published research validation studies, an overall sensitivity and
      specificity in the range of 85% to 95%.  This test is based on
      extensive testing in our lab, utilizing in excess of 2,000 CSF samples to
      differentiate patients diagnosed with AD from patients diagnosed with
      other forms of dementia and relevant neurological diseases, including
      major depression, as well as healthy controls.  We are
      continuing development of our CSF-based diagnostic to reduce the tests
      incubation time. Our most recent research has sought to further
      substantiate the utility of the test in the MCI population.  Two
      studies published in 2007 show the ability of our CSF-based test to be a
      strong predictor of the decline from MCI to AD.  The September
      2007 online edition of Neurobiology of Aging
      presented a study comparing five of the best-known CSF biomarkers for
      AD.  Our ptau biomarker was the strongest predictor of the
      decline from MCI to AD.  The December 2007 issue of Neurology published an
      internationally based multi-center study that demonstrated our ptau
      biomarker was a significant predictor of the decline from MCI to AD in a
      clinically useful time period of 1.5 years.  Studies published
      in the December 2005 edition of Neuroscience Letters
      and in the March 2006 journal Neurobiology of Aging
      support the use of our CSF-based diagnostic test in identifying
      individuals with MCI who, over time, are most likely to develop AD.
      Current data seems to suggest that 60% to 80% of individuals with MCI will
      eventually progress to AD.  As a neurodegenerative disease, it
      is theorized that early detection of AD could greatly enhance the ability
      of current and future therapies to better manage the
      disease.    A study published in the January 2004
      edition of Archives of
      General Psychiatry has shown that detecting phosphorylated tau
      (“ptau”) proteins in CSF comes closest to fulfilling the criteria of a
      biological marker for AD.  This publication reported that our
      CSF-based test exceeded standards for an AD diagnostic test established by
      the National Institute of Aging and the Ronald and Nancy Reagan Research
      Institute of the Alzheimer’s Association in a 1998 published “Consensus
      Report”.  It was determined by that group that a successful
      biological marker would be one that had a sensitivity level and
      specificity level of at least 80%.  A Position Paper, “Research
      Criteria for the Diagnosis of Alzheimer’s Disease: Revising the
      NINCDS-ADRDA Criteria”, was published in the August 2007 edition of Lancet Neurology that
      describes suggested revisions to the criteria for the diagnosis of
      Alzheimer’s disease, including the use of CSF biomarkers, specifically
      referencing our CSF-based p-tau 231
test.




24




We are
utilizing the knowledge gained during the development of our CSF-based
diagnostic test to aid in the development of serum-based diagnostic tests to
detect Alzheimer’s disease, specifically a screening test to rule out AD as well
as the detection of our ptau biomarker to support the diagnosis of
AD.  In January 2006, we entered into a research agreement with
Nanosphere, Inc., a nanotechnology-based molecular diagnostics company, to
assist us in the development of a serum-based diagnostic test for
AD.  Work performed during the research agreement resulted in
Nanosphere and APNS scientists achieving a better understanding (in January
2007) of the tools necessary to advance the development of a serum-based AD
diagnostic test with our scientifically accepted biomarkers.  We
established a project plan and began developing these key tools in early 2007,
and targeted to have the first of these tools developed during the first quarter
of 2008 to enable us to continue to advance our serum diagnostic development
work.





We sought
additional expertise and resources by conducting a scientific advisory board
meeting that brought together APNS scientists, Dr. Davies and three outside
diagnostic experts to assist us in assessing the most effective approaches and
resources to advance our diagnostic development programs.  Through
2007, we followed our work plans to develop antibody tools and we achieved a key
milestone in the first quarter of 2008 by identifying several high affinity
antibodies that meet our requirements.  These tools will support
advancing development of a “rule out” serum based test for
AD.  Additional back up tool options to support a “rule out” test are
also in development.  In addition, tools directed toward the
development of a ptau biomarker based test in serum that could support the early
identification of AD are targeted for completion in the second quarter
2008.  Throughout the tool development process we have been
identifying specialized technologies that may enable us to advance our
diagnostic development programs.  Technology assessments have been
initiated.  Currently there is no FDA-approved diagnostic test to
detect AD.





While
continuing development of our diagnostic programs, we are seeking appropriate
partnerships and expertise to assist us in advancing towards
commercialization.  We are having discussions with experts and
companies regarding various approaches and opportunities for collaboration and
to assist us in advancing our diagnostic programs towards
commercialization.





·
            Transgenic Mice –To
      date, no widely accepted animal model that exhibits both AD pathologies
      has been developed.  Dr. Peter Davies, through collaboration
      with a researcher at Nathan Klein Institute (“NKI”), has developed a
      transgenic mouse containing the human tau gene that develops human paired
      helical filaments, the building blocks of the neurofibrillary tangles,
      which are known to be involved in the pathology of Alzheimer’s disease.
      The pathology in these mice is Alzheimer-like, with hyperphosphorylated
      tau accumulating in cell bodies and dendrites as neurofibrillary
      tangles.  In addition, these transgenic mice have exhibited
      extensive neuronal death that accompanies the tau
      pathology.  These transgenic mice could be used for testing the
      efficacy of therapeutic compounds.  AECOM and the New York State
      Office of Mental Health, the agency that oversees NKI, each have an
      interest in these transgenic mice.  Through our agreements with
      AECOM, we have license rights to AECOM’s interest in these transgenic
      mice.  In 2006, we entered into additional license agreements
      that provide us with the exclusive rights to sell these
      mice.  The mice are currently available through Jackson
      Laboratories.  In December 2006, we entered into an agreement to
      sell a breeding pair of these mice.





25


As we currently do not have any
approved products in the marketplace, we do not have a time frame for generating
significant revenues from our research and development activities.





As of December 31, 2007, we had a cash
balance of $2,960,141.  We anticipate that our cash balance at
December 31, 2007, coupled with our annual R & D support from Eli Lilly and
Company, should be sufficient to fund our current planned development activities
and operating expenses through the first quarter of 2009.  We will
need additional funding during the first quarter of 2009 to continue our
research, product development and our operations.  We intend to seek
such additional funding through private and/or public financing, through
exercise of currently outstanding stock options and warrants or through
collaborative or other arrangements with partners.  If we need to sell
additional shares of common stock in order to raise such additional funding, we
will in all likelihood amend our certificate of incorporation to increase the
number of authorized shares of common stock.  This amendment would
require the approval of our stockholders.  The cash on hand will be
used for ongoing research and development, working capital, general corporate
purposes and possibly to secure appropriate partnerships and
expertise.





We do not anticipate the purchase,
lease or sale of any significant property and equipment during
2008.  We do not anticipate any significant changes in our employee
count during 2008.





Plan
of Operation







Our strategic plan involves focusing
our resources, and establishing priorities, to maximize the return to the
shareholders.  In order to accomplish this objective, it is expected
that we will focus on advancing our therapeutic collaboration with Eli Lilly and
Company and developing the projects in our diagnostic pipeline to detect AD,
including our CSF-based test and serum-based tests, toward
commercialization.




In November
2006, we entered into an agreement with Eli Lilly and Company (“Lilly”) to
develop therapeutics to treat AD.  Pursuant to the terms of the
agreement, we received $2 million in cash, including an equity investment of
$500,000, from Lilly, plus we will receive annual research and development
support for the duration of the collaboration agreement.  In addition,
Lilly will, based on the achievement of certain defined milestones, provide us
over time with up to $20 million in milestone payments for advancing our
proprietary target to a therapeutic compound.  The collaboration has
also made progress on other targets that are part of the collaboration that
could provide milestone payments to us over time of up to $10 million for
advancing each of these other targets to a therapeutic
compound.  There is no limit to the number of targets that we could
receive milestone payments from Lilly.  Royalties are to be paid to us
for AD drug compounds brought to market that result from the
collaboration.  There is no limit on the number of drug compounds for
which royalty payments may be due to us.  Lilly received the exclusive
worldwide rights to the intellectual property related to our expertise in
understanding the molecular neuropathology of AD as it pertains to the formation
of neurofibrillary tangles in the development of AD
therapeutics.  Lilly will fund the vast majority of all pre-clinical
research and development and will fully finance the clinical testing,
manufacturing, sales and marketing of AD therapeutics developed from our
collaboration.




Our product
farthest along in development is a CSF-based diagnostic test to detect whether a
person has AD.  We are planning to continue development to reduce the
tests incubation time.  We are utilizing the knowledge gained during
the development of our CSF-based diagnostic test to aid in the development of
serum-based diagnostic tests to detect Alzheimer’s disease, specifically a
screening test to rule out AD as well as the detection of our ptau biomarker to
support the diagnosis of AD.  In January 2006, we entered into a
research agreement with Nanosphere, Inc., a nanotechnology-based molecular
diagnostics company, to assist us in the development of a serum-based diagnostic
test for AD.  Work performed during the research agreement resulted in
Nanosphere and APNS scientists achieving a better understanding (in January
2007) of the tools necessary to advance the development of a serum-based AD
diagnostic test with our scientifically accepted biomarkers.  We
established a project plan and began developing these key tools in early 2007,
and targeted to have the first of these tools developed during the first quarter
of 2008 to enable us to continue to advance our serum diagnostic development
work.





26





We sought
additional expertise and resources by conducting a scientific advisory board
meeting that brought together APNS scientists, Dr. Davies and three outside
diagnostic experts to assist us in assessing the most effective approaches and
resources to advance our diagnostic development programs.  Through
2007, we followed our work plans to develop antibody tools and we achieved a key
milestone in the first quarter of 2008 by identifying several high affinity
antibodies that meet our requirements.  These tools will support
advancing development of a “rule out” serum based test for
AD.  Additional back up tool options to support a “rule out” test are
also in development.  In addition, tools directed toward the
development of a ptau biomarker based test in serum that could support the early
identification of AD are targeted for completion in the  second
quarter 2008.  Throughout the tool development process we have been
identifying specialized technologies that may enable us to advance our
diagnostic development programs.  Technology assessments have been
initiated.





In order to maximize the value, and
minimize the time to market, of our diagnostic programs, we are seeking some
form of partnering, including collaborations, strategic alliance and/or
licensing opportunities.





We will need additional funding prior
to the end of the first quarter 2009 to cover operations, and to fund the costs
of any diagnostic products in development.  Eli Lilly and Company
funds the vast majority of our therapeutic program through our
collaboration.  If additional funding is not obtained, we will not be
able to fund any programs in development, and we may have to discontinue all our
product development and/or our operations.





Critical
Accounting Policies and Estimates





Our consolidated financial statements
have been prepared in accordance with accounting principles generally accepted
in the United States of America.  The consolidated financial
statements include the accounts of APNS and its wholly-owned subsidiaries prior
to our dissolution of our subsidiaries in 2004.  All significant
intercompany balances and transactions have been eliminated.  The
preparation of these financial statements requires our management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and the disclosure of contingent assets and liabilities at the date
of the financial statements and the reported amounts of revenues and expenses
during the reporting period.





On an on-going basis, our management
evaluates its estimates and judgments, including those related to tax valuation
and equity compensation.  Our management bases its estimates and
judgments on historical experience and on various other factors that are
believed to be reasonable under the circumstances.  Actual results may
differ from these estimates under different assumptions or
conditions.  Our management believes the following critical accounting
policies, among others, affect our more significant judgments and estimates used
in preparation of these consolidated financial statements.





Revenue
Recognition





We generate revenues from research
agreements and collaborations, and in the past, we also generated revenues from
grants, and recognize these revenues when earned.  Grant revenues
represent funds received from certain government agencies for costs expended to
further research on the subject of the grant.  In accordance with EITF
00-21 “Revenue Arrangements with Multiple Deliverables”, for arrangements that
contain multiple deliverables, we separate the deliverables into separate
accounting units if they meet all of the following:  a) the delivered
items have stand-alone value to the customer; b) the fair value of any
undelivered items can be reliably determined; and c) if the arrangement includes
a general right of return, delivery of the undelivered items if probable and
substantially controlled by the seller.  Deliverables that do not meet
these criteria are combined with one or more other deliverables into one
accounting unit.  Revenue from each accounting unit is recognized
based on the applicable accounting literature, primarily Staff Accounting
Bulletin No. 104 (SAB 104), "Revenue Recognition".





27





Research and
Development





All research and development costs are
expensed as incurred and include salaries of, and expenses related to, employees
and consultants who conduct research and development.  We have, from
time to time, entered into arrangements whereby we will obtain research
reimbursement in the form of funds received to partially reimburse us for costs
expended.





Net Deferred Tax Asset
Valuation Allowance





We record our net deferred tax assets
in the amount that we expect to realize based on projected future taxable
income.  In assessing the appropriateness of the valuation,
assumptions and estimates are required such as our ability to generate future
taxable income.  In the event that we were to determine that we would
be able to realize our deferred tax assets in the future in excess of our net
recorded amount, an adjustment to the deferred tax asset would increase income
in the period such determination was made.  Since inception, we have
concluded that the more likely than not criteria of Statement of Financial
Accounting Standard No. 109, Accounting for Income Taxes,
has not been met and accordingly, we have recorded a valuation allowance for all
our deferred income taxes for all periods presented.





For the year ended December 31, 2007,
we adopted Financial Accounting Standards Board (FASB) Interpretation
48, Accounting for Uncertainty
in Income Taxes — an Interpretation of FASB Statement No. 109, (FIN
48), which clarifies the accounting for uncertain income tax
positions.  This interpretation prescribes a financial statement
recognition threshold and measurement attribute for any tax position taken, or
expected to be taken, in a tax return. The interpretation also provides guidance
on derecognition, classification, interest and penalties, accounting in interim
periods, disclosure and transition.  Upon adoption, there was not
any unrecognized income tax benefits and the adoption of FIN
48 had no effect on shareholders’ equity.  We do not expect any
reasonably possible material changes to the estimated amount in our liability
associated with our uncertain tax position through December 31,
2007.





Equity
Compensation





Effective January 1, 2006, we adopted
Statement No. 123R, Share-Based Payment (SFAS
123R), which requires companies to measure and recognize compensation expense
for all stock-based payments at fair value.  SFAS 123R is being applied on
the modified prospective basis.  Prior to the adoption of SFAS 123R,
we accounted for our stock-based compensation plans under the recognition and
measurement principles of Accounting Principles Board (APB) Opinion No. 25,
Accounting for Stock Issued to
Employees, and related interpretations, and accordingly, recognized no
compensation expense related to the stock-based plans.




Under the
modified prospective approach, SFAS 123R applies to new awards and to awards
that were outstanding on January 1, 2006 that are subsequently modified,
repurchased, cancelled or vest.  Under the modified prospective
approach, compensation cost recognized in 2006 includes compensation cost for
all share-based payments granted prior to, but not yet vested on, January 1,
2006, based on the grant-date fair value estimated in accordance with the
provisions of SFAS 123R, and compensation cost for all shared-based payments
granted subsequent to January 1, 2006, based on the grant-date fair value
estimated in accordance with the provisions of SFAS 123R.  Prior
periods were not restated to reflect the impact of adopting the new
standard.





We apply Statement of Financial
Accounting Standards (SFAS) No. 123 and EITF 96-18 Accounting for Equity Instruments
That are Issued to Other Than Employees for Acquiring, or in Conjunction with
Selling, Goods or Services, for our options awarded to non-employee
consultants.  To determine fair value, management is required to make
assumptions such as the expected volatility and expected life of the
instruments.














28







Results
of Operations





The following discussion of the
financial condition and results of operations should be read in conjunction with
the consolidated financial statements and notes thereto included in Item
7.







Year
Ended December 31, 2007 Compared to Year Ended December 31, 2006





Revenues





We recognized $1,083,333 of revenues in
2007 from the completion of one research agreement and the recognition of twelve
months of our initial funds received from our collaboration with Eli Lilly and
Company.  We recognized $251,634 of revenues in 2006 from the
completion of two research agreements and the recognition of approximately one
month of our initial funds received from our collaboration with Eli Lilly and
Company.





Research
and development





Research and development expenses
consist primarily of compensation of personnel and related benefits and taxes,
funding of research related to license agreements, scientific consultant
expenses, laboratory supplies and overhead costs.  Research and
development expenses for the year ended December 31, 2007 decreased 22% or
$460,173 to $1,659,258 from $2,119,431 for the year ended December 31,
2006.  Below is a summary of our most significant research and
development expenses:





IncreaseExpense
            
            2007
            
            
            2006
            
            
            (Decrease)Compensation,
      taxes and benefits
            
            $
            786,961
            
            
            $
            885,127
            
            
            $
            (98,166
            )Program
      R & D funding, license fees and consulting
            
            
            791,890
            
            
            
            871,575
            
            
            
            (79,685
            )Rent,
      telephone and utilities
            
            
            107,342
            
            
            
            110,645
            
            
            
            (3,303
            )Stock
      option compensation expense
            
            
            3,423
            
            
            
            230,018
            
            
            
            (226,595
            )Other
      research and development expenses, net of reimbursements
            
            
            (30,358
            )
            
            
            22,066
            
            
            
            (52,424
            )Total
      Research and Development Expenses
            
            $
            1,659,258
            
            
            $
            2,119,431
            
            
            $
            (460,173
            )





This decrease in 2007 is primarily due
to non-cash costs associated with expensing stock options, a decrease in
research funding, license fees and consulting and a decrease in compensation
related expenses.  Beginning January 1, 2006, SFAS 123R requires
companies to measure and recognize compensation expense for all stock based
payments at fair value.  Expense included in 2007 was $3,423 while
expense included in 2006 was $230,018, which was comprised of $112,558 primarily
due to option grants prior to 2006 and a non-cash expense of $117,460 for
unrecognized compensation costs for options granted in 2005 that were
subsequently cancelled in June 2006.  We also had a decrease in
research funding, licensing and consulting of $79,685 due to our agreement with
Nanosphere in 2006 and expense for regulatory consultants in 2006, which was
offset by an increase in our payments to AECOM, license fees incurred, costs of
our scientific advisory meeting, and an increase in our direct costs for R &
D programs in 2007.  Our compensation related expenses decreased due
to a reduction in one of our lab technicians in the second half of 2006, an
additional reduction due to a restructuring of our VP-R & D position in the
fourth quarter of 2007 and a $45,000 reduction in benefit expense in
2007.  We estimate that we may incur costs of approximately $150,000
to $180,000 per month on research and development activities going
forward.  This excludes the non-cash effect of accounting for equity
instruments included in the annual amounts mentioned above.  These
expenditures, however, may fluctuate from quarter-to-quarter and year-to-year
depending upon the resources available, our development schedule, and our
progress.  Results of preclinical studies, clinical trials, regulatory
decisions and competitive developments for our diagnostic programs may
significantly influence the amount of our research and development
expenditures.  In addition, if we incur clinical development costs of
any diagnostic program, research and development spending will significantly
increase.








29





General
and administrative





General and administrative expenses
consist primarily of compensation of personnel and related benefits and taxes,
legal and accounting expenses, and occupancy related
expenses.  General and administrative expenses for the year ended
December 31, 2007 decreased 10% or $224,500 to $2,000,439 from $2,224,939 for
the year ended December 31, 2006.  Below is a summary of our most
significant general and administrative expenses:





IncreaseExpense
            
            2007
            
            
            2006
            
            
            (Decrease)Compensation,
      taxes and benefits
            
            $
            753,513
            
            
            $
            502,614
            
            
            $
            250,899Consulting
            
            
            138,603
            
            
            
            212,459
            
            
            
            (73,856
            )Professional
      fees
            
            
            319,960
            
            
            
            552,366
            
            
            
            (232,406
            )Rent,
      telephone and utilities
            
            
            44,876
            
            
            
            50,317
            
            
            
            (5,441
            )Stock
      option compensation expense
            
            
            532,917
            
            
            
            687,929
            
            
            
            (155,012
            )Other
      general and administrative expenses
            
            
            210,570
            
            
            
            219,254
            
            
            
            (8,684
            )Total
      General and Administrative Expenses
            
            $
            2,000,439
            
            
            $
            2,224,939
            
            
            $
            (224,500
            )





This decrease in 2007 is primarily due
to non-cash costs associated with expensing stock options and decreases in
professional fees and consulting costs partially offset by an increase in
compensation costs.  Beginning January 1, 2006, SFAS 123R requires
companies to measure and recognize compensation expense for all stock based
payments at fair value.  Expense included in 2006 was $687,929 while
it was $532,917 in 2007.  The expense in 2006 was greater due to
larger grants in 2006, primarily to our new CEO and Chairman who was appointed
in June 2006.  The decrease in professional fees is primarily related
to costs incurred to retain an executive search firm to assist us in hiring
Ellen R. Hoffing as President and CEO in August 2006, plus additional legal time
spent on specific projects in 2006, including our stockholders’ meeting,
numerous licensing agreements and SEC filings.  Consulting costs
decreased in 2007 primarily due to a reduction in consulting projects and a
reduction in PR expense.  In 2006, we contracted with a business
development consultant and with operational review consultants for specific
projects.  The increase in compensation expense is primarily due to
the hiring of Ms. Hoffing in August 2006.  We estimate that we may
incur costs of approximately $100,000 to $150,000 per month on general and
administrative activities going forward.  This excludes the non-cash
effect of accounting for equity instruments included in the annual amounts
mentioned above.  These expenditures, however, may fluctuate from
quarter-to-quarter and year-to-year depending upon the resources available, SEC
requirements, and our development schedule.





Other
income and expense





Interest expense for the year ended
December 31, 2007 was $12,159 due to non-cash amortization of debt discount
related to the bridge loan.  Interest expense for the year ended
December 31, 2006 was $218,740, primarily due to $189,707 non-cash amortization
of debt discount and $29,000 accrued interest related to the bridge
loan.    Interest income for the year ended December 31,
2007 increased 172% or $38,011, to $60,160 from $22,149 for the year ended
December 31, 2006.  The increase is primarily due to higher average
invested balances and a higher rate of return.





We currently do not hedge foreign
exchange transaction exposures.  As of December 31, 2007, we do not
have any assets and liabilities denominated in foreign currencies.





Net
loss





We incurred a net loss of $2,528,363
for the year ended December 31, 2007 compared to a net loss of $4,289,327 for
the year ended December 31, 2006.  The primary reasons for the
$1,760,964 decrease in the net loss in 2007 were the $831,699 increase in
revenues; the $381,607 decrease in stock based compensation expense; the
$306,262 decrease in professional fees and consulting; and the $244,592 net
decrease in interest expense/income.





Capital
resources and liquidity





To date, we have raised equity and
convertible debt financing and received research agreement revenues,
collaboration revenues and grant revenues to fund our operations, and we expect
to continue this practice to fund our ongoing operations.  Since
inception, we have raised net proceeds of approximately $42.1 million from
private equity and convertible debt financings.  We have also received
approximately $3.9 million from research agreements, collaboration revenues and
grant revenues.





30




Our cash and
cash equivalents were $2,960,141 and $1,433,250 at December 31, 2007 and 2006,
respectively.  The increase in our cash balance is due to the $4.6
million in funds raised in 2007 less repayment of the $500,000 July 2006 bridge
loan in January 2007 less the excess cash used in operations.





We used cash in operating activities of
$2,565,860 for the year ended December 31, 2007 versus cash used in operating
activities of $1,809,803 for the year ended December 31, 2006.  This
increase primarily reflects the funds received from Eli Lilly and Company in
December 2006 net of the increase in non-cash equity and interest expense in
2006.  Improved cash flow in 2007 due to funds received in financings
allowed us to pay down liabilities during 2007.  Cash used in
investing activities was negligible in 2007 and 2006.  Net cash
provided by financing activities was $4,097,539 for the year ended December 31,
2007 versus net cash provided by financing activities of $1,581,299 for the year
ended December 31, 2006.  This increase primarily reflects additional
funds raised through sale of stock and exercise of warrants in
2007.  The bridge loan funds received in 2006, were repaid, plus
accrued interest, in January 2007.





We have incurred recurring losses since
our inception and expect to incur substantial additional research and
development costs prior to reaching profitability.  We incurred
research and development costs of $1,655,835 in 2007 and $1,889,413 in 2006,
excluding non-cash costs related to accounting for stock options and other costs
associated with the issuance of equity instruments.  Through 2007,
virtually all of our research and development costs were internal costs and
license costs which were not specifically allocated to any of our research and
development projects.  Beginning in 2008, an increasing amount of our
research and development costs are being specifically allocated to our research
and development projects.  Through a restructuring, we eliminated a
senior scientist position in November 2007.  The compensation that had
been utilized for the senior scientist is now being allocated to direct R &
D projects and working with outside companies and consultants to obtain specific
expertise and technologies to assist us in advancing our programs.  We
anticipate that our cash balances as of December 31, 2007, coupled with
anticipated funds to be received from operations, will be sufficient to cover
our planned research and development activities and general operating expenses
through the first quarter 2009.  We will need additional funding prior
to the end of the first quarter 2009 to cover operations.  If
additional funding is not obtained, we will not be able to fund the costs of any
programs in development.  This would have a material adverse effect on
our operations and our prospects.





As we currently do not have any
approved products in the marketplace, we do not have a time frame for generating
significant revenues from our research and development activities.





We currently do not have sufficient
resources to maintain operations and complete the development of our proposed
research projects.  Therefore, we will need to raise substantial
additional capital prior to the end of the first quarter 2009 to fund our
operations.  We cannot be certain that any financing will be available
when needed, or on terms acceptable to us.  If we fail to raise
additional financing as we need it, we may have to delay or terminate our own
product development programs or pass on opportunities to in-license or otherwise
acquire new products and/or technologies that we believe may be beneficial to
our business.  We may spend capital on:





•      research
and development programs;


•      pre-clinical
studies and clinical trials; and


•      regulatory
processes.





The
amount of capital we may need will depend on many factors, including
the:





•      progress,
timing and scope of research and development programs;


•      progress,
timing and scope of our pre-clinical studies and clinical trials;


•      time and
cost necessary to obtain regulatory approvals;


•      time and
cost necessary to seek third party manufacturers to manufacture our products for
us;


•      time and
cost necessary to seek marketing partners to market our products for
us;


•      time and
cost necessary to respond to technological and market developments;


•      changes
made to, or new developments in, our existing collaborative, licensing and
other


commercial relationships;
and


•      new
collaborative, licensing and other commercial relationships that we may
establish.





31




Commitments





We have several financial commitments,
including those relating to our license agreements with Albert Einstein College
of Medicine (“AECOM”).





Under our license agreements with
AECOM, we are required to:


•      pay
semi-annual maintenance payments in January and July each year;


•
            pay
      quarterly funding payments in February, May, August and November each year
      as long as the license agreements are in place;
  and


•      pay the
costs of patent prosecution and maintenance of the patents included in the
agreement.





Our fixed expenses, such as rent,
license payments and other contractual commitments, may increase in the future,
as we may:


•      enter into
additional leases for new facilities and capital equipment;


•      enter into
additional licenses and collaborative agreements; and


•      incur
additional expenses associated with being a public company.





In addition to the commitments to
AECOM, we also have consulting agreements and minimum annual lease
payments.





The following table summarizes the
timing of these future long term contractual obligations and commitments for the
next five years ending December 31:





Contractual
      Obligations
            
            2008
              Year
      1
            
            
            2009
              Year
      2
            
            
            2010
              Year
      3
            
            
            2011
              Year
      4
            
            
            2012
              Year
      5
            
            
            TotalOperating
      Leases
            
            $
            99,375
            
            
            $
            99,375
            
            
            $
            37,266
            
            
            $
            -
            
            
            $
            -
            
            
            $
            236,016Consulting
      Agreements with initial terms greater than one year
            
            
            99,000
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            99,000Commitments
      Under License Agreement with AECOM
            
            
            500,000
            
            
            
            500,000
            
            
            
            500,000
            
            
            
            500,000
            
            
            
            500,000
            
            
            
            2,500,000Total
      Contractual Cash Obligations
            
            $
            698,375
            
            
            $
            599,375
            
            
            $
            537,266
            
            
            $
            500,000
            
            
            $
            500,000
            
            
            $
            2,835,016





We are obligated to continue to pay
AECOM $500,000 for each year in which the Agreements are still in
effect.  In addition, we are obligated to pay AECOM a percentage of
all revenues we receive from selling and/or licensing aspects of the AD
technology licensed under the Agreements that exceeds the minimum obligations
reflected in the annual license maintenance payments.





Recently
issued accounting pronouncements





In July 2006, the FASB issued
Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (“FIN 48”).
FIN 48 prescribes a recognition threshold and measurement attribute for the
financial statement recognition and measurement of a tax position taken or
expected to be taken in its tax return. FIN 48 also provides guidance on
derecognition, classification, interest and penalties, accounting in interim
periods, disclosure and transition. FIN 48 is effective in fiscal years
beginning after December 15, 2006. The provisions of FIN 48 are to be applied to
all tax positions upon initial adoption, with the cumulative effect adjustment
reported as an adjustment to the opening balance of retained earnings.Upon adoption, there were
no unrecognized income tax benefits and the adoption of FIN
48 had no effect on shareholders’ equity.





In February 2007, the FASB Board
issued SFAS No. 159, “The Fair Value Option for Financial Assets and
Financial Liabilities” (“SFAS 159”). This statement permits entities to choose
to measure many financial instruments and certain other items at fair value.
SFAS 159 is effective for fiscal years beginning after November 15,
2007.  We are currently assessing the effect that SFAS 159 will have on our
results of operations and financial position.





32




In
December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in
Consolidated Financial Statements an amendment of ARB No. 51” (“SFAS
160”).  This statement establishes accounting and reporting standards
for noncontrolling interests in subsidiaries and for the deconsolidation of
subsidiaries and clarifies that a noncontrolling interest in a subsidiary is an
ownership interest in the consolidated entity that should be reported as equity
in the consolidated financial statements.  This Statement also
requires expanded disclosures that clearly identify and distinguish between the
interests of the parent owners and the interests of the noncontrolling owners of
a subsidiary.  SFAS 160 is effective for fiscal years beginning on or
after December 15, 2008.  We do not believe that the adoption of SFAS
160 will have a material effect on our results of operations or financial
position.





In December 2007, the FASB issued SFAS
No. 141 (Revised 2007), “Business Combinations” (“SFAS 141 (Revised
2007)”).  While this statement retains the fundamental requirement of
SFAS 141 that the acquisition method of accounting (which SFAS 141 called the
purchase method) be
used for all business combinations, SFAS 141 (Revised 2007) now establishes the
principles and requirements for how an acquirer in a business
combination:  1) recognizes and measures in its financial statements
the identifiable assets acquired, the liabilities assumed, and any
noncontrolling interests in the acquiree; 2) recognizes and measures the
goodwill acquired in the business combination or the gain from a bargain
purchase; and 3) determines what information should be disclosed in the
financial statements to enable the users of the financial statements to evaluate
the nature and financial effects of the business combination.SFAS 141 (Revised 2007)
is effective for fiscal years beginning on or after December 15,
2008.  We do not believe that the adoption of SFAS 141 (Revised 2007)
will have a material effect on our results of operations or financial
position.


33


ITEM
      7.
            FINANCIAL
      STATEMENTS











APPLIED
NEUROSOLUTIONS, INC.


(a
development stage company)




FINANCIAL
STATEMENTS











Contents





PageReport
      of Independent Registered Public Accounting Firm
            35Consolidated
      Balance Sheets as of December 31, 2007 and 2006
            36Consolidated
      Statements of Operations for the Years Ended December 31, 2007 and 2006,
      and for the Cumulative Period From March 14, 1992 (inception) to December
      31, 2007
            37Consolidated
      Statements of Stockholders’ Equity/(Deficit) for the Years Ended December
      31, 2007, and 2006, and for the Cumulative Period From March 14, 1992
      (inception) to December 31, 2007
            38-40Consolidated
      Statements of Cash Flows for the Years Ended December 31, 2007, and 2006,
      and for the Cumulative Period From March 14, 1992 (inception) to December
      31, 2007
            41-42Notes
      to Consolidated Financial Statements for the Years Ended December 31,
      2007, and 2006, and for the Cumulative Period From March 14, 1992
      (inception) to December 31, 2007
            43-61




















34


REPORT OF
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM











To the
Stockholders, Audit Committee and Board of Directors


Applied
NeuroSolutions, Inc.


Vernon
Hills, Illinois








We have
audited the accompanying consolidated balance sheets of Applied NeuroSolutions,
Inc. (a development stage company) as of December 31, 2007 and 2006, and the
related consolidated statements of operations, shareholders' equity/(deficit)
and cash flows for the years then ended.  These consolidated financial
statements are the responsibility of the company's management.  Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.





We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States).  Those standards require
that we plan and perform the audit to obtain reasonable assurance about whether
the consolidated financial statements are free of material
misstatement.  The Company is not required to have, nor were we
engaged to perform, an audit of its internal control over financial
reporting.  Our audit included consideration of its internal control
over financial reporting as a basis for designing audit procedures that are
appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the Company's internal control over financial
reporting.  Accordingly, we express no such opinion.  An
audit includes examining, on a test basis, evidence supporting the amounts and
disclosures in the consolidated financial statements.  An audit also
includes assessing the accounting principles used and significant estimates made
by management as well as evaluating the overall consolidated financial statement
presentation.  We believe that our audits provide a reasonable basis
for our opinion.




In our
opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the financial position of Applied NeuroSolutions, Inc.
(a development stage company) as of December 31, 2007 and 2006 and the results
of their operations and their cash flows for the years then ended, in conformity
with U.S. generally accepted accounting principles.







The
accompanying consolidated financial statements have been prepared assuming that
the Company will continue as a going concern. As discussed in Note 1(c) to the
consolidated financial statements, the Company has suffered recurring losses
from operations, has an accumulated deficit and requires additional capital to
support the Company's continued development efforts, which raises substantial
doubt about its ability to continue as a going concern.  Management’s
plans in regard to these matters are also described in Note 1(c).  The
consolidated financial statements do not include any adjustments that might
result from the outcome of this uncertainty.








/s/
Virchow, Krause & Company, LLP





Chicago,
Illinois


February
21, 2008

















35


APPLIED
NEUROSOLUTIONS, INC.


(a
development stage company)




CONSOLIDATED
BALANCE SHEETS


December
      31,
            
            
            December
      31,2007
            
            
            2006Assets
              Current
      assets:Cash
            
            $
            2,960,141
            
            
            $
            1,433,250Accounts
      receivable
            
            
            -
            
            
            
            250,000Prepaids
      and other current assets
            
            
            73,615
            
            
            
            94,649Total
      current assets
            
            
            3,033,756
            
            
            
            1,777,899Property
      and equipment:Equipment
      and leaseholds
            
            
            2,167,515
            
            
            
            2,162,727Accumulated
      depreciation and amortization
            
            
            (2,140,321
            )
            
            
            (2,124,464
            )Net
      property and equipment
            
            
            27,194
            
            
            
            38,263Other
      assets:Prepaids
            
            
            20,124
            
            
            
            42,889Deposits
            
            
            8,641
            
            
            
            15,072Total
      other assets
            
            
            28,765
            
            
            
            57,961Total
      assets
            
            $
            3,089,715
            
            
            $
            1,874,123Liabilities
      and Stockholders’ Equity / (Deficit)Current
      liabilities:Accounts
      payable
            
            $
            74,170
            
            
            $
            270,698Bridge
      loan
            
            
            -
            
            
            
            500,000Bridge
      loan, discount on debt
            
            
            -
            
            
            
            (11,159
            )Deferred
      revenues, current portion
            
            
            333,333
            
            
            
            583,333Accrued
      collaborator fees
            
            
            -
            
            
            
            70,000Accrued
      consultant fees
            
            
            4,800
            
            
            
            37,000Accrued
      wages
            
            
            120,000
            
            
            
            56,756Accrued
      vacation wages
            
            
            39,060
            
            
            
            92,671Accrued
      401k match
            
            
            53,672
            
            
            
            30,506Accrued
      interest
            
            
            -
            
            
            
            29,000Other
      accrued expenses
            
            
            28,797
            
            
            
            51,616Total
      current liabilities
            
            
            653,832
            
            
            
            1,710,421Long
      term liabilities:Deferred
      revenues, net of current portion
            
            
            301,399
            
            
            
            634,733Stockholders'
      equity / (deficit):Preferred
      stock, par value $0.0025: 5,000,000 shares authorized; none issued and
      outstanding
            
            
            -
            
            
            
            -Common
      stock, par value $0.0025; 200,000,000 shares authorized;
              130,217,808
      shares issued and outstanding
            
            
            325,547
            
            
            
            246,025Treasury
      stock, 23,294 shares, at cost
            
            
            (10,614
            )
            
            
            (10,614
            )Additional
      paid in capital
            
            
            49,850,566
            
            
            
            44,796,210Deficit
      accumulated during the development stage
            
            
            (48,031,015
            )
            
            
            (45,502,652
            )Total
      stockholders' equity / (deficit)
            
            
            2,134,484
            
            
            
            (471,031
            )Total
      liabilities and stockholders' equity / (deficit)
            
            $
            3,089,715
            
            
            $
            1,874,123See
      accompanying notes to consolidated financial statements.


36


APPLIED
NEUROSOLUTIONS, INC.


(a
development stage company)




CONSOLIDATED
STATEMENTS OF OPERATIONS





Year Ended December 31,
            
            
            Period
      from March 14, 1992 (inception) to December 31,2007
            
            
            2006
            
            
            2007(unaudited)Research
      agreement revenues
            
            $
            250,000
            
            
            $
            219,700
            
            
            $
            1,702,700Collaboration
      revenues
            
            
            833,333
            
            
            
            31,934
            
            
            
            865,267Grant
      revenues
            
            
            -
            
            
            
            -
            
            
            
            669,022Total
      revenues
            
            
            1,083,333
            
            
            
            251,634
            
            
            
            3,236,989Operating
      expenses:Research
      and development
            
            
            1,659,258
            
            
            
            2,119,431
            
            
            
            31,040,668General
      and administrative
            
            
            2,000,439
            
            
            
            2,224,939
            
            
            
            16,454,340Loss
      on impairment of intangible assets
            
            
            -
            
            
            
            -
            
            
            
            411,016Loss
      on writedown of leasehold improvements
            
            
            -
            
            
            
            -
            
            
            
            1,406,057Total
      operating expenses
            
            
            3,659,697
            
            
            
            4,344,370
            
            
            
            49,312,081Operating
      loss
            
            
            (2,576,364
            )
            
            
            (4,092,736
            )
            
            
            (46,075,092
            )Other
      (income) expense:Interest
      expense
            
            
            12,159
            
            
            
            218,740
            
            
            
            716,344Interest
      income
            
            
            (60,160
            )
            
            
            (22,149
            )
            
            
            (878,515
            )Amortization
      of debt discount
            
            
            -
            
            
            
            -
            
            
            
            272,837Beneficial
      conversion of debt to equity
            
            
            -
            
            
            
            -
            
            
            
            274,072Inducement
      to convert debt to equity
            
            
            -
            
            
            
            -
            
            
            
            1,631,107Cost
      of fund raising activities
            
            
            -
            
            
            
            -
            
            
            
            62,582Loss
      on extinguishments of debt
            
            
            -
            
            
            
            -
            
            
            
            4,707,939Gain
      on derivative instruments, net
            
            
            -
            
            
            
            -
            
            
            
            (4,894,163
            )Net
      other (income) expense
            
            
            -
            
            
            
            -
            
            
            
            63,720Total
      other (income) expense
            
            
            (48,001
            )
            
            
            196,591
            
            
            
            1,955,923Net
      loss
            
            
            (2,528,363
            )
            
            
            (4,289,327
            )
            
            
            (48,031,015
            )Less: Deemed dividend to
      common
              stockholders
            
            
            (391,312
            )
            
            
            -
            
            
            
            (391,312
            )Less:
      Fair value of induced preferred stock conversion
            
            
            -
            
            
            
            -
            
            
            
            (1,866,620
            )Net
      loss attributable to common stockholders
            
            $
            (2,919,675
            )
            
            $
            (4,289,327
            )
            
            $
            (50,288,947
            )Basic
      and diluted loss per common share:Net
      loss attributable to common stockholders per share – basic
            
            $
            (0.03
            )
            
            $
            (0.04
            )
            
            $
            (1.51
            )Weighted
      average shares outstanding
            
            
            113,325,596
            
            
            
            95,371,726
            
            
            
            33,287,402See
      accompanying notes to consolidated financial statements


37




APPLIED
NEUROSOLUTIONS, INC.




(a
development stage company)




CONSOLIDATED
STATEMENTS OF STOCKHOLDERS’ EQUITY / (DEFICIT)




FOR
THE PERIOD FROM MARCH 14, 1992 (INCEPTION) TO DECEMBER 31, 2007








Shares
            
            
            Common
              Stock
            
            
            Treasury
              Stock
            
            
            Additional
              Paid
      in
              Capital
            
            
            Deficit
      Accumulated During the DevelopmentStage
            
            
            Total
              Stockholders’
              Equity
              (Deficit)Issuance
      of Common Stock
            
            
            372,682
            
            
            $
            932
            
            
            $
            -
            
            
            $
            (332
            )
            
            $
            -
            
            
            $
            600Net
      loss
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (922,746
            )
            
            
            (922,746
            )Balance
      at December 31, 1992
            
            
            372,682
            
            
            
            932
            
            
            
            -
            
            
            
            (332
            )
            
            
            (922,746
            )
            
            
            (922,146
            )Issuance
      of Common Stock
            
            
            434,793
            
            
            
            1,087
            
            
            
            -
            
            
            
            (387
            )
            
            
            -
            
            
            
            700Issuance
      of Preferred Stock, subsequently converted to Common Stock
            
            
            165,936
            
            
            
            415
            
            
            
            -
            
            
            
            1,201,750
            
            
            
            -
            
            
            
            1,202,165Issuance
      of Preferred Stock, subsequently converted to Common Stock
            
            
            762,066
            
            
            
            1,905
            
            
            
            -
            
            
            
            5,640,172
            
            
            
            -
            
            
            
            5,642,077Issuance
      of Common Stock upon conversion of note and accrued
    interest
            
            
            368,322
            
            
            
            921
            
            
            
            -
            
            
            
            2,964,005
            
            
            
            -
            
            
            
            2,964,926Net
      loss
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (4,875,845
            )
            
            
            (4,875,845
            )Balance
      at December 31, 1993
            
            
            2,103,799
            
            
            
            5,260
            
            
            
            -
            
            
            
            9,805,208
            
            
            
            (5,798,591
            )
            
            
            4,011,877Issuance
      of Preferred Stock, subsequently converted to Common Stock
            
            
            533,020
            
            
            
            1,333
            
            
            
            -
            
            
            
            4,006,404
            
            
            
            -
            
            
            
            4,007,737Retirement
      of Common Stock
            
            
            (1,887
            )
            
            
            (5
            )
            
            
            -
            
            
            
            (13,663
            )
            
            
            -
            
            
            
            (13,668
            )Net
      loss
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (6,154,275
            )
            
            
            (6,154,275
            )Balance
      at December 31, 1994
            
            
            2,634,932
            
            
            
            6,588
            
            
            
            -
            
            
            
            13,797,949
            
            
            
            (11,952,866
            )
            
            
            1,851,671Issuance
      of Preferred Stock, subsequently converted to Common Stock
            
            
            493,801
            
            
            
            1,235
            
            
            
            -
            
            
            
            748,765
            
            
            
            -
            
            
            
            750,000Issuance
      of Preferred Stock upon conversion of bridge loan and accrued interest,
      subsequently converted to Common Stock
            
            
            689,179
            
            
            
            1,723
            
            
            
            -
            
            
            
            1,005,840
            
            
            
            -
            
            
            
            1,007,563Net
      loss
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (2,191,159
            )
            
            
            (2,191,159
            )Balance
      at December 31, 1995
            
            
            3,817,912
            
            
            
            9,546
            
            
            
            -
            
            
            
            15,552,554
            
            
            
            (14,144,025
            )
            
            
            1,418,075Issuance
      of Preferred Stock, subsequently converted to Common Stock
            
            
            4,957,145
            
            
            
            12,393
            
            
            
            -
            
            
            
            6,864,881
            
            
            
            -
            
            
            
            6,877,274Issuance
      of Common Stock
            
            
            31,802
            
            
            
            80
            
            
            
            -
            
            
            
            96,524
            
            
            
            -
            
            
            
            96,604Net
      loss
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (2,591,939
            )
            
            
            (2,591,939
            )Balance
      at December 31, 1996
            
            
            8,806,859
            
            
            
            22,019
            
            
            
            -
            
            
            
            22,513,959
            
            
            
            (16,735,964
            )
            
            
            5,800,014Issuance
      of Common Stock in connection with acquisition of intangible
      assets
            
            
            131,682
            
            
            
            329
            
            
            
            -
            
            
            
            399,671
            
            
            
            -
            
            
            
            400,000Net
      loss
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (2,040,092
            )
            
            
            (2,040,092
            )Balance
      at December 31, 1997
            
            
            8,938,541
            
            
            
            22,348
            
            
            
            -
            
            
            
            22,913,630
            
            
            
            (18,776,056
            )
            
            
            4,159,922Net
      loss
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (2,549,920
            )
            
            
            (2,549,920
            )Balance
      at December 31, 1998
            
            
            8,938,541
            
            
            
            22,348
            
            
            
            -
            
            
            
            22,913,630
            
            
            
            (21,325,976
            )
            
            
            1,610,002Net
      loss
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (1,692,356
            )
            
            
            (1,692,356
            )Balance
      at December 31, 1999
            
            
            8,938,541
            
            
            
            22,348
            
            
            
            -
            
            
            
            22,913,630
            
            
            
            (23,018,332
            )
            
            
            (82,354
            )Issuance
      of Preferred Stock, subsequently converted to Common Stock
            
            
            1,466,495
            
            
            
            3,666
            
            
            
            -
            
            
            
            983,614
            
            
            
            -
            
            
            
            987,280Issuance
      of warrants to purchase shares of Common Stock
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            83,406
            
            
            
            -
            
            
            
            83,406


38





Shares
            
            
            Common
              Stock
            
            
            Treasury
              Stock
            
            
            Additional
              Paid
      in
              Capital
            
            
            Deficit
      Accumulated During the DevelopmentStage
            
            
            Total
              Stockholders’
              Equity
              (Deficit)Extension
      of warrants to purchase shares of Common Stock
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            154,685
            
            
            
            -
            
            
            
            154,685Stock
      options granted to non-employees
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            315,976
            
            
            
            -
            
            
            
            315,976Net
      loss
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (2,395,538
            )
            
            
            (2,395,538
            )Balance
      at December 31, 2000
            
            
            10,405,036
            
            
            
            26,014
            
            
            
            -
            
            
            
            24,451,311
            
            
            
            (25,413,870
            )
            
            
            (936,545
            )Issuance
      of Common Stock upon conversion of bridge loans/accrd. int
            
            
            4,474,649
            
            
            
            11,185
            
            
            
            -
            
            
            
            2,027,696
            
            
            
            -
            
            
            
            2,038,881Issuance
      of Common Stock
            
            
            580,726
            
            
            
            1,452
            
            
            
            -
            
            
            
            211,048
            
            
            
            -
            
            
            
            212,500Stock
      options granted to non-employees
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            77,344
            
            
            
            -
            
            
            
            77,344Issuance
      of warrants to purchase shares of Common Stock
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            27,367
            
            
            
            -
            
            
            
            27,367Options
      reissued to adjust exercise term
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            64,033
            
            
            
            -
            
            
            
            64,033Beneficial
      conversion feature of convertible debt
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            229,799
            
            
            
            -
            
            
            
            229,799Induced
      conversion of convertible debt
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            1,631,107
            
            
            
            -
            
            
            
            1,631,107Net
      loss
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (4,146,913
            )
            
            
            (4,146,913
            )Balance
      at December 31, 2001
            
            
            15,460,411
            
            
            
            38,651
            
            
            
            -
            
            
            
            28,719,705
            
            
            
            (29,560,783
            )
            
            
            (802,427
            )Issuance
      of Common Stock upon conversion of bridge loans, accrued interest, other
      payables and as payment for services
            
            
            7,201,971
            
            
            
            18,005
            
            
            
            -
            
            
            
            1,792,878
            
            
            
            -
            
            
            
            1,810,883Issuance
      of Common Stock upon conversion of warrants
            
            
            156,859
            
            
            
            392
            
            
            
            -
            
            
            
            35,536
            
            
            
            -
            
            
            
            35,928Stock
      options granted to non-employees
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            6,136
            
            
            
            -
            
            
            
            6,136Repurchase
      of Common Stock
            
            
            (23,294
            )
            
            
            (58
            )
            
            
            (10,614
            )
            
            
            58
            
            
            
            -
            
            
            
            (10,614
            )Merger
      between the Company and Molecular Geriatrics Corporation
            
            
            24,905,151
            
            
            
            62,263
            
            
            
            -
            
            
            
            (62,263
            )
            
            
            -
            
            
            
            -Issuance
      of warrants to purchase shares of Common Stock
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            159,934
            
            
            
            -
            
            
            
            159,934Net
      loss
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (2,929,955
            )
            
            
            (2,929,955
            )Balance
      at December 31, 2002
            
            
            47,701,098
            
            
            
            119,253
            
            
            
            (10,614
            )
            
            
            30,651,984
            
            
            
            (32,490,738
            )
            
            
            (1,730,115
            )Variable
      accounting for stock options
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            604,100
            
            
            
            -
            
            
            
            604,100Stock
      options granted to non-employees
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            80,975
            
            
            
            -
            
            
            
            80,975Issuance
      of warrants to purchase shares of common stock
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            193,130
            
            
            
            -
            
            
            
            193,130Net
      loss
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (3,301,420
            )
            
            
            (3,301,420
            )Balance
      at December 31, 2003
            
            
            47,701,098
            
            
            
            119,253
            
            
            
            (10,614
            )
            
            
            31,530,189
            
            
            
            (35,792,158
            )
            
            
            (4,153,330
            )Issuance
      of units in private placement
            
            
            32,000,000
            
            
            
            80,000
            
            
            
            -
            
            
            
            1,483,066
            
            
            
            -
            
            
            
            1,563,066Issuance
      of placement agent warrants
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            875,407
            
            
            
            -
            
            
            
            875,407Issuance
      of units upon conversion of bridge loans
            
            
            10,440,714
            
            
            
            26,102
            
            
            
            -
            
            
            
            7,292,016
            
            
            
            -
            
            
            
            7,318,118Issuance
      of common stock for services
            
            
            200,000
            
            
            
            500
            
            
            
            -
            
            
            
            64,500
            
            
            
            -
            
            
            
            65,000Issuance
      of units for services
            
            
            400,000
            
            
            
            1,000
            
            
            
            -
            
            
            
            268,426
            
            
            
            -
            
            
            
            269,426Issuance
      of warrants to purchase shares of common stock
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            124,775
            
            
            
            -
            
            
            
            124,775Variable
      accounting for stock options
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            1,535
            
            
            
            -
            
            
            
            1,535Net
      loss
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (2,800,526
            )
            
            
            (2,800,526
            )Balance
      at December 31, 2004
            
            
            90,741,812
            
            
            
            226,855
            
            
            
            (10,614
            )
            
            
            41,639,914
            
            
            
            (38,592,684
            )
            
            
            3,263,471Issuance
      of stock upon exercise of warrants
            
            
            3,755,772
            
            
            
            9,389
            
            
            
            -
            
            
            
            667,745
            
            
            
            -
            
            
            
            677,134


39





Shares
            
            
            Common
              Stock
            
            
            Treasury
              Stock
            
            
            Additional
              Paid
      in
              Capital
            
            
            Deficit
      Accumulated During the DevelopmentStage
            
            
            Total
              Stockholders’
              Equity
              (Deficit)Issuance
      of stock options to purchase shares of common stock
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            77,057
            
            
            
            -
            
            
            
            77,057Variable
      accounting for stock options
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            219,952
            
            
            
            -
            
            
            
            219,952Net
      loss
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (2,620,641
            )
            
            
            (2,620,641
            )Balance
      at December 31, 2005
            
            
            94,497,584
            
            
            
            236,244
            
            
            
            (10,614
            )
            
            
            42,604,668
            
            
            
            (41,213,325
            )
            
            
            1,616,973Issuance
      of stock upon conversion of warrants
            
            
            2,014,195
            
            
            
            5,036
            
            
            
            -
            
            
            
            438,419
            
            
            
            -
            
            
            
            443,455Issuance
      of stock upon conversion of stock options
            
            
            510,206
            
            
            
            1,275
            
            
            
            -
            
            
            
            75,256
            
            
            
            -
            
            
            
            76,531Issuance
      of stock
            
            
            1,387,916
            
            
            
            3,470
            
            
            
            -
            
            
            
            559,054
            
            
            
            -
            
            
            
            562,524Non
      cash compensation for options FAS123R
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            720,322
            
            
            
            -
            
            
            
            720,322Issuance
      of warrants to purchase shares of common stock
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            200,866
            
            
            
            -
            
            
            
            200,866Non
      cash unrecognized compensation for options granted and
      cancelled
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            197,625
            
            
            
            -
            
            
            
            197,625Net
      loss
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (4,289,327
            )
            
            
            (4,289,327
            )Balance
      at December 31, 2006
            
            
            98,409,901
            
            
            
            246,025
            
            
            
            (10,614
            )
            
            
            44,796,210
            
            
            
            (45,502,652
            )
            
            
            (471,031
            )Issuance
      of stock upon conversion of warrants
            
            
            10,167,305
            
            
            
            25,420
            
            
            
            -
            
            
            
            1,672,119
            
            
            
            -
            
            
            
            1,697,539Issuance
      of stock
            
            
            21,640,602
            
            
            
            54,102
            
            
            
            -
            
            
            
            2,845,898
            
            
            
            -
            
            
            
            2,900,000Non
      cash compensation for options FAS123R
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            496,848
            
            
            
            -
            
            
            
            496,848Issuance
      of warrants to purchase shares of common stock
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            39,491
            
            
            
            -
            
            
            
            39,491Net
      loss
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (2,528,363
            )
            
            
            (2,528,363
            )Balance
      at December 31, 2007
            
            
            130,217,808
            
            
            $
            325,547
            
            
            $
            (10,614
            )
            
            $
            49,850,566
            
            
            $
            (48,031,015
            )
            
            $
            2,134,484








See
accompanying notes to consolidated financial statements


40




APPLIED
NEUROSOLUTIONS, INC.




(a
development stage company)




CONSOLIDATED
STATEMENTS OF CASH FLOWS





Year
      Ended December 31,
            
            
            Period
      from March 14, 1992 (inception) to December 31,2007
            
            
            2006
            
            
            2007(unaudited)Cash
      flows from operating activities:Net loss
            
            $
            (2,528,363
            )
            
            $
            (4,289,327
            )
            
            $
            (48,031,015
            )Adjustments to reconcile net
      loss to net cash
              used in operating
      activities:Depreciation and
      amortization
            
            
            15,857
            
            
            
            24,933
            
            
            
            2,625,414Non-cash expense for equity
      compensation
            
            
            -
            
            
            
            -
            
            
            
            2,379,241Non-cash expense for equity
      compensation
              to employees and
      directors
            
            
            536,340
            
            
            
            917,947
            
            
            
            2,583,668Non-cash interest
      expense
            
            
            11,159
            
            
            
            218,707
            
            
            
            334,912Amortization of deferred
      financing costscosts
            
            
            -
            
            
            
            -
            
            
            
            111,000Non-cash expense for
      beneficial conversion
              of debt
            
            
            -
            
            
            
            -
            
            
            
            274,072Non cash expense for induced
      conversion
              of debt
            
            
            -
            
            
            
            -
            
            
            
            1,631,107Non-cash expense for loss
      on
              extinguishments of
      debt
            
            
            -
            
            
            
            -
            
            
            
            4,707,939Non-cash income for gain on
      derivative
              instrument, net
            
            
            -
            
            
            
            -
            
            
            
            (4,894,163
            )Amortization of intangible
      assets
            
            
            -
            
            
            
            -
            
            
            
            328,812Loss on writedown of
      leasehold
              Improvements
            
            
            -
            
            
            
            -
            
            
            
            1,406,057Loss on impairment of
      intangible assets
            
            
            -
            
            
            
            -
            
            
            
            411,016Gain on sale of
      equipment
            
            
            -
            
            
            
            -
            
            
            
            (250
            )Fund raising
      expense
            
            
            -
            
            
            
            -
            
            
            
            62,582Changes in assets and
      liabilities:Accounts
      receivable
            
            
            250,000
            
            
            
            (203,420
            )
            
            
            203,290Prepaids and other
      assets
            
            
            50,230
            
            
            
            13,731
            
            
            
            (87,662
            )Accounts
    payable
            
            
            (196,528
            )
            
            
            167,251
            
            
            
            170,774Deferred research agreement
      revenues
            
            
            (583,334
            )
            
            
            1,123,866
            
            
            
            634,732Accrued wages
            
            
            63,244
            
            
            
            56,756
            
            
            
            120,000Accrued collaborator
      payments
            
            
            (70,000
            )
            
            
            70,000
            
            
            
            -Accrued consultant
      fees
            
            
            (32,200
            )
            
            
            18,100
            
            
            
            29,800Accrued vacation
      wages
            
            
            (53,611
            )
            
            
            27,360
            
            
            
            39,060Other accrued
      expenses
            
            
            (28,654
            )
            
            
            44,293
            
            
            
            205,618Net
      cash used in operating activities
            
            
            (2,565,860
            )
            
            
            (1,809,803
            )
            
            
            (34,753,996
            )Cash
      flows from investing activities:Acquisition of investment
      securities
            
            
            -
            
            
            
            -
            
            
            
            (9,138,407
            )Redemption of investment
      securities
            
            
            -
            
            
            
            -
            
            
            
            9,138,407Acquisition of intangible
      assets
            
            
            -
            
            
            
            -
            
            
            
            (339,829
            )Acquisition of equipment
      and
              leasehold
      improvements
            
            
            (4,788
            )
            
            
            (1,986
            )
            
            
            (4,044,528
            )Net cash used in investing
      activitiesActivities
            
            
            (4,788
            )
            
            
            (1,986
            )
            
            
            (4,384,357
            )


41





Year Ended December 31,
            
            
            Period
      from March 14, 1992 (inception) to December 31,2007
            
            
            2006
            
            
            2007Cash
      flows from financing activities:
            
            
            
            
            
            
            
            (unaudited)Proceeds
      from issuance of Preferred Stock
            
            
            -
            
            
            
            -
            
            
            
            12,193,559Proceeds
      from issuance of units, net of issuance costs
            
            
            2,900,000
            
            
            
            562,524
            
            
            
            22,433,555Proceeds
      from exercise of warrants
            
            
            1,697,539
            
            
            
            443,455
            
            
            
            2,818,128Proceeds
      from exercise of stock options
            
            
            -
            
            
            
            76,531
            
            
            
            76,531Proceeds
      from issuance of (repayments of) debt
            
            
            (500,000
            )
            
            
            500,000
            
            
            
            -Deferred
      financing costs incurred
            
            
            -
            
            
            
            -
            
            
            
            (111,000
            )Advances
      from (repayments to) director and shareholders
            
            
            -
            
            
            
            -
            
            
            
            120,000Principal
      payments under capital lease
            
            
            -
            
            
            
            (1,211
            )
            
            
            (11,766
            )Proceeds
      from issuance of promissory loans payable
            
            
            -
            
            
            
            -
            
            
            
            4,438,491Payments
      to shareholders for registration statement penalties
            
            
            -
            
            
            
            -
            
            
            
            (84,000
            )Payments
      to repurchase Common Stock
            
            
            -
            
            
            
            -
            
            
            
            (10,614
            )Payments
      received on employee stock purchase notes receivable
            
            
            -
            
            
            
            -
            
            
            
            235,610Net
      cash provided by financing activities
            
            
            4,097,539
            
            
            
            1,581,299
            
            
            
            42,098,494Net
      increase (decrease) in cash
            
            
            1,526,891
            
            
            
            (230,490
            )
            
            
            2,960,141Cash
      beginning of period
            
            
            1,433,250
            
            
            
            1,663,740
            
            
            
            -Cash
      end of period
            
            $
            2,960,141
            
            
            $
            1,433,250
            
            
            $
            2,960,141Supplemental
      cash flow information:Cash
      paid for interest
            
            $
            30,000
            
            
            $
            33
            
            
            $
            72,090Supplemental
      disclosure of non-cash investing and financing activities:Issuance
      of stock for prior services
            
            $
            -
            
            
            $
            -
            
            
            $
            4,149,521Intangible
      assets acquired in exchange for stock
            
            $
            -
            
            
            $
            -
            
            
            $
            400,000Equipment
      acquired for account payable
            
            $
            -
            
            
            $
            -
            
            
            $
            31,649Equipment
      acquired under capital lease
            
            $
            -
            
            
            $
            -
            
            
            $
            11,766Issuance
      of stock for promissory loans payable
            
            $
            -
            
            
            $
            -
            
            
            $
            2,473,991Issuance
      of stock for accrued interest on promissory loans payable
            
            $
            -
            
            
            $
            -
            
            
            $
            136,188See
      accompanying notes to consolidated financial statements.


42




APPLIED
NEUROSOLUTIONS, INC.




(a
development stage company)




NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS









Note 1 – Organization and
Summary of Significant Accounting Policies





(a)           Organization and Basis of
Presentation





Applied NeuroSolutions, Inc. (“APNS”or
the “Company”), is a development stage biopharmaceutical company primarily
engaged in the research and development of novel therapeutic targets for the
treatment of Alzheimer's disease (“AD”) and diagnostics to detect
AD.





Prior to 2004, the Company had two
wholly-owned operating subsidiaries.  One of the wholly-owned
operating subsidiaries was Molecular Geriatrics Corporation (“MGC”), a
development stage biopharmaceutical company incorporated in November 1991, with
operations commencing in March 1992, to develop diagnostics to detect, and
therapeutics to treat, Alzheimer’s disease (“AD”).





The other wholly-owned operating
subsidiary was Hemoxymed Europe, SAS, a development stage biopharmaceutical
company incorporated in February 1995 to develop therapies aimed at improving
tissue oxygenation by increasing oxygen release from hemoglobin to provide
therapeutic value to patients with serious, unmet, medical needs.  We
are not currently funding the development of this technology.  The
Company dissolved these two subsidiaries, and transferred all of their assets to
APNS in 2004.





On September 10, 2002, Hemoxymed, Inc.
and Molecular Geriatrics Corporation (“MGC”) established a strategic alliance
through the closing of a merger (the “Merger”).  The Merger Agreement
provided that the management team and Board of Directors of MGC took over
control of the merged company.  The transaction was tax-free to the
shareholders of both companies.  In October 2003, the Company changed
its’ name to Applied NeuroSolutions, Inc.





This transaction has been accounted for
as a reverse merger.  For financial reporting purposes, MGC is
continuing as the primary operating entity under the Company’s name, and its
historical financial statements have replaced those of the
Company.  Thus, all financial information prior to the Merger date is
the financial information of MGC only.





The consolidated financial statements
have been prepared in accordance with the provisions of Statement of Financial
Accounting Standards (“SFAS”) No. 7, "Accounting and Reporting by Development
Stage Enterprises," which requires development stage companies to employ the
same accounting principles as operating companies.





The Company is subject to risks and
uncertainties common to small cap biotech companies, including competition from
larger, well capitalized entities, patent protection issues, availability of
funding and government regulations.





(b)           Principles of
Consolidation





Prior to 2004, the consolidated
financial statements include the accounts of the Company and its subsidiaries,
MGC and Hemoxymed Europe, SAS.  All significant intercompany balances
and transactions have been eliminated.





(c)           Going Concern





The Company has experienced losses
since inception in addition to incurring cash outflows from operating activities
for the last two years as well as since inception.  The Company
expects to incur substantial additional research and development costs and
future losses prior to reaching profitability.  These matters have
raised substantial doubt about the Company's ability to continue as a going
concern for a reasonable period of time.  The Company's ability to
continue as a going concern is dependent on obtaining adequate funding and
ultimately


43


achieving
profitable operations.  In the opinion of management, the Company
anticipates cash balances as of December 31, 2007, coupled with annual R & D
support from Eli Lilly and Company, will be sufficient to fund operations
through the first quarter 2009.  The Company will need additional
funding prior to the end of the first quarter 2009 in order to continue its
research, product development and operations.  If additional funding
is not obtained, the Company will not be able to fund any of its programs, and
the Company will possibly discontinue all its product development and/or
operations.  Management is currently evaluating its options to
maximize the value of the Company’s diagnostic technology, including evaluating
partnering and licensing opportunities.  The Company intends to seek
such additional funding through private and/or public financing, through
exercise of currently outstanding stock options and warrants or through
collaborative or other arrangements with partners, however, there is no
assurance that additional funding will be available for the Company to finance
its operations on acceptable terms, or at all.  This would have a
material adverse effect on the Company’s operations and prospects.





(d)           Cash





The Company maintains cash at financial
institutions from time to time in excess of the Federal Depository Insurance
Corporation (FDIC) insured limit.





(e)           Revenue
Recognition





The Company generates revenues from
research agreements, collaborations and grants and recognizes these revenues
when earned.  Grant revenues represent funds received from certain
government agencies for costs expended to further research on the subject of the
grant.  In accordance with Emerging Issues Task Force (EITF) 00-21
“Revenue Arrangements with Multiple Deliverables”, for arrangements that contain
multiple deliverables, the Company separates the deliverables into separate
accounting units if they meet all of the following:  a) the delivered
items have stand-alone value to the customer; b) the fair value of any
undelivered items can be reliably determined; and c) if the arrangement includes
a general right of return, delivery of the undelivered items is probable and
substantially controlled by the seller.  Deliverables that do not meet
these criteria are combined with one or more other deliverables into one
accounting unit.  Revenue from each accounting unit is recognized
based on the applicable accounting literature, primarily Staff Accounting
Bulletin No. 104 (SAB 104), “Revenue Recognition”.





(f)           Equipment and Leasehold
Improvements





Equipment and leasehold improvements
are recorded at cost.  Depreciation of equipment is calculated using
accelerated methods over their useful lives, approximating five to seven
years.  Amortization of leasehold improvements is provided on the
straight-line method over the lesser of the asset’s useful life or the lease
term.





(g)           Research and
Development





All research and development costs are
expensed as incurred and include salaries of, and expenses related to, employees
and consultants who conduct research and development.  The Company has
entered into arrangements whereby the Company will obtain research
reimbursements in the form of funds received to partially reimburse the Company
for costs expended.  For the years ended December 31, 2007 and 2006,
the Company has recorded reimbursements of  $-0- and $32,875 against
research and development expenses, respectively.





(h)           Income Taxes





Under the asset and liability method of
Statement of Financial Accounting Standards (“SFAS”) No. 109, Accounting for Income Taxes,
the Company’s deferred tax assets and liabilities are recognized for the future
tax consequences attributable to differences between financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases, and operating loss and tax credit carryforwards.  In assessing
the realizability of the deferred tax assets, management considers whether it is
more likely than not that some portion or all of the deferred tax assets will
not be realized.  A valuation allowance is recorded for the portion of
the deferred tax assets that are not expected to be realized based on the levels
of historical taxable income and projections for future taxable income over the
periods in which the deferred tax assets are deductible.





In July 2006, the FASB issued
Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (“FIN 48”).
FIN 48 prescribes a recognition threshold and measurement attribute for the
financial statement recognition and measurement of a tax position taken or
expected to be taken in its tax return. FIN 48 also provides guidance on
derecognition, classification, interest and penalties, accounting in interim
periods, disclosure and transition. FIN 48 is effective in fiscal years
beginning after December 15, 2006. The provisions of FIN 48 are to be applied to
all tax positions upon initial adoption, with the cumulative effect adjustment
reported as an adjustment to the opening balance of retained earnings.Upon adoption, there were
no unrecognized income tax benefits and the adoption of FIN
48 had no effect on shareholders’ equity.





44




(i)           Stock Option
Plan





Effective
      January 1, 2006, the Company adopted SFAS No. 123R, Share-Based Payment
      (SFAS 123R), which requires companies to measure and recognize
      compensation expense for all stock-based payments at fair value. SFAS
      123R is being applied on the modified prospective basis.  Prior
      to the adoption of SFAS 123R, the Company accounted for its stock-based
      compensation plans under the recognition and measurement principles of
      Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to
      Employees, and related interpretations, and accordingly, recognized
      no compensation expense related to the stock-based plans.Under
      the modified prospective approach, SFAS 123R applies to new awards and to
      awards that were outstanding on January 1, 2006, that are subsequently
      modified, repurchased, cancelled or vest.  Under the modified
      prospective approach, compensation cost recognized for 2006 includes
      compensation cost for all share-based payments granted prior to, but not
      yet vested on, January 1, 2006, based on the grant-date fair value
      estimated in accordance with the provisions of SFAS 123R, and compensation
      cost for all shared-based payments granted subsequent to January 1, 2006,
      based on the grant-date fair value estimated in accordance with the
      provisions of SFAS 123R.  Prior periods were not restated to
      reflect the impact of adopting the new standard.


The weighted average estimated fair
value of the options granted in 2007 and 2006 was $0.08 and $0.11, respectively,
based on the Black-Scholes valuation model using the following
assumptions:





2007
            2006Risk-free
      interest rate, average
            4.81%
            4.99%Dividend
            0.00%
            0.00%Expected
      volatility
            75.00%
            75.00%Expected
      life in years, average
            3
            3





From time to time, the Company has
issued equity awards to non-employees.  In these instances, the
Company applies the provisions of SFAS No. 123 and EITF No. 96-18 Accounting for Equity Instruments
That Are Issued to Other Than Employees for Acquiring, or in Conjunction with
Selling, Goods or Serviceswhich results in the recognition of expense
related to these awards over the vesting or service period of an amount equal to
the estimated fair value of these awards at their respective measurement dates
(see Note 6).





(j)           Restricted
Shares





The holder of a restricted share award
is generally entitled at all times on and after the date of issuance of the
restricted shares to exercise the rights of a shareholder of the Company,
including the right to vote the shares and the right to receive dividends on the
shares. During 2007 and 2006 the Company granted 526,316 and 400,000 restricted
shares, respectively, to its CEO based on the terms of her employment. The
restricted shares are valued based on the closing price on the date of
grant and vest over a three-year period based on the continuation of
employment.





(k)           Use of Estimates





Management of the Company has made a
number of estimates and assumptions relating to the reporting of assets and
liabilities and the disclosure of contingent assets and liabilities at the date
of the financial statements, and the reported amounts of revenues and expenses
during the reporting period, to prepare these financial statements in conformity
with accounting principles generally accepted in the United States of
America.  Actual results could differ from those
estimates.





45




(l)           Computation of Net Loss Attributable
to Common Stockholder per Share





Net loss attributable to common
stockholder per share is computed based upon the weighted average number of
common shares of outstanding during the period as if the exchange of common
shares in the merger between the Company and MGC was in effect at the beginning
of all periods presented.





For each period, net loss attributable
to common stockholder per share is computed based on the weighted average number
of common shares outstanding with potential equivalent shares from all stock
options, warrants and convertible investor bridge loans excluded from the
computation because their effect is anti-dilutive.  The Company had
19,242,347 stock options and 44,418,453 warrants outstanding to issue common
stock at December 31, 2007.  The Company had 20,452,531 stock options
and 48,071,472 warrants outstanding to issue common stock at December 31,
2006.





(m)           Fair Value of Financial
Instruments





The Company’s financial instruments
include cash, accounts receivable, accounts payable, loans payable, and other
accrued expenses.  The carrying value of these financial instruments
approximates their fair values due to the nature and short-term maturity of
these instruments.





(n)           Recent Accounting
Pronouncements





In February 2007, the FASB Board
issued SFAS No. 159, “The Fair Value Option for Financial Assets and
Financial Liabilities” (“SFAS 159”). This statement permits entities to choose
to measure many financial instruments and certain other items at fair value.
SFAS 159 is effective for fiscal years beginning after November 15,
2007.  We are currently assessing the effect that SFAS 159 will have on our
results of operations and financial position.





In
December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in
Consolidated Financial Statements an amendment of ARB No. 51” (“SFAS
160”).  This statement establishes accounting and reporting standards
for noncontrolling interests in subsidiaries and for the deconsolidation of
subsidiaries and clarifies that a noncontrolling interest in a subsidiary is an
ownership interest in the consolidated entity that should be reported as equity
in the consolidated financial statements.  This Statement also
requires expanded disclosures that clearly identify and distinguish between the
interests of the parent owners and the interests of the noncontrolling owners of
a subsidiary.  SFAS 160 is effective for fiscal years beginning on or
after December 15, 2008.  We do not believe that the adoption of SFAS
160 will have a material effect on our results of operations or financial
position.





In December 2007, the FASB issued SFAS
No. 141 (Revised 2007), “Business Combinations” (“SFAS 141 (Revised
2007)”).  While this statement retains the fundamental requirement of
SFAS 141 that the acquisition method of accounting (which SFAS 141 called the
purchase method) be
used for all business combinations, SFAS 141 (Revised 2007) now establishes the
principles and requirements for how an acquirer in a business
combination:  1) recognizes and measures in its financial statements
the identifiable assets acquired, the liabilities assumed, and any
noncontrolling interests in the acquiree; 2) recognizes and measures the
goodwill acquired in the business combination or the gain from a bargain
purchase; and 3) determines what information should be disclosed in the
financial statements to enable the users of the financial statements to evaluate
the nature and financial effects of the business combination.SFAS 141 (Revised 2007)
is effective for fiscal years beginning on or after December 15,
2008.  We do not believe that the adoption of SFAS 141 (Revised 2007)
will have a material effect on our results of operations or financial
position.





Note 2 – Collaboration
Agreement with Eli Lilly and Company





In November 2006, the Company entered
into an agreement with Eli Lilly and Company (“Lilly”) to develop therapeutics
to treat AD.  Pursuant to the terms of the agreement, the Company
received $2 million in cash, including an equity investment of $500,000, from
Lilly, plus it will receive annual research and development support for the
duration of the collaboration agreement.  In addition, Lilly will,
based on the achievement of certain defined milestones, provide the Company over
time with up to $20 million in milestone payments for advancing the Company’s
proprietary target to a therapeutic compound.  The collaboration has
also made progress on other targets that are part of the collaboration that
could provide milestone payments to the Company over time of up to $10 million
for advancing each of these other targets to a therapeutic
compound.  There is no limit to the number of targets that the Company
could receive milestone payments from Lilly.  There are no assurances
that any milestones will be met.  Royalties are to be paid to the
Company for AD drug compounds brought to market that result from the
collaboration.  There is no limit on the number of drug compounds for
which royalty payments may be due to the Company.  Lilly received the
exclusive worldwide rights to the intellectual property related to the Company’s
expertise in understanding the molecular neuropathology of AD as it pertains to
the formation of neurofibrillary tangles.  Lilly will fund the vast
majority of all pre-clinical research and development and will fully finance the
clinical testing, manufacturing, sales and marketing of AD therapeutics
developed from the collaboration.  The Company recorded $1 million
received in 2006 as deferred revenues and is amortizing the deferral over 36
months.  Included in collaboration revenues for 2007 and 2006 is an
amortization of these deferred revenues of $333,333 and $31,934,
respectively.  Also included in collaboration revenues in 2007 is
$500,000 received as research and development support.  In addition,
$66,173 of legal fees directly associated with the agreement are included in
prepaid assets and are being amortized over 36 months.





46




Note
3  -  Property and Equipment





Property and equipment consist of the
following:





December 31,2007
            December 31, 2006Equipment
            $ 2,071,136
            $ 2,066,348Equipment
      held under capital lease
            11,766
            11,766Leasehold
      improvements
            84,613
            84,6132,167,515
            2,162,727Less
      accumulated depreciation and
              Amortization
            (2,140,321)
            (2,124,464)$ 27,194
            $ 38,263





Depreciation and amortization expense
amounted to $15,857 and $24,933 for the years ended December 31, 2007 and 2006,
respectively.





Note
4  -  Warrants





The Company issued warrants to
investors in conjunction with funds raised in December 1995.  These
warrants had an original expiration date of December 2000.  During
2000, these warrants were extended until December 2001.  Compensation
expense related to this extension was $154,685 in 2000.  These
warrants expired, unexercised, in December 2001.





The Company issued warrants to
investors in conjunction with funds raised in August through November
2000.  Compensation expense related to the issuance of these warrants
was $83,406 in 2000.  These warrants were converted to shares of
Common Stock in the 2001 Recapitalization (see Note 5).





The Company issued warrants to
investors in conjunction with funds raised in February through December
2001.  Compensation expense related to the issuance of these warrants
was $27,367 in 2001.  The majority of these warrants were converted to
shares of Common Stock in the 2001 Recapitalization (see Note
5).  Total compensation expense of $351,811 was recognized upon the
conversion of all the warrants in 2002.





The Company, in September 2002 prior to
the Merger date, issued 1,562,258 warrants to previous investors in the
Company.  These warrants have an exercise price of $0.0001 per share,
and expire in September 2009.





The Company issued 800,000 warrants, in
September 2002, to an entity controlled by the two largest shareholders of
Hemoxymed (prior to the Merger), in lieu of
compensation.  Compensation expense related to the issuance of these
warrants was $159,934 in 2002.  These warrants have an exercise price
of $0.20 per share, and expire in September 2007.





47




The Company
issued 850,000 warrants to consultants in September 2003, in lieu of
compensation.  Compensation expense related to the issuance of these
warrants was $74,077 in 2003.  These warrants have an exercise price
of $0.20 per share, and expire in September 2008.





The Company issued 1,250,000 warrants
to a board member and a non-employee in September 2003, in lieu of compensation,
for fundraising.  Compensation expense related to the issuance of
these warrants was $119,053 in 2003.  These warrants have an exercise
price of $0.15 per share, and expire in September 2008.





The Company issued 200,000 warrants to
consultants in January 2004, in lieu of compensation, for investor relations and
business consulting services and included the value of such warrants, $42,705,
in general and administrative expenses for the year ended December 31,
2004.  These warrants have an exercise price of $0.20 per share, and
expire in September 2008.





The Company issued 400,000 warrants to
consultants in February 2004, in lieu of compensation, for financial advisory
and business consulting services and included the value of such warrants,
$109,426, in general and administrative expenses for the year ended December 31,
2004.  These warrants have an exercise price of $0.30 per share, and
expire in February 2009.





The Company issued 43,564,795 warrants
to investors in the February 2004 offering and to bridge loan investors upon
conversion of their bridge loans upon closing the February 2004
offering.  These warrants have an exercise price of $0.30 per share,
and expire in February 2009.





The Company issued 3,200,000 warrants
to the placement agents for the February 2004 offering.  These
warrants have an exercise price of $0.30 per share, and expire in February
2009.  These warrants were not eligible to be exercised for a one-year
period from the date of grant.





The Company issued 500,000 warrants to
consultants in November 2004, in lieu of compensation, for investor relations
and business consulting services and included the value of such warrants,
$44,160, in general and administrative expenses for the year ended December 31,
2004.  These warrants have an exercise price of $0.30 per share, and
expire in November 2009.





The Company issued 400,000 warrants to
consultants in November 2004, in lieu of compensation, for financial advisory
and business consulting services and included the value of such warrants,
$37,910, in general and administrative expenses for the year ended December 31,
2004.  These warrants have an exercise price of $0.25 per share, and
expire in November 2009.





In 2005, 3,755,772 warrants were
exercised and 27,584 warrants were forfeited by warrant holders.  Net
proceeds of $677,134 were received by the Company (at an average exercise price
of $0.18 per warrant).





The Company issued 922,500 warrants to
bridge loan holders in July 2006.  These warrants have an exercise
price of $0.0025 per share, and expire in July 2011.





In 2006, 2,014,195 warrants were
exercised and 1,475 warrants were forfeited by warrant holders.  Net
proceeds of $443,455 were received by the Company (at an average exercise price
of $0.22 per warrant).





The Company issued 300,000 warrants to
a consultant in May 2007, as part  of compensation paid to the
consultant, for investor relations and business consulting services and included
the value of such warrants, $39,491, in general and administrative expenses for
the year ended December 31, 2007.  These warrants have an exercise
price of $0.305 per share, and expire in May 2012.





The Company issued 6,214,286 warrants
to the investor in the September 2007 offering.  These warrants have
an exercise price of $0.19 per share, and expire in September 2012.





48


In 2007, 10,167,305 warrants were
exercised.  Net proceeds of $1,697,539 were received by the Company
(at an average exercise price of $0.17 per warrant).





As of December 31, 2007, the Company
has reserved 44,418,453 shares of Common Stock for the exercise and conversion
of the warrants described above.





A summary of the status of, and changes
in, the Company’s warrants as of and for the years ended December 31, 2007 and
2006, is presented below for all warrants issued:





2007
            
            
            2006Warrants
            
            
            Weighted-
              Average-Exercise
              Price
            
            
            Warrants
            
            
            Weighted-
              Average-Exercise
              PriceOutstanding
      at beginning
              of
      year
            
            
            48,071,472
            
            
            $
            0.29
            
            
            
            49,164,642
            
            
            $
            0.29Granted
            
            
            6,514,286
            
            
            
            0.20
            
            
            
            922,500
            
            
            
            0.0025Exercised
            
            
            10,167,305
            
            
            
            0.17
            
            
            
            2,014,195
            
            
            
            0.22Forfeited
            
            
            -
            
            
            
            -
            
            
            
            1,475
            
            
            
            0.15Outstanding
      at end
              of
      year
            
            
            44,418,453
            
            
            $
            0.27
            
            
            
            48,071,472
            
            
            $
            0.29





The weighted-average remaining
contractual life of the warrants outstanding as of December 31, 2007 is 1.7
years.





Note
5  -  Stockholders' Equity





The stockholders' equity information
presented in these financial statements reflects the retroactive recognition of
the effects of the Merger (see Note 1), and of the two recapitalizations of the
Company's capital structure, the "1996 Recapitalization", which became effective
in March, 1996 and the "2001 Recapitalization", which became effective in
November, 2001.  The 1996 Recapitalization consisted of (i) the
conversion of each share of outstanding Series A Convertible Preferred Stock and
Series B Convertible Preferred Stock of the Company into one share of Common
Stock, (ii) a 1.0-for-10.6 reverse split of the outstanding shares of Common
Stock, and (iii) a reduction in the number of authorized shares of Common Stock
and Preferred Stock from 50,000,000 to 20,000,000 and 35,000,000 to 15,000,000,
respectively.  The 2001 Recapitalization consisted of (i) the
conversion of each share of outstanding Series C Convertible Preferred Stock of
the Company into two shares of Common Stock, (ii) the conversion of each share
of outstanding Series D Convertible Preferred Stock of the Company into three
and one-third shares of Common Stock, (iii) the conversion of convertible debt
plus accrued interest into five shares of Common Stock for each $1.50 of
convertible debt, and (iv) an increase in the number of authorized shares of
Common Stock from 20,000,000 to 50,000,000 (See Note 13).





Pursuant to the terms of the General
Corporation Law of the State of Delaware, the Company's Restated Certificate of
Incorporation and the Certificates of Designation of the Series C and Series D
Convertible Preferred Stock, the increase in authorized shares in the 2001
Recapitalization was approved by the consent of a majority of the aggregate
voting power of the holders of the outstanding Common Stock and the Series C and
Series D Convertible Preferred Stock.  The conversion of the Series C
and Series D Convertible Preferred Stock was approved by a majority of the
respective holders of such shares voting separately as a class.  The
conversion of the convertible debt was approved by the individual debt
holder.





In conjunction with the Merger, each
outstanding share of MGC Common Stock was exchanged for .658394 shares of APNS
Common Stock and each outstanding MGC warrant and stock option was exchanged for
..658394 APNS warrant and stock option.





49




In December
2002, the Board of Directors approved an increase in the number of authorized
shares from 50,000,000 to 205,000,000, consisting of 200,000,000 Common Shares
and 5,000,000 Preferred Shares.  Shareholder approval for this
increase was obtained in 2003.  See note 13 for an explanation of the
Company’s authorized shares.





In the Consolidated Statements of
Stockholders’ Equity / (Deficit), the Company has elected to present each
issuance of Preferred Stock, which was subsequently converted to Common Stock,
as Common Stock as of the date of each issuance of Preferred Stock.





Original Issuances of Preferred
Stock





In July 1993, the Company issued
2,671,478 shares of Series A Convertible Preferred Stock (“Series
A”).  These shares were subsequently converted to 165,936 shares of
Common Stock.





In September through December 1993, the
Company issued 12,269,000 shares of Series B Convertible Preferred Stock
(“Series B”).  These shares were subsequently converted to 762,066
shares of Common Stock.





In March through May 1994, the Company
issued 8,581,400 shares of Series B.  These shares were subsequently
converted to 533,020 shares of Common Stock.





In December 1995, the Company issued
375,000 shares of Series C Convertible Preferred Stock (“Series
C”).  These shares were subsequently converted to 493,801 shares of
Common Stock.





In December 1995, the Company issued
523,371 shares of Series C.  These shares were subsequently converted
to 689,179 shares of Common Stock.





In March through July 1996, the Company
issued 3,764,550 shares of Series C.  These shares were subsequently
converted to 4,957,145 shares of Common Stock.





In January through May 2000, the
Company issued 668,202 shares of Series D Convertible Preferred Stock (“Series
D”).  These shares were subsequently converted to 1,466,495 shares of
Common Stock.





Current Issuances of Common
Stock





In November 2001, as part of the 2001
Recapitalization, $2,038,881 of convertible debt, including accrued interest,
was converted to 4,474,649 shares of Common Stock.





In January through June 2002, the
Company issued 3,846,692 shares of common stock through a private placement, and
upon conversion of bridge loans, plus accrued interest.





In June 2002, the Company issued
3,355,279 shares of Common Stock to Company officers, consultants and vendors in
exchange for a reduction of $750,000 of amounts due.





In June 2002, the Company issued
156,859 shares of Common Stock to certain warrant holders in exchange for the
conversion of 650,139 warrants.





In September 2002, the Company
repurchased 23,294 shares of Common Stock.





In September 2002, certain shareholders
of a predecessor of the Company were issued, in exchange for past services,
1,562,258 seven-year warrants exercisable at $0.0001 to purchase shares of
Common Stock.





In September 2002, an entity controlled
by the two largest shareholders of the Company prior to the merger were issued,
in lieu of compensation, 800,000 five year warrants exercisable at $0.20 to
purchase shares of Common Stock.  Expense of $159,934 was included in
general and administrative expense for the issuance of these
warrants.





50




In September
2003, a director of the Company and an advisor were issued, in lieu of
compensation for fund raising activities, 1,250,000 five-year warrants
exercisable at $0.15 to purchase shares of Common Stock.  Expense of
$119,053 was included in general and administrative expenses for the issuance of
these warrants.





In September 2003, two entities were
issued, in lieu of compensation, 850,000 five-year warrants exercisable at $0.20
to purchase shares of Common Stock.  Expense of $74,077 was included
in general and administrative expenses for the issuance of these
warrants.





In February 2004, the Company completed
an $8,000,000 private placement (net proceeds of $7,354,054) in
February.  The private placement included accredited institutional
investors and accredited individuals.  In conjunction with this
financing, the Company issued an aggregate of 32 million units priced at $0.25
per unit to investors.  Each unit consisted of one share of common
stock of the Company and a five-year warrant exercisable to purchase one share
of common stock of the Company at an exercise price of $0.30.  The
warrants issued to investors were immediately exercisable.





Pursuant to the terms of the
Registration Rights Agreement entered into in connection with the transaction,
within seven calendar days following the date that the Company filed its Annual
Report on Form 10-KSB, the Company was required to file, and did file, with the
Securities and Exchange Commission (the “SEC”) a registration statement under
the Securities Act of 1933, as amended, covering the resale of all of the common
stock purchased and the common stock underlying the warrants, including the
common stock underlying the placement agents’ warrants.





The Registration Rights Agreement
further provided that if a registration statement was not filed, or did not
become effective, within 150 days from the closing date of the private
placement, then in addition to any other rights the holders may have, the
Company would be required to pay each holder an amount in cash, as liquidated
damages, equal to 1.5% per month of the aggregate purchase price paid by such
holder in the private placement for the common stock and warrants then held,
prorated daily.  The registration statement was filed within the
allowed time, however it was declared effective July 28, 2004 under SEC File
Number 333-113821, resulting in the Company incurring certain liquidated damages
in accordance with the terms of the private placement.  Liquidating
damages of $84,000 were paid to the unit holders in the private placement in the
third quarter 2004.





In accordance with Emerging Issues Task
Force (EITF) Issue No. 00-19, “Accounting for Derivative Financial Instruments
Indexed To, and Potentially Settled In a Company’s Own Stock,” the terms of the
warrants and the transaction documents, the fair value of the warrants was
accounted for as a liability, with an offsetting reduction to additional paid-in
capital at the closing date (February 6, 2004).  The warrant
liability, net of the liquidated damages, was reclassified to equity on July 28,
2004, when the registration statement became effective.





The fair value of the warrants was
estimated using the Black-Scholes option-pricing model with the following
assumptions:  no dividends; risk-free interest rate of 3.20%; the
contractual life of five years and volatility of 75%.  The fair value
of the warrants was estimated to be $8,754,068 on the closing date of the
transaction.  The difference between the fair value of the warrants of
$8,754,068 and the gross proceeds from the offering was classified as a
non-operating expense in the Company’s statement of operations, and included in
“Gain on derivative instrument, net”.  The fair value of the warrants
was then re-measured at March 31, 2004, June 30, 2004 and July 28, 2004 (the
date the registration statement became effective) and estimated to be $3,105,837
at July 28, 2004, with the decrease in fair value since February 6, 2004 due to
the decrease in the market value of the Company’s common stock.  The
decrease in fair value of the warrants of $5,648,231 from the transaction date
to July 28, 2004 was recorded as non-operating income in the Company’s statement
of operations, and included in “Gain on derivative instrument,
net”.  The fair value of the warrants at July 28, 2004 was
reclassified to additional paid in capital as of July 28, 2004.





The Company used $315,783 of the
proceeds from the private placement to reimburse officers of the Company for
expenses, including compensation that was incurred but unpaid, as of January 31,
2004.





The Company paid the placement agent
and its sub-agents $560,000 in cash as fees for services performed in
conjunction with the private placement.  The Company also incurred
$85,946 in other legal and accounting fees.  The Company also issued a
five-year warrant to purchase 3.2 million shares of common stock of the Company
at an exercise price of $0.30 per share to the placement agent and its
sub-agents in the private placement.  The warrants issued to the
placement agent are exercisable commencing on February 6, 2005.  The
fair value of the warrants was computed as $875,407 based on the Black-Scholes
option-pricing model with the following assumptions:  no dividends;
risk-free interest rate of 3.20%; the contractual life of five years and
volatility of 75%.  The Company allocated $1,521,353 between issuance
costs offsetting the liability for common stock warrants and equity based on a
relative fair value allocation of the stock issued and warrants issued to the
unit holders.  As a result, the Company initially recorded $621,171 of
issuance costs as an offset to the liability for common stock warrants related
to these fund raising activities in the Company’s consolidated balance
sheet.  The Company further recorded $62,582 of amortization expenses
from these issue costs as “Costs of fund raising activities” in the statement of
operations for the year ended December 31, 2004.





51




The
adjustments required by EITF Issue No. 00-19 were triggered by the terms of the
Company’s agreements for the private placement it completed in February 2004,
specifically related to the potential penalties if the Company did not timely
register the common stock underlying the warrants issued in the
transaction.  The adjustments for EITF Issue No. 00-19 had no impact
on the Company’s working capital, liquidity, or business
operations.





All of the warrants issued in the
transaction provide a call right in favor of the Company to the extent that the
price per share of the Company’s common stock exceeds $1.00 per share for 20
consecutive trading days, subject to certain circumstances.





Concurrent with the closing of the
private placement, bridge investors, who had made loans to the Company over the
past 18 months, agreed to convert the $2,610,179 of loans and unpaid interest
into units on substantially the same terms as the investors in the private
placement.  The conversion terms accepted by the bridge investors were
substantially different than the initial conversion terms of the bridge
loans.  As a result, the Company accounted for the change in
conversion terms as a substantial modification of terms in accordance with EITF
Issue No. 96-19, “Debtor’s Accounting for a Modification or Exchange of Debt
Instruments”.  As a result, the Company recorded a $4,707,939 loss on
debt extinguishment in the three month period ended March 31, 2004 for the
difference between the carrying value of the bridge loans on the date the
conversion terms were modified ($2,610,179) and the fair value of the equity
issued under the new conversion terms ($7,318,118).  Upon conversion,
the Company issued the bridge investors 10,440,714 shares of common stock and
11,484,788 warrants to purchase shares of common stock on the same terms as the
unit holders.  The fair value of the common stock was computed as
$4,176,286 based on the closing price of the Company’s stock on February 6,
2004.  The fair value of the warrants was determined to be $3,141,832
using the Black-Scholes option-pricing model with the following
assumptions:  no dividends; risk-free interest rate of 3.20%; the
contractual life of five years and volatility of 75%.  Upon
conversion, the $7,318,118 adjusted value of the bridge loans was reclassified
as $26,102 of common stock and $7,292,016 of additional
paid-in-capital.





In February 2004, the Company issued
400,000 shares of common stock and 400,000 warrants to consultants, in lieu of
compensation, for financial advisory and business consulting services valued at
$269,426.  Consulting expense related to the issuance of the shares of
common stock was $160,000 in 2004 based on the closing price of the Company’s
stock on the date of issuance.  Expense related to the issuance of the
warrants of $109,426 was included in general and administrative
expenses.  These warrants have an exercise price of $0.30 per share,
and expire in February 2009.





In February 2004, the Company issued
100,000 shares of common stock to a consultant, in lieu of compensation, for
financial advisory and business consulting services.  Expense of
$40,000 was included in general and administrative expenses.





In November 2004, the Company issued
100,000 shares of common stock to a consultant, in lieu of compensation, for
scientific consulting services.  Expense of $25,000 was included in
research and development expenses.





During 2005, The Company issued
3,755,772 shares of common stock to warrant holders upon exercise of
warrants.





52





In August 2006, the Company issued
400,000 shares of restricted common stock to the Company’s President and CEO
under terms of her employment.  These restricted shares vest over a
three-year period.  Expense of $45,804 and $19,100 was included in
general and administrative expense in 2007 and 2006, respectively.





In October 2006, the Company issued
271,845 shares of common stock to a consultant, as part of the compensation to
the consultant, for executive search services.  Expense of $62,524 was
included in general and administrative expenses.





In November 2006, the Company sold
1,116,071 shares of common stock to Eli Lilly and Company for $500,000 (see Note
2).





During 2006, the Company issued
2,014,195 shares of common stock to warrant holders upon exercise of
warrants.





During 2006, the Company issued 510,206
shares of common stock to option holders upon exercise of options.





In September 2007, the Company sold
20,714,286 shares of common stock, along with 6,214,286 warrants to purchase
shares of common stock) to an investor in the September 2007 Placement for
$2,900,000.





During 2007, the Company issued
10,167,305 shares of common stock to warrant holders upon exercise of
warrants.





In December 2007, the Company issued
526,316 shares of restricted common stock to the Company’s President and CEO
under terms of her employment.  These restricted shares vest over a
three-year period.  Expense of $20,761 was included in general and
administrative expense in 2007.





In the event of any liquidation,
dissolution or winding up of the affairs of the Company, either voluntary or
involuntary, the holders of Preferred Stock are entitled to receive a
liquidation preference, adjusted for combinations, consolidations, stock splits
or certain issuances of Common Stock.  After payment has been made to
the holders of Preferred Stock of the full amounts to which they shall be
entitled, the holders of the Common Stock shall be entitled to receive ratably,
on a per share basis, the remaining assets.  As of December 31, 2007,
no Preferred Stock is outstanding.  The Company has reserved
44,418,453 shares of Common Stock for the exercise and conversion warrants, and
19,242,347 shares of Common Stock for the exercise and conversion of stock
options.





Note
6  -  Stock Option Plan





As of December 31, 2002, the Board of
Directors approved the Hemoxymed, Inc. (now called Applied NeuroSolutions, Inc.)
Stock Option Plan.  This plan is identical to the MGC pre-merger plan
(discussed below), with an increase in the number of options in the plan to
12,000,000.  Shareholder approval was obtained in 2003.





In conjunction with the Merger in
September 2002, each outstanding MGC stock option was exchanged for .658394 APNS
stock options.





In April 2001, management issued
non-qualifying stock options to two former employees to replace the incentive
stock options previously granted.  All terms of these options remained
the same.  Compensation expense of $64,033 was recorded to reflect the
fair value of these options.





In April 2001, the Board of Directors
granted 13,168 options to a non-employee exercisable at $1.50 per share, which
vest monthly over a twenty-four month period.  Compensation expense of
$24,170 was recorded to reflect the fair value of these options.





In July 2001, the Board of Directors
granted 6,584 options to an employee exercisable at $1.50 per share, which vest
one-fourth per year beginning July 2002.  These options were forfeited
during 2002.





In November 2001, the Board of
Directors granted 2,050,904 options exercisable at $0.30 per share which vest
one-fourth immediately and one-fourth per year beginning November
2002.  Non-employees were granted 144,847 of these options, which were
vested immediately.  Compensation expense of $53,174 was recorded to
reflect the fair value of options issued to non-employees.





53




In June 2002,
the Board of Directors granted 434,172 options exercisable at $0.15 per share
which vest one-fourth immediately and one-fourth per year beginning in June
2003.  Non-employees were granted 33,430 of these
options.  Compensation expense of $6,136 was recorded to reflect the
fair value of options issued to non-employees.





In June 2002, the Board of Directors
approved adjusting the exercise price of 4,399,052 options to $0.15 per
share.  This changed the accounting treatment for these stock options
to variable accounting until they are exercised.  For the year ended
December 31, 2003, the Company recorded compensation expense under variable
accounting equal to $604,100 related to these modified options.  For
the year ended December 31, 2002, no compensation expense had been recorded
related to these modified options as the Company’s stock price was below $0.15
as of December 31, 2002.





In September 2003, the Board of
Directors granted 5,337,000 options exercisable at $0.15 per share which vest
one-fourth immediately and one-fourth per year beginning in September
2004.  Non-employees were granted 752,000 of these
options.  Compensation expense of $80,975 was recorded to reflect the
fair value of options issued to non-employees.





In November 2004, the Board of
Directors granted 120,000 options exercisable at $0.17 per share which vest
one-fourth immediately and one-fourth per year beginning in November
2005.





In April 2005, the Company granted
4,045,136 stock options to employees, officers, independent directors and a
consultant, of which 3,302,565 options were granted to executive officers and
directors, 542,571 options were granted to employees, and 200,000 options were
granted to a consultant.  Compensation expense of $31,870 was recorded
to reflect the fair value of options issued to the consultant.  In
addition, the Company granted 300,000 stock options to independent directors in
the second half of 2005.  The 3,602,565 stock options granted to
executive officers and independent directors in 2005 were not approved by the
Company’s stockholders at the Company’s Annual Stockholder Meeting on June 20,
2006 and were cancelled and not reissued.  Included in general and
administrative expense and research and development expense in the quarter ended
June 30, 2006 was a non-cash expense of $80,165 and $117,460, respectively, to
record unrecognized compensation costs on these options.





In January 2006, 94,041 options were
exercised at an average exercise price of $0.l5 and 676,674 options with
exercise prices ranging from $0.15 to $5.30 expired, unexercised.  In
May 2006, 42,796 options with an exercise price of $0.15 expired,
unexercised.





On June 20, 2006, at the Company’s
Annual Stockholder Meeting, the stockholders voted against increasing the
maximum allowable shares of common stock issuable under the Company’s 2003 stock
option plan from 12,000,000 shares to 20,000,000 shares and voted against
ratification of the 3,602,565 options granted to executive officers and
independent directors in 2005.  Thus, these 2005 stock options were
cancelled and not reissued, and consequently, became available for future grants
under the Company’s 2003 stock option plan.





On June 27, 2006, the Board of
Directors approved a grant of 600,000 stock options to independent directors or
the Company.





On June 27, 2006, the Board of
Directors also approved a grant of 4,000,000 stock options to the Company’s new
Chairman.  This option grant was not made under the Company’s 2003
stock option plan, but was made in consideration of the engagement of the new
Chairman.





On August 29, 2006, The Board of
Directors approved a grant of 6,000,000 stock options to the Company’s newly
appointed President and CEO.  This option grant was made pursuant to
the terms of the new CEO’s employment and was not made under the Company’s 2003
stock option plan.  The Board of Directors also approved a grant to
the Company’s new CEO of 400,000 restricted shares of common stock, which grant
was made (i) on the same day as the new CEO’s option grants and (ii) pursuant to
the terms of the new CEO’s employment.  In addition, the Board of
Directors approved a grant to the Company’s new CEO of $100,000 of restricted
shares of common stock on both the first and second anniversaries of her
employment (August 29, 2007 and 2008).





54




On
September 7, 2006, the Board of Directors approved a grant of 300,000 stock
options to an outside director of the Company.





On October 23, 2007, the Board of
Directors approved a grant of 300,000 stock options to a new outside director of
the Company.





During 2007, 176,851 stock options
expired, unexercised.





On December 7, 2007, the Company’s
Chairman stepped down, remaining as a Director, and offered to return to the
Company 1,333,333 unvested stock options.  These options were
cancelled and the underlying shares are available for future issuance by the
Company.





The Company calculates expected
volatility for stock options using historical volatility.  The
starting point for the historical period used is September 2002, the timing of
the Merger (see Note 1).  The Company currently estimates the
forfeiture rate for stock options to be minimal.





The risk-free rates for the expected
terms of the stock options and awards and the employee stock purchase plan is
based on the U.S. Treasury yield curve in effect at the time of the
grant.





As of December 31, 2007, the Company
had 10,575,680 outstanding stock options granted under its 2003 stock option
plan and had 8,666,667 outstanding stock options granted outside the 2003 stock
option plan.  As of December 31, 2007 there was approximately $340,320
of total unrecognized non-cash compensation costs related to the outstanding
stock options, which is expected to be recognized over a weighted-average period
of 1.89 years.





As of December 31, 2007, 19,242,347
options were outstanding (15,528,374 were fully vested and exercisable) at
prices ranging from $0.15 to $2.00 per share.





A summary of the status of, and changes
in, the Company’s stock options as of and for the years ended December 31, 2007
and 2006, is presented below for all stock options issued to employees,
directors and non-employees:





2007
            
            
            2006Options
            
            
            Weighted-
              Average-Exercise
              Price
            
            
            Options
            
            
            Weighted-
              Average-Exercise
              PriceOutstanding
      at beginning
              of
      year
            
            
            20,452,531
            
            
            $
            0.20
            
            
            
            14,384,772
            
            
            $
            0.22Granted
            
            
            300,000
            
            
            
            0.19
            
            
            
            10,900,000
            
            
            
            0.22Voted
      against at annual
              stockholders
      meeting
            
            
            -
            
            
            
            -
            
            
            
            3,602,565
            
            
            
            0.29Exercised
            
            
            -
            
            
            
            -
            
            
            
            510,206
            
            
            
            0.15Forfeited
            
            
            1,510,184
            
            
            
            0.21
            
            
            
            719,470
            
            
            
            0.55Outstanding
      at end
              of
      year
            
            
            19,242,347
            
            
            $
            0.19
            
            
            
            20,452,531
            
            
            $
            0.20Options
      exercisable at
              end
      of year
            
            
            15,528,374
            
            
            $
            0.18
            
            
            
            11,746,246
            
            
            $
            0.17





55




The intrinsic
value of options outstanding and options exercisable at December 31, 2007 was $0
and $0, respectively.  No options were exercised during
2007.  The intrinsic value at December 31, 2007 of options expected to
vest was $0.





Stock
      Options as of December 31, 2007Exercise
              Price
            Number
              Outstanding
      at
              December 31, 2007
            Weighted-Average
              Remaining
              Contractual Life
            Number
              Exercisable
      at
              December 31, 2007$0.15
            8,650,127
            4.3 years
            8,650,1270.17
            75,000
            6.8 years
            75,0000.19
            300,000
            9.8 years
            200,0000.20
            3,166,667
            8.5 years
            3,166,6670.23
            6,000,000
            8.7 years
            2,666,6700.275
            300,000
            8.7 years
            250,0000.285
            722,571
            7.3 years
            541,9281.50
            14,814
            3.1 years
            14,8142.00
            13,168
            0.3 years
            13,16819,242,347
            
            15,528,374








Note
7  -  Employee Savings Plan





The Company sponsors a defined
contribution benefit plan (the “Savings Plan”) which qualifies under Section
401(k) of the Internal Revenue Code.  The Savings Plan covers all
eligible employees who are at least eighteen years of age and have completed six
months of service with the Company.  Employee contributions to the
Savings Plan are based on percentages of employee compensation plus a
discretionary matching contribution by the Company.  Vesting in the
Company’s contributions is based on length of service over a five-year
period.  The Company amended the Savings Plan, effective January 1,
2001, to increase the Company match from 50% to 100% of the first 5% of an
employee’s deferral, subject to certain limitations.  Contributions by
the Company for the years ended December 31, 2007 and 2006 were $53,672 and
$42,506, respectively.








Note
8  -  Income Taxes





No Federal or state income taxes have
been provided for in the accompanying consolidated financial statements because
of net operating losses incurred to date and the establishment of a valuation
allowance equal to the amount of the Company's deferred tax
assets.  At December 31, 2007, the Company has net operating loss and
research and development credit carry-forwards for Federal income tax purposes
of approximately $39,800,000 and $1,025,000, respectively.  These
carry-forwards expire between 2008 and 2027.  In 2007, net operating
loss carry-forwards of $892,112 expired and research and development credit
carry-forwards of $23,863 expired.  Changes in the Company's ownership
may cause annual limitations on the amount of loss and credit carry-forwards
that can be utilized to offset income in the future.  Net operating
loss and research and development credit carry-forwards, as of December 31,
2007, expiring over the next five years are as follows:








56








Year
      Expiring
            Net
      Operating Loss
            Research
      and Development Credit2008
            $4,655,901
            $121,6532009
            6,039,518
            208,1482010
            2,100,609
            31,5222011
            2,003,368
            21,4542012
            2,398,264
            51,237Total
            $17,197,660
            $434,014





The net deferred tax assets as of
December 31, 2007 and 2006 are summarized as follows:





December 31, 2007
            
            
            December 31, 2006Deferred
      tax assets:Depreciation
            
            $
            170,000
            
            
            $
            190,000Net operating loss
      carry-forwards
            
            
            15,900,000
            
            
            
            15,500,000Tax credit
      carry-forwards
            
            
            1,025,000
            
            
            
            970,00017,095,000
            
            
            
            16,660,000Valuation
      allowance
            
            
            (17,095,000
            )
            
            
            (16,660,000
            )Net deferred income
      taxes
            
            $
            -
            
            
            $
            -





The net change in the valuation
allowance during 2007, after taking into account expiring net operating loss and
research and development credit carry-forwards, was an increase of
$435,000.  The net change in the valuation allowance during 2006 was
an increase of $1,360,000.





Note
9  -  Commitments and Contingencies





Operating
Lease


The Company operates out of a
laboratory and office facility in Vernon Hills, Illinois.  The
original lease term was for sixty-three months through May 14, 2002 and included
a renewal option for two additional five-year periods.  In May 2002,
the lease was extended for a five-year period, through May 14,
2007.  In April 2007, the lease was extended for a three-year period,
through May 14, 2010.





Future minimum lease payments as of
December 31, 2007, under the terms of the operating lease for the facility in
Vernon Hills, Illinois are as follows:





Year ending December 31,
            Amount2008
            $99,3752009
            99,3752010
            37,266





Rental expense, including allocated
operating costs and taxes, was $120,038 and $125,995 for the years ended
December 31, 2007 and 2006, respectively.





Capital
Lease


The Company purchased a telephone
system under the terms of a capital lease in March 2003.  The lease
called for thirty-six monthly payments of $414 through March 2006, and was fully
paid in 2006.





Collaboration, Consulting
and Licensing Agreements


Under the terms of various license and
collaborative research agreements with Albert Einstein College of Medicine
(“AECOM”) the Company is obligated to make semi annual maintenance payments and
quarterly funding payments.  In addition, the agreements call for
royalty and revenue sharing agreements upon the sale and/or license of products
or technology licensed under the agreements.  In March 2002, September
2002 and October 2006 the Company renegotiated various terms of the AECOM
agreements.





57




Total expense
for these outside research, collaboration and license agreements, included in
research and development expenses, was $505,000 and $450,000 for the years ended
December 31, 2007 and 2006, respectively.





The Company has a consulting agreement
with Dr. Peter Davies, its founding scientist, which has been renewed through
November 2008, but in some instances, may be terminated at an earlier date by
the Company and the consultant.  Expense for the consulting agreement,
included in research and development expenses, was $108,000 and $108,000 for the
years ended December 31, 2007 and 2006, respectively.





Future minimum payments, as of December
31, 2007, under the above agreements are as follows:





Year ending December
    31,
            Collaborations
            Consulting2008
            $500,000
            $99,0002009
            500,000
            -2010
            500,000
            -2011
            500,000
            -2012
            500,000
            -Total
            $2,500,000
            $99,000





The Company is obligated to pay AECOM
$500,000 each year subsequent to 2007 that the Agreements are still in
effect.  In addition, the Company is obligated to pay AECOM a
percentage of all revenues received from selling and/or licensing aspects of the
AD technology licensed from AECOM that exceeds the minimum obligations reflected
in the annual license maintenance payments.  The Company can terminate
the Agreements at any time with sixty days written notice, but would be required
to return all rights granted under the Agreements to AECOM and reimburse AECOM
for any salary obligations undertaken by AECOM for the research projects covered
by the Agreements for up to one year from the termination date.





Employment
Agreement


Under the terms of her employment
agreement, Ellen R. Hoffing, the President and CEO, receives a minimum base
salary of $300,000 per year, plus a bonus of up to 40% of Ms. Hoffing’s base
salary upon attainment of performance objectives established by the Company’s
Board of Directors and acceptable to Ms. Hoffing.  On August 29, 2006,
the Company granted Ms. Hoffing a stock option to purchase 6,000,000 shares of
the Company’s common stock at an exercise price of $0.23 (which was the closing
price of the common stock on the over-the-counter market on the date of
grant).  The option vests as to 1,000,000 shares of common stock on
the sixth month anniversary of the grant, and then will vest as to an additional
166,667 shares for each month thereafter until the option is vested in full
(which will be on the third anniversary of the date of grant).  On
August 29, 2006, the Company also granted Ms. Hoffing 400,000 shares of
restricted stock ($100,000 at $0.25 per share, which was the high price of the
common stock on the over-the-counter market on the date of the grant), which
vests as to 133,334 shares on the first anniversary of the date of grant and
133,333 shares on the second and third anniversaries of the date of
grant.  On October 23, 2007, the Company granted Ms. Hoffing 526,316
shares of restricted stock ($100,000 at $0.19, which was the closing price of
the common stock on the over-the-counter market on  the date of the
grant), which vests as to 175,439 shares on August 29, 2008 and 2009 and 175,438
shares on August 29, 2010.  In addition, Ms. Hoffing will receive
$100,000 worth of shares of restricted stock on her two-year anniversary with
the Company (August 29, 2008).  If Ms. Hoffing’s employment is
terminated by the Company without cause, she is entitled to her base salary and
benefits for a period of 12 months after such termination, and the portion of
her options and restricted stock that would have vested during the 12 months
following such termination will immediately vest.  If Ms. Hoffing’s
employment is terminated upon or in connection with a change of control of the
Company, then Ms. Hoffing will be paid the equivalent of one year’s base salary
and benefits and any unvested shares of restricted stock and stock options will
immediately vest in full upon such change in control.





58




Prior Employment
Agreements




David Ellison, the Chief Financial
Officer and Corporate Secretary, was employed pursuant to an agreement through
October 31, 2007 that provided for a minimum base salary of $174,000 per year,
with an annual cost of living increase.  Mr. Ellison had not received
an increase in his base salary since April 2005.  Included in general
and administrative expense is $8,672 and $4,529 for 2007 and 2006, respectively,
representing his earned cost of living increase from April 2006 to October
2007.  Mr. Ellison’s agreement also provided a minimum monthly
non-accountable allowance of $300 for automobile and cell phone
expenses.  This allowance was increased to $400 per month in April
2005.  In July 2007, the Company gave Mr. Ellison timely notice that
his employment agreement was not being renewed.  On October 31, 2007,
the Company paid Mr. Ellison $13,201, representing his earned, but unpaid, cost
of living increase for the period April 2006 through October
2007.  Since November 1, 2007, Mr. Ellison has continued in his
current position with the Company as an at-will employee with an annual base
salary of $205,000.





John F. DeBernardis, Ph.D., the Chief
Scientific Officer, was employed pursuant to an agreement through October 31,
2007 that provided for a minimum base salary of $282,000 per year, with an
annual cost of living increase.  Dr. DeBernardis had not received an
increase in his base salary since April 2005.  Included in research
and development expense is $14,026 and $7,326 for 2007 and 2006, respectively,
representing his earned cost of living increase from April 2006 to October
2007.  Dr. DeBernardis’s agreement also provided a minimum monthly
non-accountable allowance of $1,000 for automobile and cell phone
expenses.  This allowance was increased to $1,150 per month in April
2005.  In addition, the Company also provided Dr. DeBernardis, at the
Company’s expense, a term life insurance policy in the amount of
$600,000.  This term life insurance policy was cancelled in April
2007.  In July 2007, the Company gave Dr. DeBernardis timely notice
that his employment agreement was not being renewed.  On October 31,
2007, the Company paid Dr. DeBernardis $21,352, representing his earned, but
unpaid, cost of living increase for the period April 2006 through October
2007.  Since November 1, 2007, Dr. DeBernardis has continued in his
current position with the Company as an at-will employee with an annual base
salary of $185,000.





Daniel J. Kerkman, Ph.D., the Company’s
former Vice President of Research and Development, was employed pursuant to an
agreement through October 31, 2007 that provided for a minimum base salary of
$189,000 per year, with an annual cost of living increase.  Dr.
Kerkman had not received an increase in his base salary since April
2005.  Included in research and development expense is $9,382 and
$4,901 for 2007 and 2006, respectively, representing his earned cost of living
increase from April 2006 to October 2007.  Dr. Kerkman’s agreement
also provided a minimum monthly non-accountable allowance of $300 for automobile
and cell phone expenses.  This allowance was increased to $400 per
month in April 2005.  In July 2007, the Company gave Dr. Kerkman
timely notice that his employment agreement was not being renewed.  On
October 31, 2007, the Company paid Dr. Kerkman $14,283, representing his earned,
but unpaid, cost of living increase for the period April 2006 through October
2007.  Dr. Kerkman’s position was eliminated and his employment ended
on October 31, 2007.  Dr. Kerkman received $8,803 in severance in
December 2007.  The resources that had been deployed for Dr. Kerkman’s
compensation are now being allocated to direct R & D projects and working
with outside companies and consultants to access specific expertise and
technologies to assist us in advancing our programs.





Contingencies


The Company does not maintain any
product liability insurance for products in development.  The Company
believes that even if product liability insurance were obtained, there is no
assurance that such insurance would be sufficient to cover any
claims.  The Company is unaware of any product liability
claims.





The ability to develop the Company’s
technologies and to commercialize products will depend on avoiding patents of
others.  While the Company is aware of patents issued to competitors,
as of December 31, 2007, the Company was not aware of any claim of patent
infringement against it.





In March 2004, the Company was notified
by email from Innogenetics, a Belgian biopharmaceutical company involved in
specialty diagnostics and therapeutic vaccines, that it believes the CSF
diagnostic test the Company has been developing uses technology that is
encompassed by the claims of its’ U.S. patents.  Innogenetics also
informed the Company that it could be amenable to entering into a licensing
arrangement or other business deal with the Company regarding its
patents.  The Company had some discussions with Innogenetics
concerning a potential business relationship, however no further discussions
have been held since the second quarter of 2006.





The Company has reviewed these patents
with its patent counsel on several occasions prior to receipt of the email from
Innogenetics and subsequent to receipt of the email.  Based on these
reviews, the Company believes that its CSF diagnostic test does not infringe the
claims of these Innogenetics patents.  If the Company is unable to
reach a mutually agreeable arrangement with Innogenetics, it may be forced to
litigate the issue.  Expenses involved with litigation may be
significant, regardless of the ultimate outcome of any litigation.  An
adverse decision could prevent the Company from possibly marketing a future
diagnostic product and could have a material adverse impact on its
business.





59





Note
10 – Bridge Funding





On July 10, 2006, the Company entered
into a Note and Warrant Purchase Agreement with private investors pursuant to
which the Company sold to the investors 12% senior unsecured notes due January
10, 2007 in the aggregate principal amount of $500,000 (“Bridge Funding”), and
five year warrants (the “Warrants”) exercisable to purchase an aggregate of
922,500 shares of the Company’s common stock at an exercise price of $.0025 per
share.  The Notes, plus accrued interest, were paid in full as of
January 10, 2007.  The Notes were not guaranteed by any third party,
and not secured by the Company, and were senior to all of the Company’s
indebtedness and were non-transferable.  The Warrants are immediately
exercisable, however, the shares of common stock to be issued upon exercise of
the warrants have not yet been registered.





Pursuant to FSP EITF 00-19-2,
“Accounting for Registration Payment Arrangements” (“FSP”), which addresses an
issuer’s accounting for registration payment arrangements, the Company concluded
that no obligation should be recorded related to the registration rights for the
warrants issued.  "





The Company accounted for the warrants
issued based on guidance from SFAS No. 133, Accounting for Derivative
Instruments and Hedging Activities and Emerging Issues Task Force (“EITF”) No.
00-19. Accounting for Derivative Financial Instruments Indexed to and
Potentially Settled in a Company’s Own stock.  Accordingly, the
warrants are classified as equity.





The Company allocated the proceeds from
the Bridge Funding of $500,000 between the debt and the warrants based upon the
fair value of the debt and warrants at the transaction date.  The
warrants were valued using the Black-Scholes pricing model.  This
resulted in an increase in additional paid-in capital at the transaction date
related to the warrants in the amount of $200,866.  The carrying value
of the debt was reduced by the $200,866 and the discount was amortized over the
life of the loan (6 months).  During 2007 and 2006, $11,159 and
$189,707 of the discount was recognized as interest expense,
respectively.  Included in current liabilities as of December 31,
2006, was a bridge loan balance of $488,841, comprised of the $500,000 Bridge
Funding proceeds received, net of the unamortized debt discount of
$11,159.





The fair value of the warrants issued
was determined using the Black-Scholes option pricing model based on the
following assumptions: volatility of 75%, expected life of two years, risk free
interest rate of 5.14% and no dividends.





Note
11 – Accounts Receivable





Included in accounts receivable at
December 31, 2006 is one signed contract for $250,000.  The revenues
from this agreement were not  recognized in 2006, and are included in
deferred revenues at December 31, 2006, as performance of the agreement had not
been completed by either party.  The revenues were recognized in the
2nd
quarter of 2007.





Note
12 – Research Agreement with Nanosphere, Inc.





In January 2006, the Company entered
into a research agreement with Nanosphere, Inc., a nanotechnology-based
molecular diagnostics company, to assist the Company in the development of
serum-based diagnostic tests for AD.  The research agreement resulted
in Nanosphere and APNS scientists achieving a better understanding of the tools
necessary to advance the development of a serum-based AD diagnostic test based
on the Company’s scientifically accepted biomarkers.  The Company is
currently working on developing additional tools that may enable it to best
utilize Nanosphere’s proprietary technology, or other appropriate technologies,
to continue to advance its serum diagnostic development work.


60





Note
      13 – Authorized Shares





The Company discovered in the first
quarter of 2006 that three prior amendments to its certificate of incorporation
were approved by written consent of the stockholders.  The first
amendment, approved in October 2001 and filed in November 2001, increased the
Company's authorized common stock from 22.4 million shares to 50 million shares,
and the second amendment, approved in June 2003 and filed in September 2003,
increased the authorized common stock to 200 million shares.  The
third amendment to the Company's certificate of incorporation was approved and
filed in October 2003 to change the name of the Company to “Applied
NeuroSolutions, Inc.”  For each of these amendments, the Company filed
an information statement and duly mailed it to stockholders 20 days prior to
effective date of the stockholders' written consents becoming effective, all in
accordance with the Exchange Act and its applicable rules.





In January 2006, in preparation of the
proxy statement for the Company’s annual meeting, the Company discovered that
the certificate of incorporation of its predecessor entity, Ophidian
Pharmaceuticals, Inc., limited stockholders from taking action by written
consent.  That provision is still in effect.  Consequently,
the 2001 and 2003 amendments to the certificate of incorporation, while approved
by the Board of Directors and approved by a majority of the then-outstanding
shares of common stock in the manner described above, were technically not
adopted properly under Delaware law.  Such shares may be deemed issued
in excess of the Company's 22,400,000 authorized and outstanding shares of
common stock.





To remedy this technical error, the
Company corrected its certificate of incorporation by means of a
subsidiary-parent merger approved by the stockholders, with a new “corrected”
certificate of incorporation resulting from such merger.





To assure that this correction would be
made, thereby preserving the status quo for the Company's existing common
stockholders, the Company created a new class of “super voting” Series A
preferred stock, which is permitted by the “blank check” provisions of the
current certificate of incorporation that was approved by the stockholders of
the Company's predecessor at an annual meeting held in 1999.  The
shares of this Series A preferred stock were issued solely to the members of the
Company's Audit Committee, in trust for the benefit of the Company's common
stockholders.  The members of the Audit Committee agreed to vote the
shares in favor of the curative merger transaction.  Following the
merger transaction and the correction of the certificate of incorporation to
affirm the previous actions of the Company's stockholders, the Company redeemed
and canceled the shares of the Series A preferred stock at a nominal cost of
$250.





The Board of Directors
unanimously approved the Merger Agreement and the approach
outlined above.


The
Company’s annual meeting was held on June 20, 2006 and the parent-subsidiary
merger, as described above, was approved and the Company immediately filed a
certificate of merger to effect the technical correction to its certificate of
incorporation.  The Company’s authorized common stock under Article IV
of the amended and restated certificate of incorporation is now 200 million
shares.





Because the holders of the Series A
preferred stock had informed the Company of their agreement with each other to
vote the Series A preferred shares in favor of the Merger Agreement, the Company
continued to treat the over-issued shares of common stock in the same manner as
the remaining outstanding shares of the Company’s common stock.








61


ITEM
8.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.





None.





ITEM
8A. CONTROLS AND PROCEDURES




(a)Disclosure
Controls and Procedures.   Our management, with the
participation of our principal executive officer (chief executive officer) and
principal financial officer (chief financial officer), has conducted an
evaluation of the effectiveness of the design and operation of our disclosure
controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the
Securities Exchange Act of 1934, as amended (the “Exchange Act”), as of the end
of the period covered by this report (the “Evaluation Date”).  Based
on this evaluation, and due to the material weaknesses in our internal control
over financial reporting (as described below in the “Report of Management on Applied
NeuroSolutions, Inc.’s Internal Control over Financial Reporting”), our
chief executive officer and chief financial officer concluded that as of
December 31, 2007, our disclosure controls and procedures were not
effective to ensure that information required to be disclosed by us in reports
that we file or submit under the Exchange Act is recorded, processed, summarized
and reported within the time periods specified in SEC rules and
forms.






(b)Internal
Controls Over Financial
Reporting.      There was no change in our
internal control over financial reporting during our most recently completed
fiscal quarter that has materially affected or is reasonably likely to
materially affect our internal control over financial reporting.  Set
forth below is the “Report of
Management on Applied NeuroSolutions, Inc.’s Internal Control over Financial
Reporting”




Report
of Management on Applied NeuroSolutions, Inc.’s Internal Control Over Financial
Reporting




Our
principal executive officer (chief executive officer) and principal financial
officer (chief financial officer), as members of management of Applied
NeuroSolutions, Inc., are responsible for establishing and maintaining adequate
internal control over financial reporting, as such term is defined in Exchange
Act Rules 13a-15(f) or 15d-15(f).  Internal control over
financial reporting is a process designed to provide reasonable assurance
regarding the reliability of financial reporting and the preparation of
financial statements for external purposes in accordance with generally accepted
accounting principles.  Internal control over financial reporting
includes those policies and procedures that (1) pertain to the maintenance
of records that, in reasonable detail, accurately and fairly reflect the
transactions and dispositions of our assets; (2) provide reasonable
assurance that transactions are recorded as necessary to permit preparation of
financial statements in accordance with generally accepted accounting
principles, and that our receipts and expenditures are being made only in
accordance with authorizations of our management and directors; and
(3) provide reasonable assurance regarding prevention or timely detection
of unauthorized acquisition, use, or disposition of our assets that could have a
material effect on the financial statements.




Because
of its inherent limitations, our internal controls and procedures may not
prevent or detect misstatements.  A control system, no matter how well
conceived and operated, can provide only reasonable, not absolute, assurance
that the objectives of the control system are met. Because of the inherent
limitations in all control systems, no evaluation of controls can provide
absolute assurance that all control issues and instances of fraud, if any, have
been detected.  Also, projections of any evaluation of effectiveness
to future periods are subject to the risk that controls may become inadequate
because of changes in conditions, or that the degree of compliance with the
policies and procedures may deteriorate.




The
following material weaknesses have been identified by members of our management
and reported to the audit committee:




·
            We
      lack segregation of duties in the period-end financial reporting
      process.  Our Chief Financial Officer (CFO) is the only
      employee with any significant knowledge of generally accepted accounting
      principles. The CFO is also the sole employee in charge of the general
      ledger (including the preparation of routine and non-routine journal
      entries and journal entries involving accounting estimates), the
      preparation of accounting reconciliations, the selection of accounting
      principles, and the preparation of interim and annual financial statements
      (including report combinations, consolidation entries and footnote
      disclosures) in accordance with generally accepted accounting
      principles.




62


·
            We
      use accounting software that has inherent control deficiencies over user
      access and audit trail
capabilities.




As of
December 31, 2007, our management, with the participation of our chief executive
officer and chief financial officer, documented our control environment,
however, management did not assess our internal control over financial reporting
based on criteria for effective internal control over financial reporting as
described in “Internal Control — Integrated Framework” issued by the Committee
of Sponsoring Organizations (COSO) of the Treadway Commission.  As a
result of the material weaknesses described above, management has concluded that
our internal controls over financial reporting were not effective as of
December 31, 2007.








ITEM
8B. OTHER INFORMATION





None.











PART
III





ITEM
      9.   DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS, CONTROL
      PERSONS AND CORPORATE GOVERNANCE; COMPLIANCE WITH SECTION 16(A) OF THE
      EXCHANGE ACT





Our
executive officers and directors as of December 31, 2007, and their ages as of
February 29, 2008, are as follows:








Name
            
            Age
            
            PositionEllen
      R. Hoffing
            
            51
            
            President,
      Chief Executive Officer, Chairman of the Board of Directors & Class II
      DirectorAlan
      L. Heller (2)(3)
            
            54
            
            Class
      III DirectorJay
      B. Langner (1)
            
            78
            
            Class
      II DirectorDavid
      C. Tiemeier (3)
            
            61
            
            Class
      I DirectorRobert
      S. Vaters (1)(2)
            
            47
            
            Class
      III DirectorDavid
      Ellison
            
            46
            
            Chief
      Financial Officer & Corporate
Secretary





(1)
            Member
      of the Audit Committee


(2)
            Member
      of the Compensation and Stock Option
Committee


(3)
            Member
      of Nominating Committee





Ellen R. Hoffing, a Class II
director, was appointed Chairman of the Board of Directors in December 2007 and
has been President, Chief Executive Officer and a Director since August 29,
2006.  Since 2005, she has been a consultant to healthcare focused
companies.  In 2005, Ms. Hoffing was Vice President, Strategic Planning at
American Pharmaceutical Partners, a publicly traded specialty pharmaceutical
company focused on injectable oncology, anti-infective and critical care
products.  From 2002 to 2005, Ms. Hoffing was Vice President, Renal
Pharmaceuticals at Baxter Healthcare, a New York Stock Exchange listed company.
From 2001 to 2002, she was Vice President, Strategy and Acquisitions, at
Merisant (the maker of Equal®) and from 2000 to 2001, Ms. Hoffing was a strategy
and management consultant to healthcare focused companies. Prior to 2000, Ms.
Hoffing took on roles of increasing responsibility in her 17 years at the Searle
division of Monsanto, which culminated in her position as Vice President, Global
Analytics.





Alan L. Heller, a Class III
director, has been a director since September 2006.  Since March 2006,
Mr. Heller has been an Operating Partner at a private equity firm, Water Street
Capital Partners.  Mr. Heller currently serves on the Board of
Directors of two public companies: Savient Pharmaceuticals, Inc. and Northfield
Laboratories Inc..  From November 2004 to November 2005, Mr. Heller
was President and Chief Executive Officer of American Pharmaceutical Partners,
Inc., a company that develops, manufactures and markets branded and generic
injectable pharmaceutical products.  From January 2004 to November
2004 Mr. Heller served as an investment advisor on life science
transactions to One Equity Partners, a private equity arm of JP Morgan
Chase.  From 2000 to 2004, Mr. Heller also served as Senior Vice
President and President Global Renal operations at Baxter Healthcare
Corporation.  Prior to joining Baxter, Mr. Heller spent 23 years at
G.D. Searle. He served in several senior level positions including Co-President
and Chief Operating Officer, with responsibility for all commercial operations
worldwide, and Executive Vice President and President, Searle
Operations.





63


JayB.Langner, a Class II director, has
been a director since July 2005.  Since 1985, Mr. Langner has served
as the Chairman of the Board of Trustees of Montefiore Medical
Center.  Located in The Bronx, NY, Montefiore Medical Center is the
University Hospital for the Albert Einstein College of Medicine (AECOM) and one
of the largest health care systems in the United States.  From 1961 to
2003, he served as Chairman and CEO of the Hudson General Corporation, which was
sold to Luftansa Airlines in 1999.  Mr. Langner began his career in
1954, serving as president of Langner Leasing Corporation.





David C. Tiemeier, Ph.D., a Class I director, has
been a director since October 2007.  He is currently serving as Deputy
Director of UChicagoTech, the University of Chicago’s Office of Technology and
Intellectual Property.  Previously, Dr. Tiemeier pursued postdoctoral
studies in molecular genetics at the National Institutes of Health before
joining the faculty of the University of California, Irvine, Medical
School.  He joined Monsanto Co. (NYSE:MON) as the head of Molecular
Genetics, and continued his career in Monsanto’s pharmaceutical division as
Senior Director of Immunoinflammatory and Infectious Diseases and took on roles
of increasing responsibility including General Manager of the Global New
Business Franchise and Vice President of Global Business Development.  He
subsequently held senior positions in Pharmacia Corporation and Pfizer Inc.
(NYSE:PFE).  Following his retirement from Pfizer, Dr. Tiemeier held senior
management positions with NeoPharm, Inc. (Nasdaq:NEOL), Immtech Pharmaceuticals,
Inc. (Amex:IMM) and Kalypsys, Inc.





Robert S. Vaters, a Class III director,has been a Director of
the Company since October 2005.  Mr. Vaters was Chairman of the Board
of Directors from July 2006 until December 2007.  Mr. Vaters is currently a
General partner in Med Opportunity Partners, a New York based private equity
firm. Previously, Mr. Vaters was Executive Vice President, Strategy and
Corporate Development of Inamed Corporation from November 2004 to March
2006 after serving as Inamed's Chief Financial Officer from August 20, 2002
to November 2004. From September 2001 to August 2002, Mr. Vaters
worked on a variety of private merchant banking transactions. He was Executive
Vice President and Chief Operating Officer at Arbinet Holdings, Inc., a
leading telecom capacity exchange from January 2001 to July 2001. He
served as Chief Financial Officer at Arbinet from January 2000 to
December 2000. Prior to that he was at Premiere Technologies from
July 1996 through January 2000, where he held a number of senior
management positions, including Executive Vice President and Chief Financial
Officer, Managing Director of the Asia Pacific business based in Sydney,
Australia and Chief Financial Officer of Xpedite Systems Inc., formerly an
independent public company that was purchased by Premiere. Additional experience
includes Senior Vice President, Treasurer of Young and Rubicam Inc., a
global communications firm with operations in 64 countries. From 1995 to 1998,
Mr. Vaters was also an independent board member and chairman of the audit
committee of Rockford Industries, a public company providing healthcare
equipment financing.





David Ellison, CPA, has been
Chief Financial Officer of the Company since May 1996 and Corporate Secretary
since August 1999.  He had been Chief Financial Officer of a long-term
care facility specializing in Alzheimer’s care and prior to that he was a senior
manager in a Chicago-area public accounting firm.








Board
of directors committees and other information





Since April 1999, the Company's
Certificate of Incorporation and Bylaws have provided that the Company's Board
of Directors is divided into three classes with staggered terms of three years
each.  In June 2006, the Company's stockholders voted on initial terms
for the three classes of directors as set forth in the Company’s By-laws,
because the terms for all classes of directors had expired.  As a
result of the election of directors in June 2006, the initial term of the
directors of the first class (“Class I”) will expire in 2007, the initial term
of the directors of the second class (“Class II”) will expire in 2008 and the
initial term of the directors of the third class (“Class III”) will expire in
2009.  In August and September 2006, we appointed Ellen R. Hoffing as
a Class II director and Alan L. Heller as a Class III director.  In
October 2007, we appointed David C. Tiemeier as a Class I
director.  The Company’s By-laws require that directors who are
appointed to fill vacancies must stand for election at the next annual meeting
of stockholders and thereafter will stand for election with the other directors
in their class.  After the expiration of the initial term, all of the
Company's directors serve three year terms and hold office until the third
annual meeting of stockholders of the Company following their election to the
Board and until their respective successors have been qualified and
elected.  Officers are elected by, and serve at the discretion of, the
Board of Directors.  On April 20, 2007, Michael Sorell, MD, a Class
III director since November 2004, passed away.    On January
30, 2007, Bruce N. Barron, a Class I director since 1994, informed the Company
that he would not run for re-election at the Company’s next annual meeting of
stockholders, due to an increase in Mr. Barron’s external business commitments.
On December 7, 2007, Mr. Barron resigned.





64




Section
16(a) beneficial reporting compliance





The Company's executive officers,
directors and shareholders beneficially owning more than 10% of the Company's
Common Stock are required under the Exchange Act to file reports of ownership of
Common Stock of the Company with the Securities and Exchange
Commission.  Copies of those reports must also be furnished to the
Company.  The Company believes that during the preceding year all
filing requirements applicable to executive officers, directors and shareholders
beneficially owning more than 10% of the Company's Common Stock have been
complied with, except (i) Ellen Hoffing (who filed a late Form 4 on October 29,
2007 for a transaction that occurred on October 23, 2007, (ii) David Tiemeier
(who filed a late Form 4 on November 1, 2007 for a transaction that occurred on
October 23, 2007) and (iii) Michael Roth and Brian Jay Stark (who jointly filed
a late Form 3 on October 9, 2007 for two transactions that occurred on September
28, 2007).





Committees





In December 2007, the Board of
Directors appointed Robert S. Vaters (Chairman) and Jay B. Langner to the Audit
Committee.  The Audit Committee reviews the scope and results of the
Company's financial statements conducted by the Company's independent
auditors.  The Committee also reviews the scope of other services
provided by the Company's independent auditors, proposed changes in the
Company's financial and accounting standards and principles, and the Company's
policies and procedures with respect to its internal accounting, and auditing
and financial controls.  The Committee makes recommendations to the
Board of Directors on the engagement of the independent auditors, as well as
other matters which may come before it or as directed by the Board of
Directors.  Our Board of Directors has determined that Mr. Vaters is
an “audit committee financial expert” within the applicable definition of the
Securities and Exchange Commission.  Each of Mr. Vaters and Mr.
Langner qualify as independent directors under Rule 10A-3 of the Securities
Exchange Act of 1934 and as defined in NASD Marketplace Rule
4200(15).





In December 2007, the Board of
Directors appointed Alan L. Heller (Chairman) and Robert S. Vaters to the
Compensation Committee.  The Compensation Committee makes decisions
concerning matters of executive compensation; administers the Company's
executive incentive plans; reviews compensation plans, programs and policies;
and monitors the performance and compensation of executive
officers.  The goal of our Board of Directors executive compensation
policy is to ensure that an appropriate relationship exists between executive
compensation and the creation of stockholder value, while at the same time
attracting, motivating and retaining senior management.Each of Mr. Heller and Mr.
Vaters qualify as independent directors under Rule 10A-3 of the Securities
Exchange Act of 1934 and as defined in NASD Marketplace Rule
4200(15).





In December 2007, the Board of
Directors appointed David C. Tiemeier (Chairman) and Alan L. Heller to the
Nominating Committee.  The Nominating Committee participates in
identifying qualified individuals to become directors and determining the
composition of the Board and its committees.  Each of Dr. Tiemeier and
Mr. Heller qualify as independent directors under Rule 10A-3 of the Securities
Exchange Act of 1934 and as defined in NASD Marketplace Rule
4200(15).





Code
of Ethics





Effective June 1, 2005, we adopted a
code of ethics that applies to all of our directors, officers (including our
chief executive officer and chief financial officer, and any person performing
similar functions) and employees.  We have made our Code of Ethics
available by filing it as Exhibit 14 with our 2005 Annual Report on Form
10-KSB.





65


ITEM
      10.
            EXECUTIVE
      COMPENSATION





SUMMARY
COMPENSATION TABLE




The following table sets forth all
compensation awarded to, earned by, or paid for services in all capacities
during 2007 and 2006 by our President and Chief Executive Officer, Chief
Financial Officer, and Chief Scientific Officer.





Name
      and
              Principal
      Position
            
            Year
            
            
            Salary
            
            
            Bonus
            
            
            Stock
              Awards
            
            
            Option
              Awards
            
            
            All
      Other
              Compensation
            
            
            TotalEllen
      R. Hoffing
              President
      & CEO (1)
            
            
            2007
              2006
            
            
            
            $301,250
              92,115
            
            
            
            $120,000
              40,000
            
            
            
            $20,761
              39,805
            
            
            
            $0
              718,685
            
            
            
            $0
              0
            
            
            
            $442,011
              890,605David
      Ellison
              CFO
      (2)
            
            
            2007
              2006
            
            
            
            $195,339
              187,529
            
            
            
            $0
              0
            
            
            
            $0
              0
            
            
            
            $0
              0
            
            
            
            $0
              0
            
            
            
            $195,339
              187,529John
      F. DeBernardis
              Chief
      Scientific Officer (3)
            
            
            2007
              2006
            
            
            
            $291,526
              303,326
            
            
            
            $0
              0
            
            
            
            $0
              0
            
            
            
            $0
              0
            
            
            
            $1,000
              4,263
            
            
            
            $292,526
              307,589





(1)
            Ms.
      Hoffing began employment as President and Chief Executive Officer of the
      Company in September 2006.  Her minimum annual base salary per
      her employment agreement is $300,000.  On August 29, 2006, The
      Company’s Board of Directors approved a grant of 6,000,000 stock options
      to Ms. Hoffing.  This option grant was made pursuant to her
      employment agreement and was not made under the Company’s 2003 stock
      option plan.  On August 29, 2006, the Company granted Ms.
      Hoffing 400,000 shares of restricted stock.  On October 23,
      2007, the Company granted Ms. Hoffing 526,316 shares of restricted
      stock.  Both restricted stock grants were made pursuant to her
      employment agreement.  In January 2007, The Company’s Board of
      Directors approved a $40,000 bonus for 2006 to Ms. Hoffing.  In
      February 2008, The Company’s Board of Directors approved a $120,000 bonus
      for 2007 to Ms. Hoffing.  The bonuses were made pursuant to her
      employment agreement.  In December 2007, Ms. Hoffing was
      appointed as  Chairman of the Company’s Board of
      Directors.  Effective December 1, 2007, the Company’s Board of
      Directors approved an increase in Ms. Hoffing’s annual base salary to
      $315,000.


(2)
            Mr.
      Ellison was employed as Chief Financial Officer of the Company pursuant to
      an agreement through October 31, 2007 that provided for a minimum base
      salary of $174,000 per year, with an annual cost of living
      increase.  Mr. Ellison had not received an increase in his base
      salary of $183,000 since April 2005.  Mr. Ellison’s agreement
      also provided a minimum monthly non-accountable allowance of $300 for
      automobile and cell phone expenses.  This allowance was
      increased to $400 per month in April 2005.  In July 2007, the
      Company gave Mr. Ellison timely notice that his employment agreement was
      not being renewed.  On October 31, 2007, the Company paid Mr.
      Ellison $13,201, representing his earned, but unpaid, cost of living
      increase for the period April 2006 through October 2007.  Since
      November 1, 2007, Mr. Ellison has continued in his current position with
      the Company as an at-will employee with an annual base salary of
      $205,000.


(3)
            Dr.
      DeBernardis was President and CEO of the Company from October 2004 through
      August 2006.  Dr. DeBernardis was employed as Chief Scientific
      Officer of the Company pursuant to an agreement through October 31, 2007
      that provided for a minimum base salary of $282,000 per year, with an
      annual cost of living increase.  Dr. DeBernardis had not
      received an increase in his base salary of $296,000 since April
      2005.  Dr. DeBernardis’s agreement also provided a minimum
      monthly non-accountable allowance of $1,000 for automobile and cell phone
      expenses.  This allowance was increased to $1,150 per month in
      April 2005.  Dr. DeBernardis’s employment agreement provided for
      the Company to pay for a life insurance policy, in addition to the life
      insurance policy provided through the Company’s group health
      plan.  The annual premium is included in All Other
      Compensation.  This additional life insurance policy was
      cancelled in April 2007.  In July 2007, the Company gave Dr.
      DeBernardis timely notice that his employment agreement was not being
      renewed.  On October 31, 2007, the Company paid Dr. DeBernardis
      $21,352, representing his earned, but unpaid, cost of living increase for
      the period April 2006 through October 2007.  Since November 1,
      2007, Dr. DeBernardis has continued in his current position with the
      Company as an at-will employee with an annual base salary of
      $185,000.




66


OUTSTANDING
EQUITY AWARDS AT FISCAL YEAR-END





Option
      Awards
            
            Stock
      AwardsName
            
            Number
      of Securities Underlying Unexercised Options (#)
    Exercisable
            
            
            Number
      of Securities Underlying Unexercised Options (#) Unexercisable(1)
            
            
            Equity
      Incentive Plan Awards: Number of Securities Underlying Unexercised
      Unearned Options (#)
            
            
            Option
      Exercise Price ($)
            
            Option
      Expiration Date
            
            Number
      of Shares or Units of Stock That Have Not Vested (#)(1)
            
            
            Market
      Value of Shares or Units of Stock That Have Not Vested ($)
            
            
            Equity
      Incentive Plan Awards: Number of Unearned Shares, Units or Other
      Rights That Have Not Vested (#)
            
            
            Equity
      Incentive Plan Awards: Market or Payout Value of Unearned Shares,
      Units or Other Rights That Have Not Vested ($)Ellen
      R. Hoffing(1)
            
            
            2,666,670
            
            
            
            3,333,330
            
            
            
            -
            
            
            $
            0.230
            
            8/29/2016
            
            
            266,666
            
            
            $
            27,096
            
            
            
            -
            
            
            $
            -526,316
            
            
            $
            79,239David
      Ellison
            
            
            9,876
            
            
            
            -
            
            
            
            -
            
            
            $
            0.150
            
            4/1/2008
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            $
            -69,132
            
            
            
            -
            
            
            
            -
            
            
            $
            0.150
            
            11/16/2010164,599
            
            
            
            -
            
            
            
            -
            
            
            $
            0.150
            
            11/1/201135,656
            
            
            
            -
            
            
            
            -
            
            
            $
            0.150
            
            6/1/2012500,000
            
            
            
            -
            
            
            
            -
            
            
            $
            0.150
            
            9/2/2013John
      F. DeBernardis
            
            
            65,840
            
            
            
            -
            
            
            
            -
            
            
            $
            0.150
            
            4/1/2008
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            $
            -233,731
            
            
            
            -
            
            
            
            -
            
            
            $
            0.150
            
            11/16/2010427,957
            
            
            
            -
            
            
            
            -
            
            
            $
            0.150
            
            11/1/2001120,402
            
            
            
            -
            
            
            
            -
            
            
            $
            0.150
            
            6/1/20121,500,000
            
            
            
            -
            
            
            
            -
            
            
            $
            0.150
            
            9/2/2013





(1)
            Ms.
      Hoffing’s unexercised stock options as of December 31, 2007 will become
      exercisable as follows: 166,667 options will become exercisable each month
      through July 29, 2009 and 166,657 options will become exercisable on
      August 29, 2009.  Ms. Hoffing’s restricted common stock will
      become exercisable as follows:308,772 shares of
      restricted common stock vests on August 29, 2008, 308,772 shares of
      restricted common stock vests on August 29, 2009, and 175,438 shares of
      restricted common stock vests on August 29,
  2010.





Employment
agreement





Under the terms of her employment
agreement, Ellen R. Hoffing, the Chairman, President and CEO, receives a minimum
base salary of $300,000 per year, plus a bonus of up to 40% of Ms. Hoffing’s
base salary upon attainment of performance objectives established by the
Company’s Board of Directors and acceptable to Ms. Hoffing.  On August
29, 2006, the Company granted Ms. Hoffing a stock option to purchase 6,000,000
shares of the Company’s common stock at an exercise price of $0.23 (which was
the closing price of the common stock on the over-the-counter market on the date
of grant).  The option vests as to 1,000,000 shares of common stock on
the sixth month anniversary of the grant, and then will vest as to an additional
166,667 shares for each month thereafter until the option is vested in full
(which will be on the third anniversary of the date of grant).  On
August 29, 2006, the Company also granted  Ms. Hoffing 400,000 shares
of restricted stock ($100,000 at $0.25 per share, which was the high price of
the common stock on the over-the-counter market on the date of grant), which
vests as to 133,334 shares on the first anniversary of the date of grant and
133,333 shares on the second and third anniversaries of the date of
grant.  On October 23, 2007, the Company granted Ms. Hoffing 526,316
shares of restricted stock ($100,000 at $0.19, which was the closing price of
the common stock on the over-the-counter market on the day prior to the grant),
which vests as to 175,439 shares on August 29, 2008 and 2009 and 175,438 shares
on August 29, 2010.  In addition, Ms. Hoffing will receive $100,000
worth of shares of restricted stock on her two-year anniversary with the Company
(August 29, 2008).  If Ms. Hoffing’s employment is terminated by the
Company without cause, she is entitled to her base salary and benefits for a
period of 12 months after such termination, and the portion of her options and
restricted stock that would have vested during the 12 months following such
termination will immediately vest.  If Ms. Hoffing’s employment is
terminated upon or in connection with a change of control of the Company, then
Ms. Hoffing will be paid the equivalent of one year’s base salary and any
unvested shares of restricted stock and stock options will immediately vest in
full upon such change in control.





67




Prior employment
agreements




David Ellison, the Chief Financial
Officer and Corporate Secretary, was employed pursuant to an agreement through
October 31, 2007 that provided for a minimum base salary of $174,000 per year,
with an annual cost of living increase.  Mr. Ellison had not received
an increase in his base salary since April 2005.  Included in general
and administrative expense is $8,672 and $4,529 for 2007 and 2006, respectively,
representing his earned, but not yet paid, cost of living increase from April
2006 to October 2007.  Mr. Ellison’s agreement also provided a minimum
monthly non-accountable allowance of $300 for automobile and cell phone
expenses.  This allowance was increased to $400 per month in April
2005.  In July 2007, the Company gave Mr. Ellison timely notice that
his employment agreement was not being renewed.  On October 31, 2007,
the Company paid Mr. Ellison $13,201, representing his earned, but unpaid, cost
of living increase for the period April 2006 through October
2007.  Since November 1, 2007, Mr. Ellison has continued in his
current position with the Company as an at-will employee with an annual base
salary of $205,000.





John F. DeBernardis, Ph.D., Senior
Advisor to the Company’s Chief Executive Officer, was employed pursuant to an
agreement through October 31, 2007 that provided for a minimum base salary of
$282,000 per year, with an annual cost of living increase.  Dr.
DeBernardis had not received an increase in his base salary since April
2005.  Included in research and development expense is $14,026 and
$7,326 for 2007 and 2006, respectively, representing his earned, but not yet
paid, cost of living increase from April 2006 to October 2007.  Dr.
DeBernardis’s agreement also provided a minimum monthly non-accountable
allowance of $1,000 for automobile and cell phone expenses.  This
allowance was increased to $1,150 per month in April 2005.  In
addition, the Company also provided Dr. DeBernardis, at the Company’s expense, a
term life insurance policy in the amount of $600,000.  This additional
life insurance policy was cancelled in April 2007.  In July 2007, the
Company gave Dr. DeBernardis timely notice that his employment agreement was not
being renewed.  On October 31, 2007, the Company paid Dr. DeBernardis
$21,352, representing his earned, but unpaid, cost of living increase for the
period April 2006 through October 2007.  Since November 1, 2007, Dr.
DeBernardis has continued in his current position with the Company as an at-will
employee with an annual base salary of $185,000.





Compensation
of directors





Prior to 2008, Directors received
option grants upon becoming directors and received additional option grants from
time to time as compensation for their service as members of the board of
directors.  In March 2008, the Board of Directors approved a
compensation plan for independent Directors effective as of January 1,
2008.  Each independent Director will receive annually a $5,000 cash
retainer plus $1,000 for each in-person Board meeting attended, $500 for each
telephonic Board meeting attended and $500 for each committee meeting
attended.  The total annual cash compensation for each Director cannot
exceed $10,000.  In addition, each independent Director will receive
an annual stock option grant as of the first Board meeting of the year, valued
at $5,000, calculated using a Black-Scholes valuation on the date of the
grant.  The stock options will have an exercise price equal to the
closing price of the Company’s common stock on the day prior to the grant and
will vest on the first business day of January in the following
year.  Directors are reimbursed for reasonable out-of-pocket expenses
incurred in the performance of their duties and the attendance of board meetings
and any meeting of stockholders.  Mr. Barron was paid $38,708 as
compensation for services rendered to the Company as Chairman in
2006.  Mr. Barron was compensated as an employee of the Company and
received health benefits and participated in the Company’s 401(k) retirement
plan in 2006.  In connection with Mr. Barron’s resignation as Chairman
in June 2006, the Company and Mr. Barron agreed to reduce the monthly payments
that Mr. Barron received under his employment agreement to
$2,479.74.  Such payments were made through December 31, 2006, and
represent Mr. Barron’s contributions for the coverage of Mr. Barron and his
family under the Registrant’s group health insurance plan and Mr. Barron’s
contributions to the Registrant’s 401(k) plan.  In the event that the
Company during its 2007 fiscal year raised at least $2 million in additional
funding, the Company agreed to make six additional payments, each in the amount
of $2,479.74 to Mr. Barron.  In September 2007, the Company raised
more than $2 million and the Company made the six payments in one lump sum to
Mr. Barron in October 2007.  The Company also agreed to convert Mr.
Barron’s incentive options into non-qualified options immediately upon his
resignation as a Director in December 2007.  Mr. Vaters, who became
Chairman in June 2006 and stepped down as Chairman in December 2007, was paid
$48,000 and $20,000 for consulting services rendered to the Company as Chairman
in 2007 and 2006, respectively.




68





Name
            
            Fees
              Earned
      or
              Paid
      in
              Cash
      ($)
            
            
            Stock
              Awards
              ($)
            
            
            Option
              Awards
              ($)
            
            
            Non-Equity
              Incentive
      Plan
              Compensation
              ($)
            
            
            Change in
      Pension
              Value
      and Non-
              Qualified
      Deferred
              Compensation
              Earnings
            
            
            All
      Other
              Compensation
              ($)
            
            
            Total
      ($)Robert
      S. Vaters
            
            $
            48,000
            
            
            $
            -
            
            
            $
            -
            
            
            $
            -
            
            
            $
            -
            
            
            $
            -
            
            
            $
            48,000Bruce
      N. Barron
            
            $
            14,878
            
            
            $
            -
            
            
            $
            -
            
            
            $
            -
            
            
            $
            -
            
            
            $
            -
            
            
            $
            14,878Jay
      B. Langner
            
            $
            -
            
            
            $
            -
            
            
            $
            -
            
            
            $
            -
            
            
            $
            -
            
            
            $
            -
            
            
            $
            -Alan
      L. Heller
            
            $
            -
            
            
            $
            -
            
            
            $
            -
            
            
            $
            -
            
            
            $
            -
            
            
            $
            -
            
            
            $
            -David
      C. Tiemeier
            
            $
            -
            
            
            $
            -
            
            
            $
            24,655
            
            
            $
            -
            
            
            $
            -
            
            
            $
            -
            
            
            $
            24,655





69


ITEM
      11.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
      MANAGEMENT AND RELATED STOCKHOLDER
MATTERS





The following table sets forth the
beneficial ownership of our securities as of February 29, 2008, by (a) each
person known by the Company to be the beneficial owner of more than 5% of any
class of the Company’s securities, (b) the Company’s directors, (c) the
Company’s executive officers, and (d) all directors and executive officers as a
group.  Except as listed below, the address of all owners listed is
c/o Applied NeuroSolutions, Inc., 50 Lakeview Parkway, Suite 111, Vernon Hills,
Illinois 60061.  As of February 29, 2008, a total of 130,217,808
shares of the Company’s common stock were outstanding.





Nature of Beneficial Owner
            Amount
      and nature
              of
      beneficial
              ownership
            Percent
      of
              Class (1)SF
      Capital Partners Ltd.
              c/o
      Stark Offshore Management LLC
              235
      Pine Street, Suite 1175
              San
      Francisco, CA 94104
            26,928,572
      (5)
            19.7%Ellen
      R. Hoffing (2)
            4,309,654  (6)
            3.2%Jay
      B. Langner (3)
            600,000  (7)
            *Robert
      S. Vaters (3)
            2,666,667  (8)
            2.0%David
      Ellison (4)
            779,263 
      (9)
            *Alan
      L. Heller (3)
            350,000 (10)
            *David
      C. Tiemeier (3)
            200,000
      (11)
            *Benjamin
      Family Trusts
            8,307,780 (12)
            6.4%All
      Directors and Officers as a group
              (6
      persons)
            8,905,584 (13)
            6.5%






Indicates
ownership of less than 1.0%




(1)  Based on
130,217,808 shares of common stock outstanding as of February 29, 2008, plus
each person’s warrants or options that are currently exercisable or that will
become     exercisable within 60 days of February 29,
2008.


(2)  Director
and officer.


(3)     
Director.


(4)     
Officer.


(5)     
Consists of 20,714,286 of common stock and 6,214,286 shares of common stock
issuable upon the exercise of warrants held by SF Capital Partners Ltd. (“SF
Capital”).  Brian J. Stark and Michael A. Roth (the “Reporting
Persons”) are the Managing Members of Stark Offshore Management, LLC, (“Stark
Offshore”) which acts as investment manager and has sole power to direct the
management of SF Capital.  Through Stark Offshore, the Reporting
Persons possess voting and dispositive power over the shares of common stock
held by SF Capital.


(6)    
Consists of 50,000 shares of common stock, 3,333,338 shares of common stock
issuable upon the exercise of currently exercisable stock options and 926,316
shares of restricted stock, of which 133,334 shares have vested as of February
29, 2008.


(7)      
Consists of 350,000 shares of common stock and 250,000 shares of common stock
issuable upon the exercise of currently exercisable stock options.


(8)      
Consists of 2,666,667 shares of common stock issuable upon the exercise of
currently exercisable stock options.


(9)       Consists
of 779,263 shares of common stock issuable upon the exercise of currently
exercisable stock options.


(10)     Consists
of 100,000 shares of common stock and 250,000 shares of common stock issuable
upon the exercise of currently exercisable stock options.


(11)    
Consists of 200,000 shares of common stock issuable upon the exercise of
currently exercisable stock options.




70




(12)   
Consists of 8,207,780 shares of common stock held by various family trusts and
100,000 shares of common stock held by a family member.  The trustee
of these various family trusts is Bank of America Corporation, 100 North Tryon
Street, Floor 25, Bank of America Corporate Center, Charlotte, NC
28255.


(13)   
Consists of 500,000 shares of common stock, 7,479,268 shares of common stock
issuable upon the exercise of currently exercisable stock options, and 926,316
shares of restricted stock, of which 133,334 shares have vested as of February
29, 2008.









Securities
authorized for issuance under equity compensation plans





In October 2002, the Board of Directors
approved a Stock Option Plan (the “Plan”) under which officers, employees,
directors and consultants may be granted incentive or non-qualified stock option
to acquire common stock.  The incentive stock options granted under
the Plan are intended to meet the requirements of Section 322 of the Internal
Revenue Code of 1986.  The exercise price of each option is no less
than the market price of our stock on the date of the grant, and an option’s
maximum term is ten years.  Options typically vest over a four-year
period.  The Plan calls for a maximum of 12,000,000 options to
purchase shares of common stock.  The Plan was approved by
shareholders in 2003.  A registration statement, Form S-8, was filed
in December 2004, registering the stock option plan.





In 2006, our Compensation Committee
approved 900,000 stock options to directors under the Plan, and 6,000,000 stock
options to our President and CEO and 4,000,000 stock options to our Chairman
that were granted outside of the Plan and part of their respective individual
compensation arrangements.  Additionally, in 2006 stockholders failed
to approve proposal three in our proxy statement for our 2006 annual meeting of
stockholders, which proposal included ratification of the grant of previously
granted options to executive officers and independent directors to purchase
approximately 3.6 million shares of common stock (the “Excess
Options”).  As a result of the stockholder vote, we cancelled the
Excess Options and the approximately 3.6 million shares of our common stock
underlying such Excess Options became available for future grants under the
Plan.





In 2007, our Compensation Committee
approved 300,000 stock options to a director under the
Plan.  Additionally, in 2007, our former Chairman returned 1,333,333
unvested stock options that were granted to him in 2006.  These
options will be cancelled and the underlying shares will become available for
future issuance.





Our only
equity compensation plan is the Applied NeuroSolutions, Inc. (formerly
Hemoxymed, Inc.) 2003 Stock Option Plan.





The following table summarizes
outstanding options under our Stock Option Plan as of December 31,
2007.  Options granted in the future under the Plan and outside of the
Plan are within the discretion of our Compensation Committee and therefore
cannot be ascertained at this time.





Plan
      Category
            (a)
              
              
              
              Number
      of Securities to
              be
      Issued Upon Exercise
              of
      Outstanding Options
            (b)
              
              
              
              Weighted-Average
              Exercise
      Price of
              Outstanding
      Options
            (c)
              Number
      of Securities
              Remaining
      Available for
              Future
      Issuance Under
              Equity
      Compensation
              Plans
      (excluding securities
              Reflected
      in column (a))Equity
      compensation plans
              approved
      by security holders
            10,575,680
            $0.171
            914,114Equity
      compensation plans
              not
      approved by security
              holders
            8,666,667(1)
            $0.221
            -Total
            19,242,347
            $0.193
            914,114


71


(1) 
Consists of an option exercisable to purchase 6,000,000 shares of our common
stock that was granted to Ellen R. Hoffing in connection with her employment as
our President and Chief Executive Officer and an option to purchase 4,000,000
shares of common stock that was granted to Robert S. Vaters in connection with
his appointment as Chairman of our Board of Directors.  In December
2007, Mr. Vaters stepped down as Chairman, while continuing as a Director of the
Company, and returned to the Company 1,333,333 unvested options from this
grant.  A description of the material terms of the option granted to
Ms. Hoffing is set forth in Part III, Item 10 of this Annual
Report.  The option granted to Mr. Vaters is now exercisable for a
ten-year period to purchase 2,666,667 shares of common stock at an exercise
price of $0.20 per share (which was the closing price of our common stock on the
OTC Bulletin Board on June 23, 2006).  Mr. Vaters remaining 2,666,667
options are fully exercisable as of December 31, 2007.





ITEM
      12.   CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND
      DIRECTOR INDEPENDENCE





During 2003, 2002, and 2001, due to
cash constraints, officers of the Company deferred compensation, loaned funds to
the Company and personally paid for some Company expenses.  In June
2002, $215,000 of the amount due to these officers was converted to shares of
common stock at the merger-adjusted market price of $0.228 per
share.  The balance due to these officers was paid in February
2004.





In 2003, Richard Stone, one of our
directors until September 2004, invested $100,000 in our convertible bridge
debt, which earned interest at rate of 6% per annum.  Mr. Stone’s
investment, including accrued interest, was converted, at rate of $0.25 per unit
of one share and 1.1 warrant, to 413,819 shares of common stock and 455,201
warrants to purchase shares of common stock at an exercise price of $0.30 per
share in the debt conversion in conjunction with the February 2004 private
placement.  The conversion rate was the same offered to all holders of
the bridge debt.





We believe that each of the
transactions set forth above were entered into on (i) terms as fair as those
that could be obtained from independent third parties, and (ii) were ratified by
a majority (but no less than two) of our independent directors who did not have
an interest in the transaction and who had access to our counsel at our
expense.





ITEM
      13.   EXHIBITS





(a)
Documents filed as a part of this report.





1.
            List
      of Financial Statements.





The
following consolidated financial statements of Applied NeuroSolutions, Inc. and
Report of Virchow Krause & Company, LLP, Independent Registered Public
Accounting Firm, are included in this report:


·
            Report
      of Virchow Krause & Company, LLP, Independent Registered Public
      Accounting Firm.


·
            Consolidated
      Balance Sheets at December 31, 2007 and
2006


·
            Consolidated
      Statements of Operations for the years ended December 31, 2007 and 2006
      and for the period from March 14, 1992 (inception) to December 31,
      2007


·
            Consolidated
      Statements of Stockholders’ Equity/(Deficit) for the years ended December
      31, 2007 and 2006 and for the period from March 14, 1992 (inception) to
      December 31, 2007


·
            Consolidated
      Statements of Cash Flows for the years ended December 31, 2007 and 2006
      and for the period from March 14, 1992 (inception) to December 31,
      2007


·
            Notes
      to Consolidated Financial Statements for the years ended December 31, 2007
      and 2006 and for the period from March 14, 1992 (inception) to December
      31, 2007





2.
            List
      of all Financial Statement
Schedules.





All
schedules are omitted because they are not applicable or the required
information is shown in the financial statements or notes
thereto.


72


3.Exhibits required by
      Item 601 of Regulation S-K. The following exhibits are filed as a part of,
      or incorporated by reference into, this
Report:





Number
            Description3.1
            Certificate
      of Incorporation, filed as Exhibit C to the Company Proxy Statement on
      Schedule 14A filed on February 23, 1999 (the "Proxy Statement")
      and incorporated herein by reference.3.1.1
            Certificate
      of Amendment of Certificate of Incorporation, filed as Exhibit A to the
      Company's
      Proxy         Statement on
      Schedule 14A, filed on June 29, 1999 and incorporated herein by
      reference.3.1.2
            Certificate
      of Amendment of Certificate of Incorporation, filed as Exhibit 3.1.2 to
      the Company’s Registration Statement on Form SB-2 SEC File Number
      333-84412, filed on March 15, 2002 (the “March 2002 Registration
      Statement”) and incorporated herein by reference.3.1.3
            Amended
      and Restated Certificate of Incorporation filed as Exhibit B to the
      Company’s Proxy Statement on Schedule 14A filed on May 15, 2006 and
      incorporated herein by reference.3.1.4
            Certificate
      of Designation of Series A Preferred Stock, filed as Exhibit 4.1 to the
      Company’s Current Report on Form 8-K, dated April 25, 2006, filed on May
      1, 2006 and incorporated herein by reference.3.2
            Company
      Bylaws, filed as Exhibit D to the February 1999 Proxy Statement and
      incorporated herein by reference.4.1
            Specimen
      Common Stock Certificate, filed as Exhibit 4.1 to Amendment No. 3 to the
      Company's Registration Statement on Form S-1, 1998, Registration Number
      333-33219 (the "1998 Registration Statement") filed on January 27, 1998
      and incorporated herein by reference.4.1.1
            Specimen
      Common Stock Certificate, identifying the Company name change from
      Ophidian Pharmaceuticals, Inc. to Hemoxymed, Inc., filed as Exhibit 4.1.1
      to the March 2002 Registration Statement and incorporated herein by
      reference.4.2
            Specimen
      Warrant Certificate, filed as Exhibit 4.2 to Amendment No. 4 to the 1998
      Registration Statement filed on January 29, 1998 and incorporated herein
      by reference.4.3
            Form
      of Representatives' Warrant Agreement, including Specimen Representatives'
      Warrant filed as Exhibit 4.3 to Amendment No. 4 the 1998 Registration
      Statement filed on January 29, 2004 and incorporated herein by
      reference.4.4
            Form
      of Warrant Agreement filed as Exhibit 4.4 to Amendment No. 4 to the 1998
      Registration Statement filed on January 29, 2004 and incorporated herein
      by reference.4.5
            Specimen
      Unit Certificate filed as Exhibit 4.5 to Amendment No. 5 to the 1998
      Registration Statement filed on February 5, 1998 and incorporated herein
      by reference.4.6
            Hemoxymed,
      Inc. 2003 Stock Option Plan filed as Appendix B to the Company’s
      definitive revised information statement on Schedule 14C filed on August
      29, 2003 and incorporated herein by reference.#4.7
            Form
      of warrant agreement, filed as Exhibit 4.1 to the Company’s quarterly
      report on Form 10-QSB for the quarter ended September 30, 2007, and
      incorporated herein by reference.10.1
            Agreement
      and Plan of Merger made as of April 16, 2001, by and among the Company,
      Ophidian Holdings, Inc., a wholly owned subsidiary of the Company, and
      Hemoxymed, Inc., filed as Exhibit A to the Company's Information Statement
      on Schedule 14f-1, SEC File No. 005-55419, filed on August 8, 2001 and
      incorporated herein by reference.10.2
            Agreement
      and Plan of Merger made as of September 10, 2002, by and among the
      Company, Molecular Geriatrics Acquisition, Inc., a wholly owned subsidiary
      of the Company, and Molecular Geriatrics Corporation, filed as Exhibit 2.1
      to the Company's Current Report on Form 8-K filed on September 23, 2002
      and incorporated herein by reference.10.3
            License
      and Collaborative Research Agreement, dated October 1, 1992 between
      Molecular Geriatrics Corporation and Albert Einstein College of Medicine,
      including Amendment Agreement dated July 1, 1993 filed as Exhibit 10.3 to
      the Company’s Annual Report on Form 10-KSB for the year ended December 31,
      2002 filed on March 31, 2003 (the “2002 10-KSB”) and incorporated herein
      by reference.10.4
            License
      and Collaborative Research Agreement, dated February 1, 1994 between
      Molecular Geriatrics Corporation and Albert Einstein College of Medicine
      filed as Exhibit 10.4 to the Company’s 2002 10-KSB and incorporated herein
      by reference.10.5
            Amendment
      Agreement, dated March 24, 2002 between Molecular Geriatrics Corporation
      and Albert Einstein College of Medicine filed as Exhibit 10.5 to the
      Company’s 2002 10-KSB and incorporated herein by
  reference.10.6
            Second
      Amendment Agreement, dated September 21, 2002 between Molecular Geriatrics
      Corporation and Albert Einstein College of Medicine filed as Exhibit 10.6
      to the Company’s 2002 10-KSB, and incorporated herein by
      reference.10.7
            Consulting
      Agreements with Dr. Peter Davies, dated October 13, 1992, October 13,
      1992, and January 31, 1994 filed as Exhibit 10.7 to the Company’s 2002
      10-KSB and incorporated herein by reference.10.8
            Lease
      Agreement, dated November 22, 1996, along with First Amendment to Lease,
      dated May 2, 1997, and Lease Extension, dated March 18, 2002 between
      Molecular Geriatrics Corporation and Arthur J. Rogers & Co filed as
      Exhibit 10.10 to the Company’s 2002 10-KSB and incorporated herein by
      reference.10.9
            Form
      of Registration rights Agreement, filed as Exhibit 4.4 to the Company's
      February 2004 8-K and incorporated herein by reference.10.10
            Form
      of Warrant, filed as Exhibit 4.5 to the Company's February 2004 8-K and
      incorporated herein by reference.10.11
            Placement
      Agent Warrant, filed as Exhibit 4.6 to the Company's February 2004 8-K and
      incorporated herein by reference.10.12
            Collaboration
      Agreement, dated November 27, 2006, between Applied NeuroSolutions, Inc.
      and Eli Lilly and Company, filed as Exhibit 10.22 to the Company’s annual
      report on Form 10-KSB for the year ended December 31, 2006 and
      incorporated herein by reference (Portions of this exhibit have been
      omitted pursuant to a request for confidential
  treatment.)10.13
            Agreement
      and Plan of Merger, dated as of April 27, 2006, by and between Applied
      NeuroSolutions, Inc. and APNS Merger Corp., filed as Exhibit 10.1 to the
      Company’s Current Report on Form 8-K, dated April 25, 2006, filed on May
      1, 2006 and incorporated herein by reference.10.14
            Letter
      Agreement, dated as of January 25, 2007, between Applied NeuroSolutions,
      Inc. and Bruce N. Barron filed as Exhibit 10.26 to the Company’s annual
      report on Form 10-KSB for the year ended December 31, 2006 and
      incorporated herein by reference.10.15
            Third
      Amendment Agreement, dated October 30, 2006 between Applied
      NeuroSolutions, Inc. and Albert Einstein College of Medicine, filed as
      Exhibit 10.27 to the Company’s annual report on Form 10-KSB for the year
      ended December 31, 2006 and incorporated herein by
    reference.10.16
            Lease
      Extension, dated April 23, 2007, between Applied NeuroSolutions, Inc. and
      Arthur J. Rogers & Co. *10.17
            Employment
      Agreement, dated as of March 17, 2008 but effective as of August 29, 2006,
      between Applied NeuroSolutions, Inc. and Ellen R. Hoffing. #
    *10.18
            Form
      of letter agreement between Applied NeuroSolutions, Inc. and certain
      warrant holders filed as Exhibit 10.1 to the Company’s quarterly report on
      Form 10-QSB for the quarter ended June 30, 2007 and incorporated herein by
      reference.10.19
            Purchase
      Agreement, dated September 28, 2007, by and between Applied
      NeuroSolutions, Inc. and  SF Capital Partners Ltd., filed as
      Exhibit 10.1 to the Company’s quarterly report on Form 10-QSB for the
      quarter ended September 30, 2007, and incorporated herein by
      reference.10.20
            Registration
      Rights Agreement, dated September 28, 2007, by and between Applied
      NeuroSolutions, Inc. and SF Capital Partners Ltd., filed as Exhibit 10.2
      to the Company’s quarterly report on Form 10-QSB for the quarter ended
      September 30, 2007, and incorporated herein by
  reference.14
            Code
      of Ethics, filed as Exhibit 14 to the Company’s 2005 10-KSB and
      incorporated herein by reference.16.1
            Letter
      from KPMG to the SEC dated October 25, 2004, filed as Exhibit 16.1 to the
      Company’s Current Report on Form 8-K, dated October 25, 2004, filed on
      October 25, 2004 and incorporated herein by reference.16.2
            Letter
      from KPMG to the SEC dated November 5, 2004, filed as Exhibit 16.2 to
      Amendment No. 1 to the Company’s Current Report on Form 8-K/A, dated
      October 25, 2004, filed on November 5, 2004 and incorporated herein by
      reference.23.1
            Consent
      of Virchow, Krause & Company,
LLP.*








* Exhibit
filed herewith.





#
Management contract or compensatory plan or arrangement.











75





ITEM
14.                      PRINCIPAL
ACCOUNTANT FEES AND SERVICES





The following is a summary of the fees
billed to us by Virchow, Krause & Company, LLP for professional services
rendered for the fiscal years ended December 31, 2007 and 2006:







Fee Category
            Fiscal
      2007
              Fees
            Fiscal
      2006
              FeesAudit
      Fees
            $
      76,800
            $ 72,500Audit
      Related Fees
            1,920
            2,460Tax
      Fees
            -
            -All
      Other Fees
            -
            -Total
      Fees
            $78,720
            $ 74,960





Audit
Fees.  Consists of fees billed for professional services
rendered for the audit of our consolidated financial statements and review of
interim consolidated financial statements included in quarterly reports and
services that are normally provided by Virchow, Krause & Company, LLP in
connection with statutory and regulatory filings or engagements.





Audit Related
Fees.  Consists of fees billed for assurance and related
services that are reasonably related to the performance of the audit or review
of our consolidated financial statements and are not reported under “Audit
Fees”.





Tax Fees.  Consists
of fees billed for professional services for tax compliance, tax advice and tax
planning.  These services include preparation of federal and state
income tax returns.





All Other
Fees.  Consists of fees for product and services other than the
services reported above.





Policy
on audit committee pre-approval of audit and permissible non-audit services of
independent auditors





The Audit Committee has adopted a
policy that requires advance approval of all audits, audit-related, tax, and
other services performed by our independent registered public accounting
firm.  The policy provides for pre-approval by the Audit Committee of
specifically defined audit and non-audit services.  Unless the
specific service has been previously pre-approved with respect to that year, the
Audit Committee must approve the permitted service before the independent
registered public accounting firm is engaged to perform it.  The Audit
Committee has delegated to the Chair of the Audit Committee authority to approve
permitted service, provided that the Chair reports any decisions to the Audit
Committee at its next scheduled meeting.  All of the services
performed by our independent registered public accounting firm during 2007 and
2006 were pre-approved by the Audit Committee.





76


SIGNATURE
PAGE








In accordance with Section 13 or 15(d)
of the Exchange Act, the registrant has duly caused this report to be signed on
its behalf by the undersigned thereunto duly authorized.








APPLIED
NEUROSOLUTIONS, INC.





Dated:
March 19, 2008


By: /s/ DAVID
ELLISON


Chief
Financial Officer


(Principal
Financial


and Accounting Officer)














In accordance with the Exchange Act,
this report has been signed by the following persons on behalf of the registrant
in the capacities and on the dates indicated.





March 19,
2008                                                                                               By:/s/ Ellen R.
Hoffing


Ellen
R. Hoffing


President,
Chief Executive Officer


Chairman
& Director


(Principal
Executive Officer)








March 19,
2008                                                                                               By:/s/ David
Ellison


David
Ellison


Chief
Financial Officer


(Principal
Financial and


Accounting
Officer)








March 19,
2008                                                                                               By:/s/ Alan L.
Heller


Alan
L. Heller


Director








March 19,
2008                                                                                               By:/s/ Jay B.
Langner


Jay
B. Langner


Director








March 19,
2008                                                                                               By:
/s/ David C.
Tiemeier


David
C. Tiemeier


Director





March 19,
2008                                                                                               By:
/s/ Robert S.
Vaters


Robert
S. Vaters


Director





77