** **

**U.S. SECURITIES AND EXCHANGECOMMISSION**

**WASHINGTON, D.C. 20549**

** **

**FORM 10-KSB/A**

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**ý**                                 ANNUAL REPORTPURSUANT TO SECTION 13 OR 15(D) OF THESECURITIES EXCHANGE ACT OF 1934

** **

**Forthe fiscal year ended December 31, 2005**

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**o**                                 TRANSITION REPORTUNDER SECTION 13 OR 15(D) OF THESECURITIES EXCHANGE ACT OF 1934

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**Forthe transition period from                     to                  **

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**COMMISSION FILE NO. 0-24921**

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**POWER3MEDICAL PRODUCTS, INC.**

(Nameof small business issuer in its charter)

 

| **New  York**                                                          | ** ** | **65-0565144**                        |
|------------------------------------------------------------------------|------------|---------------------------------------|
| (State or other  jurisdiction of  incorporation or organization)       |       | (I.R.S. Employer  Identification No.) |
|                                                                   |       |                                  |
| **3400  Research Forest Drive, Suite B2-3  The Woodlands, Texas** | ** ** | **77381**                             |
| (Address of  principal executive offices)                              |       | (Zip Code)                            |

** **

**Issuer’s Telephone Number:  **(281)466-1600

** **

**Securities registered under Section 12(b) ofthe Exchange Act: **None

** **

**Securities registered under Section 12(g) ofthe Exchange Act**:Common Stock, $.001 par value

(Titleof class)

 

Check whether the issuer: (1) filed all reportsrequired to be filed by Section 13 or 15(d) of the Exchange Actduring the past 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2)has been subject to such filingrequirements for the past 90 days. Yes ýNo o

 

Check if there is no disclosure of delinquent filersin response to Item 405 of Regulation S-B contained in this form, and nodisclosure will be contained, to the best of registrant’s knowledge, indefinitive proxy or information statements incorporated by reference in Part IIIof this Form 10-KSB or any amendment to this Form 10-KSB. o

 

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

 

Revenues for the issuer’s fiscal year ended December 31,2005 were $ -0-. The aggregate market value of the voting and non-voting commonequity held by non-affiliates of the registrant, computed by reference to theclosing price of such stock on the Over-the-Counter Bulletin Board (“OTCBB”)administered by the National Association of Securities Dealers (“Nasdaq”) on December 31,2005 was $6,602,561. For purposes of this calculation, affiliates includedirectors, executive officers and current employees.

 

The number of shares outstanding of the registrant’scommon stock, par value .001 per share, as of March 31, 2006****was 69,600,348 shares**.**

 

**Documentsincorporated by reference**: None.

 

 

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**EXPLANATORY NOTE**

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**THIS AMENDMENT NO. 1ON FORM 10-KSB (THIS AMENDMENT) AMENDS THE REGISTRANT’S ANNUAL REPORT ON FORM 10-KSBFOR THE YEAR ENDED DECEMBER 31, 2005, ORIGINALLY FILED ON APRIL 17,2006 (THE ORIGINAL FILING.)  THEREGISTRANT HEREBY AMENDS AND CORRECTS VARIOUS TYPOGRAPHICAL ERRORS IN THEORIGINAL FILING, CLARIFIES ITS RESTATEMENT OF FINANCIAL STATEMENTS FOR THE YEARENDED DECEMBER 31, 2004 AND PROVIDES ADDITIONAL INFORMATION IN CERTAINMINOR AREAS OF THE TEXT IN OUR ORIGINAL FILING.**

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**TABLE OF CONTENTS**

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| **PART I**                                                                            | ** ** | ** ** |
|--------------------------------------------------------------------------------------------|------------|------------|
| ** **                                                                                 | ** ** | ** ** |
| Item 1. Description of Business.                                                           |       |       |
| Item 2. Description of Property                                                            |       |       |
| Item 3. Legal Proceedings                                                                  |       |       |
| Item 4. Submission of Matters to a Vote of Security  Holders                               |       |       |
|                                                                                       |       |       |
| **PART II**                                                                           | ** ** | ** ** |
| ** **                                                                                 | ** ** | ** ** |
| Item 5. Market for Common  Equity and Related Stockholder Matters                          |       |       |
| Item 6. Management’s Discussion and Analysis or Plan of  Operation                    |       |       |
| Item 7. Financial Statements                                                               |       |       |
| Note 1. Organization,  Principal Activities and Basis of Presentation                      |       |       |
| Note 2. Summary of  Significant Accounting Policies                                        |       |       |
| Note 3. Going Concern                                                                      |       |       |
| Note 4. Income Taxes                                                                       |       |       |
| Note 5. Related Party  Transactions                                                        |       |       |
| Note 6. Other Commitments  and Contingencies                                               |       |       |
| Note 7. Financing Arrangements                                                             |       |       |
| Note 8. Other Significant  Equity Transactions                                             |       |       |
| Note 9. Recent Pronouncements                                                              |       |       |
| Note 10. Subsequent Events                                                                 |       |       |
| Item 8. Controls and Procedures                                                            |       |       |
| Item 9. Changes in  Accountants and Financial Disclosure                                   |       |       |
| Item 10. Directors,  Executive Officers and Control Persons                                |       |       |
| Item 11. Executive Compensation                                                            |       |       |
| Item 12. Security Ownership  of Certain Beneficial Owners, Management, Stockholder Matters |       |       |
| Item 13. Exhibits                                                                          |       |       |
| Item 14. Principal Accountant Fees and  Services                                           |       |       |
|                                                                                       |       |       |
| SIGNATURES                                                                                 |       |       |

 

1

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**FORWARD-LOOKING STATEMENT**

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This Report contains certain forward-lookingstatements of the intentions, hopes, beliefs, expectations, strategies, andpredictions of Power3 Medical Products, Inc. (“Power3” or the “Company”)or its management with respect to future activities or other future events orconditions within the meaning of Section 27A of the Securities Act of1933, as amended, and Section 21E of the Securities Exchange Act of 1934,as amended. These statements are usually identified by the use of words such as“believes,” “will,” “anticipates,” “estimates,” “expects,” “projects,” “plans,”“intends,” “should,” “could,” or similar expressions. These statements arebased on certain assumptions and analyses made by the Company’s management inlight of its experience and its perception of historical trends, currentconditions, expected future developments and other factors believed appropriate.Readers are cautioned that these forward-looking statements are onlypredictions and that the Company’s business is subject to significant risks anduncertainties, including, without limitation:

 

•                  The Company’s history of operatinglosses;

 

•                  The Company’s need and ability toraise significant capital and obtain adequate financing for its developmentefforts;

 

•                  The Company’s ability tosuccessfully develop and complete validation studies for its products;

 

•                  The Company’s dependence upon andthe uncertainties associated with obtaining and enforcing patents andintellectual property rights important to its business;

 

•                  The uncertainties associated withthe lengthy regulatory approval process, including uncertainties associatedwith the United States Food and Drug Administration (“FDA”) decisions andtiming of product development or approval;

 

•                  Development by competitors of new orcompetitive products or services;

 

•                  The Company’s ability to retainmanagement, implement its business strategy, assimilate and integrate anyacquisitions;

 

•                  The Company’s lack of operatingexperience and present commercial production capabilities; and

 

•                  The increasing emphasis oncontrolling healthcare costs and potential legislation or regulation ofhealthcare pricing.

 

Although the Company believes that the assumptionsunderlying the forward-looking statements contained in this report arereasonable, any of the assumptions could be inaccurate, and, therefore, therecan be no assurance that the forward-looking statements included in this reportwill prove to be accurate. In light of the significant uncertainties inherentin the forward-looking statements included in this report, the inclusion ofsuch information should not be regarded as a representation by the Company orany other person that the objectives and plans of the Company will be achieved.Except for its ongoing obligation to disclose material information as requiredby the federal securities laws, the Company undertakes no obligation to releasepublicly any revisions to any forward-looking statements to reflect events orcircumstances after the date of this report or to reflect the occurrence ofunanticipated events. Accordingly, the reader should not rely onforward-looking statements, because they are subject to known and unknownrisks, uncertainties, and other factors that may cause actual results todiffer materially from those contemplated by the forward-looking statements.

 

2

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**PART I**

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*Exceptfor historical information, the matters set forth in this report includeforward-looking statements that are subject to risks and uncertainties thatcould cause actual results to differ materially from those set forth herein. Power3Medical Products, Inc. refers you to cautionary information and riskfactors contained elsewhere herein and in other documents filed with theSecurities and Exchange Commission (“SEC”) from time to time.*

* *

**Item 1. Description of Business.**

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**Overviewand Corporate History**

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Power3 Medical Products, Inc. (the “Company”or “Power3 “) was incorporated in the State of Florida on May 15, 1992 andmerged into a New York Corporation in 1994, under the name Sheffield Acres, Inc.Power3 and its wholly owned subsidiaries, C5 Health, Inc. (C5), which wasofficially dissolved in the State of Delaware and the State of Floridaeffective December 31, 2003 and Power3 Medical, Inc., a NevadaCorporation, were engaged in sales, distribution and services for thehealthcare industry. On September 12, 2003 Surgical Safety Products, Inc. amended its Certificate ofIncorporation to (a) declare a 1:50 reverse split of its common stock; (b) increaseits authorized capital to 150,000,000 shares of common stock and 50,000,000shares of preferred stock; and (c) change its name to Power3 MedicalProducts, Inc.

 

Prior to May 17, 2004, the Company had one directsubsidiary, Tenthgate, Inc. (“Tenthgate”), a Nevada corporation formerlyknown as Power3 Medical, Inc. Prior to this date, Tenthgate was accountedfor, by Power3, as a wholly-owned subsidiary, operating as a “development stagecompany”, under the cost method. Prior to the acquisition of substantially allthe assets and certain liabilities from Advanced BioChem, now known asIndustrial Enterprises of America, it was contemplated that Power3 woulddistribute the shares of its subsidiary, Tenthgate, to its shareholders ofrecord, as of May 17, 2004. To fulfill this obligation, the shares ofTenthgate were transferred to a trustee for distribution to the shareholders ofPower3 as of May 17, 2004, before the Advanced BioChem transaction and thetakeover by present management. Tenthgate was spun off because the managementof Power3, in place prior to May 17, 2004, desired to continue to own andeventually operate this subsidiary. At the time of the spinoff, Tenthgate wasgranted the rights to market a product line that had previously been marketedby Power3, but which the company had decided to abandon. Tenthgate was not anoperating company, and their management has apparently abandoned any plans tomarket the product as evidenced by their SEC filings, specifically theiramended 10-QSB filed for the quarterly period ending January 31, 2005,wherein they specifically state that they are a “development stage company.”  As of May 17, 2004, at the time of thetransfer of shares to a trustee for distribution to the previous shareholdersof Power3, Tenthgate was spun off to the previous shareholders of Power3 as of May 17,2004, and was deconsolidated from Power3 at that time. The new owners ofTenthgate, i.e. the previous shareholders of Power3 as of May 17, 2004,have been independently operating Tenthgate since May 17, 2004 and Power3does not now own or control the operations or activities of Tenthgate, nor aretheir activities associated with Power3 in any manner whatsoever.

 

The Company’s common stock is quoted on the PinkSheets Electronic Quotation Service under the symbol “PWRM.PK”. The Company’sprincipal executive offices are located at 3400 Research Forest Drive, Suite B2-3,The Woodlands, Texas 77381. The Company’s telephone number is (281) 466-1600and its facsimile number is (281) 466-1681. During 2005, the Company’s failureto timely file its Form 10-KSB caused the OTCBB to append the symbol “E”to the Company’s trading symbol. On June 14, 2005, the Company wasnotified of the OTCBB’s action to not allow the Company’s securities to bequoted on the OTCBB, as of June 16, 2005, pending the filing of the Company’sForm 10-KSB for 2004. The Company’s Form 10-KSB for 2004 was filed onSeptember 6, 2006. The Company has reapplied for quotation on the OTCBBand all quotations of the Company’s securities are deleted from the OTCBB. Power3filed a Form 211 to be reinstated to the OTCBB, but was informed by NASDthat restoration to the OTCBB was not possible until the Company’s SB-2, filedto register shares associated with the convertible debentures issued inOctober, 2004, was effective. Power3 has been informed by the NASD that theonly issue remaining, before it can be relisted to the Bulletin Board, is theeffectiveness of the SB-2, filed by the Company to register the sharesassociated with the convertible debenture and warrant agreements, originallyissued in October, 2004.

 

3

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**The Company transitioned to thedevelopment stage, from previously being an operating company, as of the assetpurchase transaction with Advanced BioChem on May 18, 2004, as referencedbelow. As a development stage company, Power3 is primarily engaged incommercializing its intellectual properties in the area of diagnosis andtreatment of breast cancer, ALS, Alzheimer’s disease and Parkinson’s disease.**

** **

**Purchaseof a Set of Assets and Assumption of a Set of Liabilities from AdvancedBio/Chem, Inc.**

** **

On May 18, 2004, Power3 purchased substantiallyall the assets of Advanced Bio/Chem, doing business as ProteEx. Since the May 18,2004 transaction, Advanced Bio/Chem has changed its name to IndustrialEnterprises of America, Inc. In this transaction, Power3 purchasedsubstantially all the assets and intellectual properties of Advanced Bio/Chemand assumed certain liabilities in exchange for the issuance of 15,000,000shares of its common stock pursuant to an Asset Purchase Agreement of even datetherewith. For financial statement purposes, the transaction has been accountedfor as a purchase transaction. Unless otherwise stated in this report, allfinancial information presented in this report is for Power3 Medical Products, Inc.,in accordance with Regulation S-B for reporting the purchase of a set of assetsand liabilities not constituting a change in control of Advanced BioChem or amerger or acquisition of Advanced BioChem into Power3 Medical Products, Inc.

 

The transaction between Power3 and Advanced BioChemwas evaluated by an independent appraiser and was determined to be a fair valuetransaction. Power3 exchanged 15,000,000 shares of common stock for a set ofassets and certain liabilities it received in the transaction from AdvancedBioChem. The physical assets acquired consisting primarily of lab equipmentwere transferred to the Balance Sheet of Power3, at cost, which is estimated tobe substantially the same as their value. In addition, the liabilities acquiredwere transferred to the Balance Sheet of Power3 at the remaining outstandingbalances due. A subset of legal fees transferred to Power3, which hadpreviously been capitalized by Advanced BioChem, were expensed at the time ofthe transaction. No other intangible assets were identified or recognized asobtained from Advanced BioChem since all such expenditures had been previouslyexpensed by Advanced BioChem as research and development expenditures. Therefore,Power3 recognized the difference in the market value of the stock given up inthe transaction versus the assets and liabilities acquired as Goodwill.

 

This accounting treatment represents a change in theaccounting treatment previously used to report the Advanced BioChem transactionas a recapitalization of Power3 as in a reverse acquisition, as previouslyshown in the Form 10-QSB issued by Power3 for the 2nd Quarter,2004. The Company, and its auditors, are in complete agreement as to theaccounting treatment of purchase accounting as an appropriate treatment toaccount for its acquisition of the assets and a certain set of liabilities ofAdvanced BioChem, now known as Industrial Enterprises of America, on May 18,2004.

 

**Businessof Issuer**

** **

As of the Company’s acquisition of assets fromAdvanced Bio/Chem on May 18, 2004, the Company’s overall business strategywas changed. The Company’s current business directive is to engage in the earlydetection, monitoring, and targeting of diseases through the analysis ofproteins. Power3’s development stage business objective is to commercialize itsintellectual properties by focusing on disease diagnosis, protein andbiomarkers identification, and drug resistance in the areas of cancers,neurodegenerative and neuromuscular diseases. Coincident with the acquisitionof assets from Advanced BioChem, the Company changed its management team andestablished a Scientific Advisory Board to assist in the research anddevelopment of its products. The members of this Scientific Advisory Board arerecognized leaders in their chosen fields and the Company is working with themto find effective therapeutics and novel predictive medicine for importanthuman diseases.

 

The Company’s business strategy, which is dependentupon obtaining sufficient additional financing, is to enhance thecommercialization of its existing diagnostic products and to aggressivelypursue appropriate product and company strategic partnerships.

 

4

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As a result of the acquisition of assets and certainliabilities of Advanced Bio/Chem, Power3 has transitioned into an advancedproteomics company that applies existing proprietary methodologies to discoverand identify protein biomarkers associated with diseases. By discovery anddevelopment of protein-based disease biomarkers, the Company has begun thedevelopment of tools for diagnosis, prognosis, early detection andidentification of new targets for drugs in cancer, and neurodegenerative andneuromuscular diseases such as amyotrophic lateral sclerosis (commonly known asALS or Lou Gehrig’s disease), Alzheimer’s disease, and Parkinson’s disease.

 

Power3’s scientific team is headed by its ChiefScientific Officer, Dr. Ira L. Goldknopf. Dr. Goldknopf was a pioneerin the science of clinical proteomics in the 1970s and 1980s and in so doingmade a significant biochemistry discovery – the ubiquitin conjugation ofproteins. This discovery was cited in the announcement of the 2004 Nobel Prizefor chemistry. The team has leveraged these significant insights and has madeprogress in the discovery of unique disease protein footprints of biomarkers inbreast cancer, neurodegenerative disease, and drug resistance tochemotherapeutic agents.

 

Proteomics is the study and analysis of proteins.Through proteomics, scientists can more accurately understand the functioningof a healthy body and are assisted in the identification of the proteinsassociated with specific diseases. Proteins that change in the course ofdisease are the building blocks for new screening and diagnostic tests whichthe Company is developing to provide earlier disease detection, enhancedtreatment and monitoring assistance.

 

**ProductCandidates**

** **

The Company plans to target the protein-baseddiagnostic and drug targeting markets utilizing the Company’s portfolio ofproprietary biomarker disease footprints. In the area of neurodegenerativedisease, the Company has completed clinical validation studies involving over650 patient samples and is utilizing biostatistics to monitor appropriatebiomarkers for diagnostic sensitivity, specificity, positive predictive value,and negative predictive value. By testing patient body fluids and tissues, suchas serum, nipple aspirate fluid, and bone marrow, the Company has discoveredunique snapshots of protein patterns in diseases including:

 

•                  cancers such as breast, leukemia,prostate, bladder, stomach, and esophageal;and

 

•                  neurodegenerative diseases such asAlzheimer’s, ALS, and Parkinson’s disease.

 

The Company’s discovery platform uses bothproprietary methodologies owned by or licensed to the Company and acceptedtechnologies to discover biomarkers in clinical samples. Following samplepreparation, a 2D Gel system is used for the separation of protein. The gelsare stained, imaged and analyzed with unprecedented sensitivity for differencesin the diseased vs. normal samples. The significance of these differences isevaluated relative to the status of the health of the individual. The proteinsof interest are removed from the gel matrix and analyzed on a massspectrometer. This information is then cross-referenced on a worldwide databaseto identify the protein of origin. This process requires a great deal ofproteomics experience and expertise to make the end-data interpretable. Inaddition, all of the procedures are scaleable. The Company’s biomarkerdiscovery platform delivers significant discoveries that are capable ofdetecting up to 20 times as many proteins in nipple aspirate fluids as Mud Pitor SELDI TOF (competing technologies); exhibiting reproducible and reliableidentification; and displaying broad dynamic range and linearity of diseaseprotein footprints.

 

The Company has successfully identified more than 400proteins, protein fragments and isoforms that are differentially expressed inresponse to disease by employing proprietary technologies gained from over 50years of combined experience in protein biochemistry.

 

Power3 is transitioning from a company focused only onresearch and development to one that is demonstrating “proof of concept” of itstechnology as it enters the commercialization stage for its technology,products and services. The Company is engaged in the process of developing aportfolio of products including the biomarkers and blood serum tests (for earlydetection of breast cancer), NuroProTM biomarkers and blood

 

5

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serum tests (forneurodegenerative diseases including Alzheimer’s, Parkinson’s and ALS diseases)and biomarkers, tests and drug targets for drug resistance to chemotherapeutics.

 

**Licenseand Sponsored Research**

** **

Advanced Bio/Chem entered into a license agreementwith the Board of Regents of The University of Texas System, an agency of theState of Texas, on behalf of The University of Texas M.D. Anderson CancerCenter in September 2003, which the Company acquired in its transactionwith Advanced Bio/Chem. The license agreement gives the Company an exclusive,worldwide, royalty-bearing license to certain patent rights and technologyrights for proteomic methods of diagnosis and monitoring of breast cancer usingnipple aspirate fluids. The license agreement also gives the Company anon-exclusive, worldwide, royalty-bearing license to certain patent rights andtechnology rights for methods of identifying specific nipple aspirate fluidproteins for diagnosis and monitoring of breast cancer. The Company ispermitted to grant sublicenses under the license agreement except for theidentification of biological markers. The Company is obligated to pay to M.D.Anderson an initial license fee, and a subsequent license fee, both of whichhave been paid. The Company is also obligated to pay annual license maintenancefees, royalties and additional milestone payments upon the occurrence ofcertain designated events. The license agreement imposes upon the Company anobligation to indemnify the Board of Regents, The University of Texas System,M.D. Anderson, the regents, officers, employees, students, and agents againstclaims arising on account of any injury or death, or damage to property causedby the exercise of the rights granted under the license agreement to theCompany, its officers and affiliates. The term of the license agreement isbased on the date of expiration of the last patent rights to expire or, in thecase of licensed technology rights, for a term of fifteen (15) years. However,in addition to customary termination provisions, M.D. Anderson has the right toterminate the license in any country if the Company fails, within ninety (90)days after receiving written notification from M.D. Anderson, to providesatisfactory evidence that it has commercialized or is attempting tocommercialize the licensed invention in such country.

 

Effective June 28, 2004, Power3 entered into anexclusive license agreement with the Baylor College of Medicine which grants tothe Company an exclusive, worldwide, sublicensable license for serum proteomicsmethods under certain patent rights for all biomarkers for both diagnostic andtherapeutic use in neurodegenerative disease. Under the terms of the agreement,Power3 paid Baylor an initial license fee and it has the obligation to payfuture royalties and additional licensing fees upon the achievement of certainmilestones. The Company is obligated under the license agreement to indemnifyBaylor, its faculty members, scientists, researchers, employees, officers,trustees and agents against claims arising from the design, process,manufacture or use of any of the patent rights or licensed products that aredeveloped through the use of the license from Baylor. Subject to customarytermination provisions, the term of the agreement is established on acountry-by-country basis and expires on the date of expiration of the lastpatent rights to expire in that country or the tenth anniversary of the firstcommercial sale of licensed products in countries where no patents exist insuch country. After such expiration the Company will have a perpetual paid infull license in such country.

 

On August 1, 2004, Power3 entered into anexclusive license agreement with M.D. Anderson which grants the Company anexclusive, worldwide, sublicensable license to patents and technologies forearly detection screening tests, identified protein biomarkers and drug targetsfor cancer patient’s resistance to drug therapy. The licensed technology wasdeveloped through joint collaboration between the Company’s scientific team andM.D. Anderson. Under the terms of the agreement, the Company paid M.D. Andersonan initial license fee and the Company has the obligation to pay furtherroyalties and additional licensing fees upon the achievement of certainmilestones. The license agreement imposes upon the Company an obligation toindemnify the Board of Regents, The University of Texas System, M.D. Anderson,the regents, officers, employees, students, and agents against claims arisingon account of any injury or death or damage to property caused by the exerciseof the rights granted under the license agreement to the Company, its officersand affiliates. The term of the license agreement is based on the date ofexpiration of the last patent rights to expire or, in the case of licensedtechnology rights, for a term of fifteen (15) years. However, in addition tocustomary termination provisions, M.D. Anderson has the right to terminate thelicense in any country if the Company fails, within ninety (90) days afterreceiving written notification from M.D. Anderson, to provide satisfactoryevidence that it has commercialized or is attempting to commercialize thelicensed invention in such country.

 

6

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On August 31, 2004 the Company entered into aresearch agreement with Baylor College of Medicine for the purpose ofdiscovering biomarkers in serum and plasma that are of particular utility inthe diagnosis and drug targeting for metabolic syndrome and associateddisorders including diabetes, cardiovascular disease, hypertension and stroke. Underthe terms of the agreement, Baylor College of Medicine will provide the Companysample materials for use in diagnosis in drug targeting metabolic syndrome andassociated diseases including diabetes, cardiovascular disease, hypertensionand stroke. With respect to any inventions developed pursuant to the agreement,the party who develops such invention will retain sole and exclusive rights tosuch invention. The other party will have the right to an exclusive license forthe invention, which has been developed. Inventions developed jointly by theparties will be jointly owned. Power3 does not have any obligations for the paymentof fees or royalties pursuant to this agreement. The agreement has a termending June 30, 2007 and may be renewed for successive one-yearperiods.

 

The Company has entered into a collaborative researchagreement with New Horizons Diagnostic effective March 21, 2005 for thedevelopment of antibody based diagnostic tests for neurodegenerative diseaseutilizing the Company’s identified biomarkers. The research agreement is basedon groups of biomarkers whose profiles are relatively sensitive and specific indistinguishing patients with ALS, Alzheimer’s disease and Parkinson’s diseasefrom each other, as well as from normal patients and patients with otherneuromuscular and neurological disorders. The purpose of the agreement is totailor monoclonal and polyclonal antibodies to the biomarkers, which will beincorporated into immunoassays. Once the assays are available, they will bedeveloped to validate diagnostic tests specifically designed to detect anddiscriminate among the neurodegenerative diseases. The research agreementprovides that the parties will develop an agreed upon schedule and budgetfor the work contemplated thereunder within sixty (60) days of the effectivedate. The agreement provides that in the event the parties are able to achievespecified goals relating to the development of a diagnostic kit as contemplatedby the research agreement, New Horizons would be compensated in any one of thefollowing manners with respect to such diagnostic kit:  (i) a contract to manufacture at leastone key component of such diagnostic kit; (ii) royalties on the sale ofsuch diagnostic kit; (iii) the opportunity to form a joint venturewith the Company for the commercialization of such diagnostic kit; or (iv) areasonable percentage of any cash consideration that the Company receives froma third party for such diagnostic kit. Although the form and amounts ofany consideration to be paid have not been agreed upon, the parties have agreedto be reasonable in negotiating such consideration.

 

On May 24, 2005, the Company entered into aCollaboration Agreement with BioSite Incorporated. The Agreement provides thatthe Company and Biosite will engage in a collaborative research program inwhich Biosite will attempt to develop antibodies and diagnostic assays for selectedtarget biomolecules proposed by the Company. The Company and Biosite will thenassess the diagnostic and therapeutic potential of these antibodies anddiagnostic assays for breast cancer and neurological diseases. If theantibodies and diagnostic assays are found to have diagnostic and/ortherapeutic potential, Biosite will develop and commercialize Biosite Productsfor the detection and/or treatment of breast cancer and/or neurologicaldiseases. Biosite will make milestone payments to the Company, as well as payroyalties on the sale of any Biosite Products containing antibodies to anyselected target biomolecule claimed in a patent application or an issuedpatent.

 

More specifically, the Agreement provides that theCompany shall propose target biomolecules for the collaborative researchprogram; Biosite and the Company shall mutually select certain targetbiomolecules for immunization (“Program Target”); and Biosite shall usecommercially reasonable efforts to develop monoclonal and omniclonal antibodiesto the selected target biomolecules that meet the specification set out by theparties (“Program Antibodies”). Upon Biosite’s written request subsequent tothe delivery of Program Antibodies to the Company, the Company will provideBiosite with blood-based clinical samples useful in the assessment of theProgram Antibodies.

 

Biosite will use commercially reasonable efforts togenerate an ELISA-based assay for each Program Target for which Biosite hasgenerated Program Antibodies. If Biosite successfully develops an ELISA-basedassay for any such Program Target, Biosite shall analyze each of the clinicalsamples provided by Power3 with such assay and shall provide the resulting datato Power3.

 

7

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Under the terms of the Agreement, Power3 grants toBiosite a worldwide, royalty-bearing license under the Power3 patent rights forthe target biomolecules and Power3 know-how rights to develop, make, have made,use, offer for sale, sell and import Biosite Products for use in the detection,prognosis, diagnosis or monitoring of any breast cancer-related disease. Thislicense is exclusive with the right to grant sublicenses for the assay of lessthan or equal to 100 patient samples per hour. This license is semi-exclusive,with the right for each party to grant one sublicense, for the assay of 100 ormore patient samples per hour.

 

Under the terms of the Agreement, Power3 grants toBiosite a non-exclusive, worldwide, royalty-bearing license under the Power3patent rights for the target biomolecules and Power3 know-how rights todevelop, make, have made, use, offer for sale, sell and import Biosite Productsfor use in the detection, prognosis, diagnosis or monitoring of anyneurological-related disease. This license includes the right for Biosite togrant one sublicense for each Program Target, provided that the grant of suchsublicense will replace Biosite’s own rights under the license.

 

In consideration for the collection and transfer ofsamples, Biosite shall pay specified fees to Power3 based on a minimum numberof samples delivered to Biosite and per unit fees for samples delivered inexcess of the minimum.

 

Biosite shall pay the Company milestone paymentsbased on certain specified events as follows:

 

•upon the earlier of (a) the First Commercial Sale by Biosite of a BiositeProduct, or the effective date of the first written agreement between Biositeand a Third Party sublicensee for a sublicense,

 

•upon demonstration, as determined in Biosite’s sole and reasonable discretion,that a panel of antibodies (including one or more antibodies to a ProgramTarget) is suitable for development of a commercial product,

 

•upon the first submission by Biosite of the first 510(k) (premarketnotification) or PMA (pre-market approval application) to the FDA for the firstBiosite Product; and

 

•upon the first FDA approval of the first 510k or PMA submitted by Biosite forthe first Biosite Product.

 

Commencing at the end of the first full calendar yearfollowing the date of First Commercial Sale for the first Biosite product, andat the end of each subsequent calendar year during the term of this Agreement,Biosite shall pay the Company specified annual minimum royalties. During theapplicable Royalty Term for a Biosite Product, on a country-by-country basis,Biosite shall pay the Company royalties, with respect to each Biosite Productequal to a specified percentage of Net Sales of each Biosite product in thatcountry. In addition to the specified royalty payments, to the extent thatBiosite reaches certain specified sales targets, then Biosite shall beobligated to make additional payment to the Company. The Agreement expires uponthe expiration of the last to expire applicable Power3 patent right. Theagreement may be terminated for cause, by either party or upon writtennotice by either party following the twenty four month anniversary date of theAgreement, or by Biosite if it is unable to develop and deliver Programantibodies to the to the Program Targets.

 

On October 13, 2005, Power3 executed a ResearchAgreement with Pfizer, Inc. to further evaluate the Company’s NuroProTMtest capabilities and to test blind and unblended samples, provided by Pfizer,under controlled conditions. The Company is completing the analysis of theresults with the blinded samples in preparation to present them to Pfizer.

 

On December 28, 2005, the Company submitted 6breast cancer blood serum biomarkers to Biosite, for consideration under theagreement. The development of antibodies was begun by Biosite for the first ofthis series.

 

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**BreastCancer Screening Test**

** **

An important factor in surviving cancer is earlydetection and treatment. According to the American Cancer Society SurveillanceResearch, when breast cancer is confined to the breast, the five-year survivalrate is close to 100%. Breast cancer is the second leading cause of cancerdeaths in women, with over $7 billion spent on breast cancer diagnosis annually.Due to the limitations of the current diagnostic techniques of mammograms andself-examination, diagnosis of cancer is often missed or inconclusive. TheCompany’s proteomic discovery platform covered by pending patentapplications and trade secrets for identifying proteins which signalpre-mammography stages of breast cancer has led to what the Company believes tobe one of the first tests of its type that may detect breast cancerearlier than current technology allows. These discoveries establish the basisof a very sensitive, non-invasive, early detection breast cancer-screeningtest.

 

The Company has decided to focus development effortsfor its early-detection tests for breast cancer on blood serum. The Company hassuccessfully used blood serum as the platform for its NuroProTMneurodegenerative tests and believes that blood serum as a single platform isthe best medium for the development and commercialization of proteomicsdiagnostic tests.

 

The Company’s Breast Cancer NAFTestTM analyzes fluidsfrom the breast called nipple aspirates fluid (NAF). Initial success yieldedthe identification of groups of breast cancer proteins in the aspirates. Theprocedure utilizes a breast pump to obtain a drop of fluid from the nipple. Theaspirate is analyzed to identify specific breast cancer protein footprints.

 

**During the past year, Power3 has conducted clinicalvalidation studies of its breast nipple aspirate fluid breast cancer test athree clinical sites:  Mercy Woman’sCenter in Oklahoma City, the NYU Medical Center in New York City and Obstetricsand Gynecological Associates at The Woman’s Hospital in Houston. The use ofbreast duct fluid samples for this purpose is the subject of an issued patentand patent pending license from MD Anderson Cancer Center.**

** **

**Concurrently, Power3 conducted its own biomarkerdiscovery program using blood serum samples collected from the same clinicalvalidation sites, in collaboration with Dr. Alan Hollingsworth at theMercy Woman’s Center.**

** **

**The blood serum biomarkers and tests for early-detectionof breast cancer discovered by comparing blood serum samples, distinguishbetween women with breast cancer, women with benign breast disease, and normalwomen with high sensitivity and specificity. The Company believes that thereare many advantages to a simple blood test over other samples taken frompatients, not the least of which is the ready acceptance by patients to havingblood drawn. This, along with numerous complaints from patients about thediscomfort of the procedure, as well as the low success rate in getting nippleaspirate samples (less than 50%) and the experience that even when samples weresuccessfully drawn, they were often not representative enough for accuratetesting, has led the Company to decide that nipple aspirate testing is notcommercially viable.**

** **

**Since the Company has elected to not pursue nippleaspirate testing for commercialization, the license agreement with MD Andersonhas not been renewed by the Company. The blood serum biomarkers and tests,discovered directly using blood serum, are covered under intellectual propertysolely owned by the Company.**

** **

**NeurodegenerativeScreening Test**

** **

Early detection of neurodegenerative disease generallyresults in better patient outcomes. Three diseases of particular interest areAlzheimer’s disease, Parkinson’s disease and ALS. The Alzheimer’s Associationreports that Alzheimer’s disease is the most common form of dementiaaffecting over 4 million Americans. People as young as 30 years old cancontract the disease and one in ten people age 65 and over have Alzheimer’sdisease. In addition, the American Parkinson’s Disease Association reports thatmore than 1.5 million people in the U.S. have Parkinson’s disease, affectingabout 1 in 100 Americans over the age of 60. On a smaller scale, the ALSAssociation reports that an average of approximately 30,000 Americans areafflicted with ALS, with 5,000 new cases diagnosed annually.

 

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The members of the Company’s scientific team havedeveloped a method for the differential diagnosis of neurodegenerative diseasesutilizing blood serum, which was co-developed with neurologist, Dr. StanAppel, now Chair of Neurology and Co-Director of Methodist NeurologicalInstitute in Houston. With this test, which involves monitoring theconcentration of differentially expressed proteins, the Company has identifiedgroups of unique markers that appear to distinguish normal patients from thosewith motor neuron, cognitive, and other neurological disorders.

 

The Company is continuing its ongoing clinicalvalidation program in collaboration with the Methodist Neurological Institute. Theinitial phase was completed in July 2004 and the latest phase wascompleted in March, 2006. During this time period, the Company’s database hasincreased from 183 to over 650 unique samples classified either as normal orbeing clinically diagnosed with ALS, Alzheimer’s, Parkinson’s, and otherrelated neurological disorders. During this time, the number of differentiallyexpressed proteins used in the discriminant analysis has increased from 9 to 47.The ability to differentiate diseases from each other and from normal anddisease controls has improved using the proprietary PD3TM process, includingPolyiterativeTM biostatistical analysis on the larger database and the expandedset of biomarkers. Currently, select panels of biomarkers are being employed indevelopment of the NuroProTM blood serum-based tests for four diseasediagnostics including neurological diseases of motor control such as Parkinson’sdisease, ALS and their like disorders; ALS specific tests for ALS vs. ALS-likedisorders; Alzheimer’s disease specific tests; and a Parkinson’sdisease-specific test. Pre-IDE applications for the first two have been filedwith the U.S. Food and Drug Administration.

 

**DrugResistance to Chemotherapeutic Agents**

** **

By the time a patient’s development of resistance tochemotherapeutic agents is detected, it is often too late to revise treatmentor otherwise save the patient. In 2002, the Company completed an initial “proofof concept,” which addresses drug resistance to a major chemotherapy agent. Determiningthat a cancer patient is sensitive or detecting a development of resistanceduring the early stages of treatment may eliminate toxic effects from thetreatment drugs, and the need for trial-and-error treatment regimens. Thesefindings may ultimately provide the pharmaceutical industry with thetechnology to screen patients, on a molecular level, prior to clinical trialsand design new drugs to overcome resistance.

 

**StrategicPartners Initiative**

** **

In January of 2006, the Company retained GloCapAdvisors, LLC, as exclusive advisor for strategic alternatives. As the Companycontinues to seek synergistic strategic partners to license and develop itsgrowing portfolio of protein biomarkers and tests, it believes Glocap Advisorsassistance, business introductions and advice will increase the Company’sexposure in target markets, provide important strategic relationships andidentify appropriate strategic partners, instrumental and essential for overallsuccessful execution of the Company’s business plan. The Company’s businessplan includes the development of these strategic partnerships which itanticipates will assist in the Company’s evolution over the next several yearsincluding the commercialization of its proprietary technologies.

 

The Company recognizes that the licensing of itsproprietary technologies to industry leaders is one of the most expedientapproaches to develop the Company’s technology into important diagnostic toolsfor the detection of diseases. The Company believes this focused positioning ofits products and services will enable the Company to capture clinical andpublic awareness of its proprietary technologies, and apply a major portion ofthat technology to the early detection and screening markets.

 

**Competition**

** **

The industry in which the Company operates isintensely competitive, and subject to significant change with respect totechnology for diagnosis and treatment of disease. Existing or futurebiotechnology, biomedical, pharmaceutical and other companies, governmententities and universities may create developments that accomplish similarfunctions to the Company’s technologies in ways that are less expensive,receive faster regulatory approval or receive greater market acceptance thanthe Company’s potential products. The Company

 

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expects that competitionin the biomarker discovery field will be based primarily on each product’s efficacy,stability, timing of entry of the product into the market, cost, and acceptanceby health care providers and health care payers.

 

The Company’s competitors have, in general, been inexistence for considerably longer than the Company has, and may havegreater capital resources and access to capital; greater internal resources foractivities in research and development, clinical testing and trials, productionand distribution; and existing collaborative relationships with third parties.

 

The existing market for biomarker discovery platformsand processes for Alzheimer’s disease alone has been estimated to be in excessof $4 billion in the U.S. based on a study prepared by Frost &Sullivan. There are several other companies engaged in the research of proteomicsand its application to biomarker discovery capabilities. Some of thesecompanies include:

 

•                  Celera Genomics, which is engaged inproteomics, bioinformatics and geonomics to identify and develop drug targetsand discover and develop new therapeutics;

 

•                  Ciphergen Biosystems, which isactive in biomarker discovery assay development and characterization;

 

•                  Europroteome, which appliesproteomics to human epithelial cancers to identify cancer specific proteinexpression patterns for clinical applications;

 

•                  Matritech, which is a developer ofproteomics-based diagnostic products for the early detection of cancer;

 

•                  Myriad Genetics, which is focused onthe development of therapeutic and diagnostic products using genomic andproteomic technologies; and

 

•                  WITA Proteomics, which focuses onthe potential role of proteins from specific cellular sources under particularconditions and analysis of the presence of modified proteins and the strategicuse of this information for drug development and diagnostic use.

 

**Sourcesand Availability of Raw Materials and Names of Principal Suppliers**

 

The Company is, as previously discussed in this section, inthe developmental stage and has not commenced commercial production of productsfor sale. Therefore the Company does not acquire, purchase, nor use anysignificant quantities of raw materials whatsoever and consequently has noprincipal suppliers.

 

**Dependenceon One or on a Few Major Customers**

 

The Company is, as discussed in this section, in thedevelopmental stage and has not commenced producing or marketing any productsto customers at this stage and has no dependence on one customer or on a fewmajor customers. The Company does have a limited set of institutions andlaboratories that it is currently involved with doing testing and developmentwork, however these associations could change and the Company is not limited towhich institutions, hospitals or laboratories it works with in the future.

 

**Researchand Development**

** **

The Company believes that research and development isan important factor in its future growth and operates a state of the artproteomics laboratory. The Company has restricted the initiation of newresearch activities during 2005 because of funding limitations and has focusedits efforts on commercializing its current inventory of test products.

 

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**Patents,Copyrights and Trademarks**

** **

The Company is continuing to pursue patent protectionfor its proprietary technologies with the U.S. Patent and Trademark Office andin foreign jurisdictions. The Company plans to prosecute, assert and defend anypatent rights it may obtain, whenever appropriate. However, securingpatent protection does not necessarily assure the Company of competitivesuccess.

 

With respect to the Company’s biomarker discoveryprocess, antibody detection system and breast cancer biomarkers, the Companyhas two provisional patents pending and four utility patents pending. TheCompany’s work in breast cancer no longer depends on certain technologies thatit has licensed from M.D. Anderson Cancer Center, as those licenses are fornipple aspirate technology that the Company has determined to be notcommercially viable. The Company’s blood serum biomarkers and tests are solelyowned by the Company.

 

In cooperation with Baylor College of Medicine, theCompany has discovered 47 biomarkers for neurodegenerative diseases such asALS, Alzheimer’s disease, and Parkinson’s disease. The Company has received anexclusive license for the rights in this technology and is responsible for thefiling, prosecution and maintenance of all patent applications covering thislicensed technology. To date, the Company has seven provisional patentapplications pending for the neurodegenerative biomarkers and assays using thesebiomarkers and has also converted four of those provisional patents intoutility applications.

 

In cooperation with the Leukemia Group at MD AndersonCancer Center, the Company has joint ownership of one utility patent pendingand one PCT international application in the area of drug resistance tochemotherapy in chronic myelogenous leukemia. The Company has also recentlydiscovered a new biomarker for drug resistance in Leukemia that exerts itseffect on the drug target, which will shortly be filed as a provisional patentapplication. The Company also has joint inventorship of a provisional patentapplication for biomarkers in gastrointestinal cancer with the University ofVirginia.

 

The Company also attempts to protect its proprietaryproducts, processes and other information by relying on trade secret laws andnondisclosure and confidentiality agreements with its employees, consultantsand certain other persons who have access to such products, processes andinformation. The agreements affirm that all inventions conceived by employeesare the exclusive property of the company. Nevertheless, there can be noassurance that these agreements will afford significant protection against oradequate compensation for misappropriation or unauthorized disclosure of theCompany’s trade secrets.

 

**Scientific Publications andPresentations**

 

In February, 2006, the Company published two peerreviewed scientific articles. Establishing the scientific basis of theirNuroProTM neurodegenerative disease biomarkers and tests is an invited reviewentitled “2D gel blood serum biomarkers reveal differential clinical proteomicsof the neurodegenerative diseases” by Essam A. Sheta, Stanley H. Appel and IraL. Goldknopf, *Expert Review of Proteomics* 3,45-62 (2006). And the second scientific article ”Complement C3c andrelated protein biomarkers in amyotrophic lateral sclerosis and Parkinson’sdisease”, by Ira L. Goldknopf, et al. *Biochemical and BiophysicaResearch Communications* 342, 1034-1039 (2006), details abreakthrough discovery of differences in a key protein that drivesneurodegeneration between Parkinson’s disease and ALS.

 

The Company is also scheduled to deliver threepresentations to major scientific meetings in April 2006: “Blood SerumBiomarkers for Differential Diagnosis of Parkinson’s Disease” and “Biomarkersfor Diagnosis and Targeting of Resistance and Sensitivity to Imatinib Mesylatein Chronic Myelogenous Leukemia” delivered at Experimental Biology 2006 in SanFrancisco in early April; and “Convergence of Proteomic-Diagnostics andPharmaco-Proteomics toward Personalized Medicine-Examples from Breast Cancerand Leukemia” given at the OncoProteomics World Congress in San Francisco inlate April, 2006.

 

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The Company believes its growing IP portfolio,industry papers and presentations demonstrate the value of its visionaryapproach to medically-useful product development and anticipates furtheracceptance by the scientific and business communities as it transitions itstechnologies into commercially-viable products.

 

**GovernmentalRegulation**

** **

The Food and Drug Administration establishesguidelines for clinical trials which are conducted in order to obtain FDAapproval. Clinical trials are required to find effective treatments to improvehealth. All clinical trials are based on a protocol which is a study plan thatdescribes the type of people who may participate in the trial, the schedule oftests and procedures, and the length of the study.

 

Clinical trials in the United States must be approvedand monitored by an Institutional Review Board (IRB) to make sure the risks ofthe trial are as low as possible and are worth any potential benefits. Allinstitutions that conduct or support biomedical research are required byfederal regulation to have an IRB that initially approves and periodicallyreviews the research.

 

Upon successful completion of a clinical trialvalidation study, an application based on the results of the clinical trial issubmitted for FDA approval. Upon receipt of FDA approval, the diagnosticscreening test would be ready for commercialization.

 

In the United States, clearance or approval tocommercially distribute new medical devices or products is received from theFDA through clearance of a 510(k) premarket notification, or 510(k), approvalof a premarket approval application, or PMA. It may take from three tonine months from submission to obtain 510(k) clearance, but may takelonger or clearance may not be obtained at all. The FDA may determinethat additional information is needed before approval to distribute the productis given.

 

For any products that are cleared through the 510(k)premarket notification process, modifications or enhancements that couldsignificantly affect safety or constitute a major change in the intended use ofthe product will require new 510(k) submissions.

 

A PMA application must be filed if a proposed productis not substantially equivalent to a medical product first marketed prior to May 1976,or if otherwise required by the FDA. The PMA approval process can be expensive,uncertain and lengthy, and a number of products for which other companies havesought FDA approval of a PMA application have never been approved for marketing.It generally takes from six to eighteen months from submission to obtain PMAapproval, but it may take longer or the submission may not beapproved at all.

 

On May 5, 2005 the Company submitted a pre-IDEapplication to the FDA on its blood test for neurodegenerative diseases ofmotor control, including Parkinson’s disease, ALS and their like disorders inorder to obtain the Agency’s guidance regarding: the appropriate regulatorypathway to pursue; the proper approach to refine and/or define its data andstatistical analyses; and the study design for the Company’s pendingneurodegenerative disease diagnostic blood tests. A submission made under thepre-IDE process is not an official IDE application as described in 21 CFR Part 812.The Pre-IDE process is designed to help companies obtain early, informal inputon aspects of a future IDE application and offers assistance in establishingthe parameters for official IDE applications when unique diagnostic testsinvolving innovative technologies are being pursued. The Company met with theFood and Drug Administration on June 1, 2005 regarding its Pre-IDEsubmission for the first in a series of its NuroProTM Blood Tests for theearly detection and differentiation of neuromuscular diseases, such as ALS andParkinson’s disease.

 

In the meeting with the FDA, guidance was offeredregarding requirements for study design, patient risk assessment and intendeduse. In addition, the FDA concurred with how the Company had approached thebiostatistics analysis utilized to interpret the test results. Based on the FDA’sadvice in preliminary discussions, Power3 presented optimized results with anincrease in specificity to more than 92% and an increase in Positive PredictedValue to more than 96%.

 

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Now, the Company is proceeding to make preparationsfor FDA applicable multiple site clinical studies for the NuroProTM suite ofblood serum tests. On August 17, 2005, the Company submitted its secondPre-IDE application on its ALS specific blood test for distinguishing ALS fromnormal and disease controls.

 

The Company is also subject to the regulatory approvaland compliance requirements for each foreign country to which it exportsproducts. In the European Union, a single regulatory approval process has beencreated, and approval is represented by the CE Mark.

 

Both before and after a product is commercialized, theCompany has ongoing responsibilities under the regulations of the FDA and otheragencies. The Company’s manufacturing facilities and those of its contractmanufacturers are, or can be, subject to periodic regulatory inspections by theFDA and other federal and state regulatory agencies, as well as civilpenalties, recall or seizure of products, total or partial suspension ofproduction, failure of the government to grant premarket clearance approval forproducts, withdrawal of marketing clearances or approvals, and criminalprosecution. The FDA has the authority to request recall, repair, replacementor refund of the cost of any product, which the Company manufactures ordistributes. The FDA also administers certain controls over the export ofmedical devices from the United States. The Company is also subject to routineinspection and must file periodic reports after the product is approved by theFDA for compliance with quality system requirements, or QSR, and medical devicereporting requirements in the United States and other applicable regulationsworldwide. Changes in existing requirements or adoption of new laws orrequirements could have a material adverse effect on the Company’s business,financial condition and results of operation. The Company will incursignificant costs to comply with laws and regulations.

 

The Company is also subject to numerous federal, stateand local laws relating to such matters as safe working conditions,manufacturing practices, environmental protection, fire hazard control anddisposal of hazardous or potentially hazardous substances. The Company may incursignificant costs to comply with laws and regulations, or such laws orregulations in the future may have a material adverse effect upon itsbusiness, financial condition and results of operations.

 

**Salesand Marketing**

** **

The Company currently has no sales or marketingemployees, and no immediate plans to hire any personnel devoted to this area. TheCompany will make decisions about sales and marketing at a later date, when itsproducts are further along in the development stage.

 

**Manufacturing**

** **

The Company does not currently have manufacturingcapabilities, but it is exploring opportunities to produce and manufacture theCompany’s diagnostic tests through collaborative agreements and strategicalliances. Exploitation of these opportunities will depend on the availabilityof further capital, qualified personnel, sufficient production resources andthe Company’s ability to establish these relationships with other parties whohave existing manufacturing and distribution capabilities. The Company does notcurrently have plans to manufacture any products in the near future. TheCompany will make decisions about manufacturing at a later date, when itsproduct portfolio is further along in the development stage.

 

**Costs and Effects of Compliancewith Environmental Laws (Federal, State or Local)**

 

The Company, as discussed earlier in this section,does not manufacture any products, nor does it purchase, store or ship anyproducts. Consequently the Company does not have any compliance issues withregard to environmental laws as they relate to commercial operations.

 

The Company does store and handle certain organicwastes and human tissue samples in its laboratory operations. The cost ofcomplying with environmental laws which govern our research and developmentlaboratory operations, during 2005, was $1,155.

 

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**Employeesand Consultants**

** **

At December 31, 2005, the Company had fourteen(14) full-time employees. None of the Company’s employees are represented bycollective bargaining agreements, and the Company considers its employeerelations to be good. The Company utilizes part-time consultants as well ascontract research organizations and other outside specialty firms for variousservices such as clinical trial support, manufacturing and regulatory approvaladvice.

 

**Divestitureof Subsidiaries**

** **

Prior to May 17, 2004, the Company had one directsubsidiary, Tenthgate, Inc. (“Tenthgate”), a Nevada corporation formerlyknown as Power3 Medical, Inc. Prior to this date, Tenthgate was accountedfor, by Power3, as a wholly-owned subsidiary, operating as a “development stagecompany”, under the cost method. Prior to the acquisition of substantially allthe assets and certain liabilities from Advanced BioChem, now known as IndustrialEnterprises of America, Power3 agreed to distribute the shares of itssubsidiary, Tenthgate, to its shareholders of record, as of May 17, 2004. Tofulfill this obligation, the shares of Tenthgate were transferred to a trusteefor distribution to the previous shareholders of Power3 on May 17, 2004,before the Advanced BioChem transaction and the takeover by present management.Tenthgate was spun off because the previous owners and management of Power3, inplace prior to May 17, 2004, desired to continue to own and eventuallyoperate this inactive subsidiary, and to pursue the prior operations of Power3.Apparently the current management of Tenthgate has decided to abandon thatproduct, because their SEC filings state that they are a “development stage company.”  Since May 17, 2004, Tenthgate has beendeconsolidated from Power3. Tenthgate has been independently operating since May 17,2004 and Power3 did not own or control the operations or activities ofTenthgate in any manner whatsoever, after May 17, 2004.

 

**RiskFactors**

** **

*In addition to the otherinformation contained in this report, the following risks may affect us. Ifany of these risks occurs, our business, financial condition or operatingresults could be adversely affected.*

* *

**We have ahistory of operating losses, and we may not achieve or maintainprofitability in the future.**

** **

We have experienced a net loss of ($13,512,696**)**for calendar year 2005. We expect these losses to continueand it is uncertain when, if ever, we will become profitable. These losses haveresulted primarily from non-cash, stock-based compensation costs incurred inconsulting contracts, stock issued for compensation, research and developmentactivities and from general and administrative costs associated withoperations. Stock issued for compensation and for consulting fees has beenvalued at market price on the effective date of the agreement, per SECrequirement. We expect to incur increasing operating losses in the future as aresult of expenses associated with research and product development as well asgeneral and administrative costs and we have estimated that we will requireapproximately $2,500,000 to carry out our business plan through the periodending December 31, 2006. Even if we do achieve profitability, we may notbe able to sustain or increase profitability on a quarterly or annual basis.

 

**We will needsignificant additional capital in the future and, if additional capital is notavailable, we may have to curtail or cease operations.**

** **

We have an immediate need for capital to continue ouroperations, and we will need to raise significant additional funds to implementour business plan. Our current plans indicate we will need significantadditional capital for research and development before we have any anticipatedrevenue generating products. The actual amount of funds that we will need willbe determined by many factors, some of which are beyond our control, and we may needfunds sooner than currently anticipated. These factors include:

 

•                  the extent to which we enter intolicensing arrangements, collaborations or joint ventures;

 

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•                  our progress with research andproduct development;

 

•                  the costs and timing of obtainingnew patent rights;

 

•                  the extent to which we acquire orlicense other technologies; and

 

•                  regulatory changes and competitionand technological developments in the market.

 

Our continued operations will therefore depend uponour ability to raise additional funds through additional equity or debtfinancing. We may seek additional funding through private sales of oursecurities, public sales of our securities, strategic alliances or by licensingall or a portion of our technology. Any such funding may significantlydilute existing shareholders or may limit our rights to our technology. Moreover,the increase in the number of shares available in the public marketplace may reducethe market price for our common stock and, consequently, the price investors may receiveat the time of sale. When we require additional funds, general marketconditions or the then-current market price of our common stock may notsupport capital raising transactions such as additional public or privateofferings of our common stock. If we are unable to obtain additional funds on atimely basis or on terms favorable to the Company, we may be required toscale back our development of new products, sell or license some or all of ourtechnology or assets, or curtail or cease operations.

 

**We may notbe successful in developing or commercializing our products, which would harmthe Company and force the Company to curtail or cease operations.**

** **

We have only recently commenced our businessoperations and our technologies are still in the early stages of development.The products we are currently developing may not be successfully developedor commercialized on a timely basis, or at all. If we are unable, fortechnological or other reasons, to complete the development, introduction orscale up of manufacturing of these products or other potential products, or ifour products do not achieve a significant level of market acceptance, we wouldbe forced to curtail or cease operations. Even if we develop our products forcommercial use and obtain all necessary regulatory approvals, we may notbe able to develop products that:

 

•                  are accepted by, and marketedsuccessfully to, the marketplace;

 

•                  are safe and effective;

 

•                  are protected from competition byothers;

 

•                  do not infringe the intellectualproperty rights of others;

 

•                  are developed prior to the successfulmarketing of similar products by competitors; or

 

•                  can be manufactured in sufficientquantities or at a reasonable cost.

 

**Many of ourresearch and development programs rely on technology licensed from thirdparties, and termination of any of those licenses would result in loss ofsignificant rights to develop and market our products, which would impair ourbusiness.**

** **

We have rights to technology through licenseagreements with third parties. We rely upon an exclusive license agreement fromBaylor College of Medicine for identification and use of biomarkers forneurodegenerative diseases. We have two license agreements from The Universityof Texas M.D. Anderson Cancer Center. One license agreement from M.D. Andersongrants the Company an exclusive license for identifying specific proteinsassociated with sensitivity or resistance to kinase inhibitor. The secondlicense agreement from M.D. Anderson grants the Company an exclusive license toemploy proteomic methods for diagnosis and monitoring of breast cancer usingnipple aspirate fluid and a non-exclusive license for methods of identifyingspecific nipple aspirate fluid proteins for diagnosis and monitoring of breastcancer. Our licenses

 

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generally may beterminated by the other party if we fail to perform our obligations,including milestone obligations to conduct a research and development programand develop the licensed products for commercialization. If terminated, wewould lose the right to develop the licensed products, which wouldsignificantly harm our business. The license agreements include paymentscontingent upon achieving specified milestones toward commercialization of thelicensed products. If disputes arise over the definition of these requirementsor whether we have satisfied the requirements in a timely manner, or if anyother obligations in the license agreement are disputed by the other party, theother party could terminate the agreement and we could lose our rights todevelop the licensed technology.

 

**If we areunable to form and maintain the collaborative relationships that ourbusiness strategy requires, our ability to develop products and revenue willsuffer.**

** **

We must form research collaborations andlicensing arrangements with several partners to operate our businesssuccessfully. To succeed, we will have to further develop our existingrelationships and establish additional collaborations. We cannot be sure thatwe will be able to establish any additional research collaborations orlicensing arrangements necessary to develop and commercialize products usingour technology or that we can do so on terms favorable to the Company. If ourcollaborations are not successful or we are not able to manage multiplecollaborations successfully, our programs may suffer.

 

Collaborative agreements generally pose the followingrisks:

 

•                  collaborators may notpursue further development and commercialization of products resulting fromcollaborations or may elect not to continue or renew research anddevelopment programs;

 

•                  collaborators may delayclinical trials, under fund a clinical trial program, stop a clinical trial orabandon a product, repeat or conduct new clinical trials or require a newformulation of a product for clinical testing;

 

•                  collaboratorscould independently develop, or develop with third parties, products that couldcompete with our future products;

 

•                  the terms of ouragreements with our current or future collaborators may not be favorableto the Company;

 

•                  a collaborator withmarketing and distribution rights to one or more products may not commitenough resources to the marketing and distribution of our products, limitingour potential revenues from the commercialization of a product;

 

•                  disputes may arisedelaying or terminating the research, development or commercialization of ourproducts, or result in significant litigation or arbitration; and

 

•                  collaborations may beterminated and, if terminated, we would experience increased capitalrequirements if we elected to pursue further development of the product.

 

In addition, business combinations or alliances amonglarge pharmaceutical companies could result in a reduced number of potentialfuture collaborators. If business combinations involving our collaborators wereto occur, the effect could be to diminish, terminate or cause delays in one ormore of our product development programs.

 

**Our productsare subject to United States, European Union and international medicalregulations and controls, which impose substantial financial costs on theCompany and which can prevent or delay the introduction of new products. As aresult, we may not obtain required approvals for the commercialization ofour products.**

** **

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** **

Our ability to sell our products is subject to variousfederal, state and international rules and regulations. In the UnitedStates, we are subject to inspection and market surveillance by the Food andDrug Administration, or FDA, to determine compliance with regulatory requirements.The regulatory process is costly, lengthy and uncertain.

 

Our future performance depends on, among othermatters, estimates as to when and at what cost we will receive regulatoryapproval for our new products. Regulatory approval can be a lengthy, expensiveand uncertain process, making the timing and cost of obtaining approvalsdifficult to predict.

 

In the United States, clearance or approval tocommercially distribute new medical devices or products is received from theFDA through clearance of a 510(k) premarket notification, or 510(k), approvalof a premarket approval application or PMA. The process to obtain 510(k)clearance is lengthy and there is no assurance clearance will be obtained.

 

For any products that are cleared through the 510(k)premarket notification process, modifications or enhancements that couldsignificantly affect safety or constitute a major change in the intended use ofthe product, will require new 510(k) submissions.

 

A PMA application must be filed if proposed productsare not substantially equivalent to a medical product first marketed prior to May 1976,or if otherwise required by the FDA. The PMA approval process can be expensive,uncertain and lengthy, and a number of products for which other companies havesought FDA approval of a PMA application have never been approved formarketing.

 

We are also subject to the regulatory approval andcompliance requirements for each foreign country to which we export ourproducts. In the European Union, a single regulatory approval process has beencreated, and approval is represented by the CE Mark.

 

Both before and after products are commercialized, wehave ongoing responsibilities under the regulations of the FDA and otheragencies. Our manufacturing facilities and those of our contract manufacturersare, or can be, subject to periodic regulatory inspections by the FDA and otherfederal and state regulatory agencies. The FDA has the authority to requestrecall, repair, replace or refund of the cost of any product manufactured ordistributed by the Company. The FDA also administers certain controls over theexport of medical devices from the United States. We are also subject toroutine inspection and must file periodic reports after the product is approvedby the FDA for compliance with quality system requirements, or QSR, and medicaldevice reporting requirements in the United States and other applicableregulations worldwide. Changes in existing requirements or adoption of new lawsor requirements could have a material adverse effect on our business, financialcondition and results of operation. We will incur significant costs to complywith laws and regulations.

 

Regulatory agencies have made, and continue to make,changes in their approval and compliance requirements and process. We cannotpredict what, how or when these changes will occur or what effect the changeswill have on the regulation of our products. Any new legislation may imposeadditional costs or lengthen review times of our products. We may not beable to obtain necessary worldwide regulatory approvals or clearances for ourproducts on a timely basis, if at all. Delays in receipts of or failure toreceive such approvals or clearances, the loss of previously received approvalsor clearances, or failure to comply with existing or future regulatoryrequirements would have a material adverse effect on our business, financialcondition and results of operations.

 

**Because manyof our competitors have substantially greater capital resources and moreexperience in research and development, manufacturing and marketing than we do,we may not succeed in developing our proposed products and bringing themto market in a cost-effective, timely manner.**

** **

We expect to compete with a broad range oforganizations that are engaged in the development and production of products,services and strategies relating to the diagnosis, prognosis, early detectionand development of new drugs in cancer, neurodegenerative and neuromusculardiseases. They include:

 

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•                  biotechnology,biomedical, pharmaceutical and other companies;

 

•                  academic andscientific institutions;

 

•                  governmentalagencies; and

 

•                  public andprivate research organizations.

 

We are an early stage development company engagedprimarily in new product development. Early in its existence, Power3 was adevelopment stage company, striving to develop products for sale to thesurgical industry. After this stage, Power3 entered the operating company stageselling the products they had developed to hospitals and medical careproviders, up until May 17, 2004. At the time of the May 18, 2004asset purchase transaction, Power3 changed its business model and entered backinto the development stage to commercialize its intellectual properties acquiredin the transaction. We have not yet completed the development of our firstproduct and have no revenue from operations. Since the change of our focus, we may havedifficulty competing with larger, established biomedical and pharmaceuticalcompanies and organizations. These companies and organizations have muchgreater financial, technical, research, marketing, sales, distribution, serviceand other resources than the Company. Moreover, they may offer broaderproduct lines, services and have greater name recognition than we do, and may offerdiscounts as a competitive tactic.

 

In addition, several early stage companies arecurrently developing products that may compete with our potential products.We anticipate strong competition from several companies that include:

 

•                  Medarex, whichis a biopharmaceutical company focused on the development of antibody-basedtherapeutics to treat life threatening and debilitating diseases includingcancer and infectious diseases;

 

•                  Matritech, whichis a developer of proteomics-based diagnostic products for the early detectionof cancer;

 

•                  CiphergenBiosystems, which is active in biomarker discovery assay development andcharacterization;

 

•                  LexiconGenetics, which is using gene knockout technology for a number of therapeuticareas which include neurological disorders and cancer; and

 

•                  Cyberonics,which designs, develops, manufactures and markets medical devices for thetreatment of Alzheimer’s disease and other chronic disorders.

 

**Ourcompetitive position depends on protection of our intellectual property.**

** **

Our success will depend on our ability to obtain andprotect patents on our technology and to protect our trade secrets. The patentswe currently license, and any future patents we may obtain or license, may notafford meaningful protection for our technology and products. Others may challengeour patents and, as a result, our patents could be narrowed, invalidated orunenforceable. In addition, our current and future patent applications may notresult in the issuance of patents in the United States or foreign countries.Competitors may develop products similar to ours that conflict with ourpatent applications and any patents we ultimately receive. In order to protector enforce our patent rights, we may initiate interference proceedings,oppositions, or patent litigation against third parties, such as infringementsuits. These lawsuits could be expensive, take significant time and divertmanagement’s attention from other business concerns. The patent position ofbiotechnology firms generally is highly uncertain, involves complex legal andfactual questions, and has recently been the subject of much litigation. Noconsistent policy has emerged from the U.S. Patent and Trademark Office or thecourts regarding the breadth of claims allowed or the degree of protectionafforded under biotechnology patents. In

 

19

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addition, there is asubstantial backlog of biotechnology patent applications at the U.S. Patent andTrademark Office, and the approval or rejection of patent applications may takeseveral years.

 

We also rely upon trade secrets, proprietary know-howand continuing technological innovation to remain competitive. Third parties may independentlydevelop such know-how or otherwise obtain access to our technology. While ouremployees, consultants and corporate partners with access to proprietaryinformation generally will be required to enter into confidentialityagreements, we cannot guarantee that these agreements will provide the Companywith adequate protection against improper use or disclosure of confidentialinformation. In addition, in some situations, these agreements may conflictwith, or be subject to, the rights of third parties with whom our employees,consultants or advisors have prior employment or consulting relationships.Further, others may gain access to our trade secrets or independentlydevelop substantially equivalent proprietary information and techniques.

 

**Our productscould infringe on the intellectual property rights of others.**

** **

Third parties may challenge the patents that havebeen issued or licensed to the Company. We may have to pay substantialdamages, possibly including treble damages, for past infringement if it isultimately determined that our products infringe a third party’s patents.Further, we may be prohibited from selling our products before we obtain alicense, which, if available at all, may require the Company to paysubstantial royalties. Even if infringement claims against the Company arewithout merit, defending a lawsuit takes significant time, may beexpensive and may divert management attention from other businessconcerns.

 

**We depend onour key scientific and management personnel to develop our products and pursuecollaborations.**

** **

Our performance is substantially dependent on theperformance of our current senior management, board of directors and keyscientific and technical personnel and advisers. The loss of the services ofany member of our senior management, board of directors, scientific ortechnical staff or scientific advisory board may significantly delay orprevent the achievement of product development and other business objectivesand could have a material adverse effect on our business, operating results andfinancial condition.

 

Recruiting and retaining qualified scientificpersonnel to perform research and development work are critical to oursuccess. There is intense competition for qualified scientists and managerialpersonnel from numerous pharmaceutical, biomedical and biotechnology companies,as well as from academic and government organizations, research institutionsand other entities. In addition, we may face particular difficultiesbecause there is a limited number of scientists specializing in proteomics andits use for the discovery of diseases, the principal focus of our company. Weexpect to rely on consultants and advisors, including our scientific andclinical advisors, to assist the Company in formulating our research anddevelopment strategy. Any of those consultants or advisors could be employed byother employers, or be self-employed, and might have commitments to, orconsulting or advisory contracts with, other entities that may limit theiravailability to the Company. Such other employment, consulting or advisoryrelationships could place our trade secrets at risk, even if we requirenon-disclosure agreements.

 

**Our lack ofoperating experience may cause the Company difficulty in managing ourgrowth.**

** **

We have no experience in manufacturing or procuring productsin commercial quantities, conducting other later-stage phases of the regulatoryapproval process or selling our products, and we have only limited experiencein negotiating, establishing and maintaining strategic relationships. We haveno experience with respect to the launch of a commercial product. Our abilityto manage our growth, if any, will require the Company to improve and expandour management and our operational and financial systems and controls. If ourmanagement is unable to manage growth effectively, our business and financialcondition would be materially harmed. In addition, if rapid growth occurs, it may strainour operational, managerial and financial resources.

 

**We have nocommercial production capability and we may encounter production problemsor delays, which could result in lower revenue.**

** **

**20**

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** **

To date, we have not produced any product incommercial quantities. Customers for any potential products and regulatoryagencies will require that we comply with current good manufacturing practicesprescribed by the FDA that we may not be able to meet. We have establishedand are in the process of establishing agreements with contract manufacturersto supply sufficient quantities of our products to conduct clinical trials aswell as for the manufacture, packaging, labeling and distribution of finishedproducts if our potential products are approved for commercialization. If sucharrangements are terminated and if we are unable to manufacture or contract fora sufficient supply of our potential products on acceptable terms, our clinicaltesting schedule may be delayed, resulting in the delay of submissionof products for regulatory approval and initiation of new development programs.If we determine to manufacture products ourselves, we may not be able tomaintain acceptable quality standards if we ramp up production. To achieveanticipated customer demand levels, we will need to scale-up our productioncapability and maintain adequate levels of inventory. We may not be ableto produce sufficient quantities to meet market demand. If we cannot achievethe required level and quality of production, we may need to outsourceproduction or rely on licensing and other arrangements with third parties. Thisreliance could reduce our gross margins and expose the Company to the risksinherent in relying on others. We may not be able to successfullyoutsource our production or enter into licensing or other arrangements underacceptable terms with these third parties, which could adversely affect ourbusiness.

 

**We have nomarketing or sales staff, and if we are unable to develop sales and marketingcapability, we may not be successful in commercializing our products.**

** **

We currently have no sales, marketing or distributioncapability. As a result, we will depend on collaborations or agreements withthird parties that have established distribution systems and direct salesforces. To the extent that we enter into co-promotion or other licensingarrangements, our revenues will depend upon the efforts of third parties, overwhich we may have little or no control.

 

If we are unable to reach and maintain agreement withone or more pharmaceutical, biomedical or biotechnology companies or otherpotential collaborators under acceptable terms, we may be required tomarket our products directly. We may elect to establish our ownspecialized sales force and marketing organization to market our products. Ifwe are unable to develop a marketing and sales force with technical expertiseand with supporting distribution capability, we may not be able tosuccessfully commercialize our products.

 

**Our businessis subject to technological obsolescence.**

** **

Proteomics, biotechnology and related pharmaceuticaltechnology have undergone and are subject to rapid and significant change. Weexpect that the technologies associated with proteomics, biotechnology researchand development will continue to develop rapidly. Our future will depend inlarge part on our ability to maintain a competitive position with respectto these technologies. Any processes, discovery platforms or products that wedevelop may become obsolete before we recover any expenses incurred inconnection with developing these products.

 

**We faceintense competition in the proteomics, biotechnology and pharmaceuticalindustries.**

** **

The proteomics, biotechnology and pharmaceuticalindustries are intensely competitive. We have numerous competitors in theUnited States and elsewhere. Our competitors include major multinationalpharmaceutical, biomedical and biotechnology companies, specialized firms anduniversities and other research institutions. Many of these competitors havegreater financial and other resources, larger research and development staffsand more effective marketing and manufacturing organizations, than we do. Inaddition, academic and government institutions have become increasingly awareof the commercial value of their research findings. These institutions are nowmore likely to enter into exclusive licensing agreements with commercialenterprises, including our competitors, to market commercial products. Smallercompanies may also prove to be significant competitors, particularlythrough collaborative arrangements with large pharmaceutical and establishedbiotechnology companies. Many of these competitors have significant productsthat have been approved or are in development and operate large, well-fundedresearch and development programs.

 

21

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Our competitors may succeed in developing orlicensing technologies and products that are more effective or less costly thanany we are developing. Our competitors may succeed in obtaining FDA orother regulatory approvals for product candidates before we do. Productsresulting from our research and development efforts, if approved for sale, may notcompete successfully with our competitors’ existing products or products underdevelopment.

 

**We facepotential difficulties in obtaining product liability and related insurance. Ifwe are subject to product liability claims and have not obtained adequateinsurance to protect against these claims, our financial condition wouldsuffer.**

** **

We do not have product liability or other professionalliability insurance. In the future, we may, in the ordinary course of business,be subject to substantial claims by, and liability to, persons alleging injuryfrom the use of our products. If we are successful in having products approvedby the FDA, the sale of such products would expose the Company to additionalpotential product liability and other claims resulting from their use. Thisliability may result from claims made directly by consumers or by othersselling such products. We do not currently have any product liability orprofessional liability insurance, and it is possible that we will not be ableto obtain or maintain such insurance on acceptable terms or that any insuranceobtained will provide adequate coverage against potential liabilities. Ourinability to obtain sufficient insurance coverage at an acceptable cost orotherwise to protect against potential product liability claims could preventor limit the commercialization of any products we develop. A successful productliability claim in excess of any insurance coverage we may procure could exceedour net worth. While we desire to reduce our risk by obtaining indemnityundertakings with respect to such claims from licensees and distributors of ourproducts, we may not be able to obtain such undertakings and, even if wedo, they may not be sufficient to limit our exposure to claims.

 

**If we aresubject to claims relating to improper handling, storage or disposal of thehazardous materials we use in our business, our financial condition wouldsuffer.**

** **

Our research and development processes involve thecontrolled storage, use and disposal of hazardous materials includingbiological hazardous materials of which we have contracts in place for properdisposal. We are subject to federal, state and local regulations governing theuse, manufacture, storage, handling and disposal of materials and wasteproducts. Although we believe that our safety procedures for handling anddisposing of these hazardous materials comply with the standards prescribed bylaw and regulation, the risk of accidental contamination or injury fromhazardous materials cannot be completely eliminated. In the event of anaccident, we could be held liable for any damages that result. We currently donot have insurance which covers any such accident and may not be able tomaintain insurance on acceptable terms, or at all. We could be required toincur significant costs to comply with current or future environmental laws andregulations.

 

**Health carecost containment initiatives may limit our returns.**

** **

Our ability to commercialize our products successfullywill be affected by the ongoing efforts of governmental and third-party payersto contain or reduce the cost of health care. Governmental and otherthird-party payers increasingly are attempting to contain health care costs by:

 

•                  challenging theprices charged for health care products and services;

 

•                  limiting bothcoverage and the amount of reimbursement for new therapeutic products;

 

•                  denying orlimiting coverage for products that are approved by the FDA but are consideredexperimental or investigational by third-party payors; and

 

•                  refusing in somecases to provide coverage when an approved product is used for diseaseindications in a way that has not received FDA marketing approval.

 

In addition, the trend toward managed health care inthe United States, the growth of organizations such as health maintenanceorganizations, and legislative proposals to reform healthcare andgovernment insurance

 

22

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programs couldsignificantly influence the purchase of healthcare services and products,resulting in lower prices and reducing demand for our products.

 

Even if we succeed in bringing any products to themarket, they may not be considered cost-effective and third-partyreimbursement might not be available or sufficient. If adequate third-partycoverage is not available, we may not be able to maintain price levelssufficient to realize an appropriate return on our investment in research andproduct development. In addition, legislation and regulations affecting thepricing of diagnostic services and testing may change in ways adverse tothe Company before or after any of our proposed products are approved formarketing. While we cannot predict whether any such legislative or regulatorychanges will be adopted, the adoption of such changes could make it difficultor impossible to sell our products.

 

**Stock pricesfor biomedical and biotechnology companies are volatile.**

** **

The market price for securities of biomedical andbiotechnology companies historically has been highly volatile, and the marketfrom time to time has experienced significant price and volume fluctuationsthat are unrelated to the operating performance of such companies. Fluctuationsin the trading price or liquidity of our common stock may adversely affectour ability to raise capital through future equity financings.

 

Factors that may have a significant impact on themarket price and marketability of our common stock include:

 

•                  announcements oftechnological innovations or new commercial therapeutic products by theCompany, our collaborative partners or our present or potential competitors;

 

•                  announcements bythe Company or others of results of validation studies and clinical trials;

 

•                  developments ordisputes concerning patent or other proprietary rights;

 

•                  adverselegislation, including changes in governmental regulation and the status of ourregulatory approvals or applications;

 

•                  changes inhealth care policies and practices; and

 

•                  economic andother external factors, including general market conditions.

 

In the past, following periods of volatility in themarket price of a company’s securities, securities class action litigationhas often been instituted. If a securities class action suit is filedagainst the Company, we would incur substantial legal fees and our management’sattention and resources would be diverted from operating our business in orderto respond to the litigation.

 

**The resale inthe open market of the shares we have issued, or shares issuable uponconversion or exercise of securities we have issued, in exempt transactionsmight adversely affect our stock price.**

** **

As of December 31, 2005, 65,215,121 shares of ourcommon stock were outstanding. We also intend to register, pursuant to aRegistration Statement on Form SB-2, **approximately 13,600,000**shares issuable upon outstanding convertible debentures and warrants. Inaddition to the shares included in the registration statement, the investorshave additional investment rights to purchase additional convertible debenturesin the aggregate principal amount of $2,500,000. These additional convertibledebentures are convertible into 2,314,815 shares of common stock, subject toadjustment. The investors will be permitted to sell the shares covered by theregistration statement in the open market from time to time without advancenotice to the Company or to the market and without limitations on volume. Thesale of a substantial number of shares of our common stock by the investors, orthe anticipation of such sales, could make it more difficult for the Company tosell equity or equity-related securities in the future at a time and at a pricethat we might otherwise wish to effect sales. In addition to the shares listedin this prospectus, approximately 15,000,000 shares of common stock issued toAdvanced Bio/Chem in our acquisition of substantially all of its assets may becomeavailable for resale. Sales

 

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of shares pursuant toother exercisable options and warrants we have issued could also lead tosubsequent sales of the shares in the public market. These sales could depressthe market price of our stock by creating an excess in supply of shares forsale. Availability of these shares for sale in the public market could alsoimpair our ability to raise capital by selling equity securities.

 

**Our stock isthinly traded, which could lead to price volatility and difficulty liquidatingyour investment.**

** **

The trading volume of our stock has been low, whichcan cause the trading price of our stock to change substantially in response torelatively small orders. During the quarter ended December 31, 2005, theaverage daily trading volume of our stock was approximately 162,500 shares andthe shares traded as low as $0.10 and as high as $0.26 per share. Both volumeand price could also be subject to wide fluctuations in response to variousfactors, many of which are beyond our control, including:

 

•                  actual oranticipated variations in quarterly and annual operating results;

 

•                  announcements oftechnological innovations by the Company or our competitors;

 

•                  developments ordisputes concerning patent or proprietary rights; and

 

•                  general marketperception of biotechnology and pharmaceutical companies.

 

**Because ourstock currently trades below $5.00 per share, and is traded on the Pink Sheets,our stock is considered by the SEC a “penny stock,” which can adversely affectits liquidity.**

** **

Our common stock does not currently qualify forlisting on the Nasdaq Stock Market or the OTCBB.. If the trading price of ourcommon stock remains less than $5.00 per share, our common stock is considereda “penny stock,” and trading in our common stock is subject to the requirementsof Rule 15g-9 under the Securities Exchange Act of 1934. Under this rule,brokers or dealers who recommend low-priced securities to persons other thanestablished customers and accredited investors must satisfy special salespractice requirements. The broker or dealer must make an individualized writtensuitability determination for the purchaser and receive the purchaser’s writtenconsent prior to the transaction.

 

SEC regulations also require additional disclosure inconnection with any trades involving a penny stock, including the delivery,prior to any penny stock transaction, of a disclosure schedule explainingthe penny stock market and its associated risks. These requirements couldseverely limit the liquidity of such securities in the secondary market becausefew brokers or dealers are likely to undertake these compliance activities. Inaddition to the applicability of the penny stock rules, another risk associatedwith trading in penny stocks may be high price fluctuations. Purchasers ofstock may be subject to substantial dilution.

 

As stated in “Market Information”, during 2005, uponthe Company’s failure to timely file its Form 10-KSB, the OTCBB appendedthe symbol “E” to the Company’s trading symbol and notified the Company of itsjeopardy of having its securities no longer quoted on the OTCBB, pending theCompany’s filing of its Form 10-KSB for 2004. On June 14, 2005, theCompany was notified of the OTCBB’s action to not allow the Company’ssecurities to be quoted on the OTCBB, as of June 16, 2005, pending thefiling of the Company’s Form 10-KSB for 2004. The 10-KSB for 2004 wasfiled in September, 2005, however the Company, per SEC comments, is nowrestating its financials for 2004 in this Form 10-KSB for the year ended December 31,20005. Accordingly, at time of this filing, the Company’s common shares areonly available for trading through the Pink Sheets.

 

**If theownership of our common stock continues to be highly concentrated, it may preventyou from influencing significant corporate decisions and may result inconflicts of interest that could cause our stock price to decline.**

** **

**24**

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** **

As of December 31, 2005, our executive officers,directors and their affiliates beneficially own or control approximately 21.7%of the outstanding shares of our common stock (after giving effect to theexercise of all options and warrants held by them which are exercisable withinsixty days of such date). Additionally, based upon our stock records,Industrial Enterprises of America, previously known as Advanced Bio/Chem, isthe record owner of approximately 22% of the outstanding shares of our commonstock as of****March 24, 2005.Accordingly, our current executive officers, directors and their affiliates, aswell as Advanced Bio/Chem, will have substantial control over the outcome ofcorporate actions requiring shareholder approval, including the election of directors,any merger, consolidation or sale of all or substantially all of our assets orany other significant corporate transactions. These shareholders may alsodelay or prevent a change of control of the Company, even if such a change ofcontrol would benefit our other shareholders. The significant concentration ofstock ownership may adversely affect the trading price of our common stockdue to investors’ perception that conflicts of interest may exist orarise.

 

**The terms ofour convertible debentures have materially modified the rights of commonshareholders, and the holders of preferred stock may be able to delay orprevent a change of control of the company.**

** **

We are authorized to issue up to 50,000,000 shares ofpreferred stock in one or more series. Our board of directors will be able todetermine the terms of preferred stock without further action by ourshareholders. If we issue preferred stock, it could affect your rights orreduce the value of your common stock. In particular, specific rights grantedto future holders of preferred stock could be used to restrict our ability tomerge with or sell our assets to a third party. These terms may includevoting rights, preferences as to dividends and liquidation, conversion andredemption rights, and sinking fund provisions.

 

Under the terms of our convertible debentures, we areprohibited from taking certain actions without the approval of the holders of atwo-thirds majority of the then-outstanding principal amount of the debentures.Specifically, we have agreed not to, so long as any portion of the debenturesare outstanding, (1) amend its certificate of incorporation, bylaws orother charter documents so as to adversely affect any rights of the holders ofthe debentures (with exception for the Series B preferred stock to beissued by the Company), or (2) repurchase more than a de minimis number ofshares of its common stock or other equity securities other than as to theshares of common stock issuable upon conversion of the debentures describedabove.

 

**We arecontractually obligated to issue shares of a Series B preferred stock toour two directors and principal officers. The Series B preferred stockwill have special voting rights such that the holders of the Series Bpreferred stock will hold a majority of the voting rights of the company.**

** **

We previously entered into employment agreements withour two directors and executive officers in which we agreed to issue 1,500,000shares of Series B preferred stock to each officer. The shares wereintended to be issued following the Advanced Bio/Chem transaction; however, wedid not file the certificate of amendment necessary to designate powers andrelative rights of the Series B preferred stock. As a result of certainrestrictions agreed to by the Company in connection with the sale of ourconvertible debentures, we are not permitted to issue common shares or commonshare equivalents such as the Series B preferred stock until 90 days afterthe effective date of the registration statement. After such restrictionslapse, we intend to designate and issue the Series B preferred stock. Itis contemplated that the Series B preferred stock will have special votingrights such that the holders of the Series B preferred stock will hold amajority of the voting rights of the company. Upon issuance of the Series Bpreferred stock, our current executive officers and directors may restrictour ability to merge with, or sell our assets to, a third party.

 

**We do notanticipate paying dividends on our common stock.**

** **

We do not plan to pay dividends on our common stockfor the foreseeable future. We currently intend to retain future earnings, ifany, to finance operations, capital expenditures and the expansion of ourbusiness.

 

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**Item 2. Description of Property**

** **

The Company does not own any real estate. The Companyconducts its operations from leased premises of approximately 7,200 square feetin The Woodlands, Texas.

 

At this facility the Company maintains its executiveoffices and conducts development and product prototyping activities. TheCompany expects this space will be adequate for its needs for the remainder ofthe lease term.

 

**Item 3. Legal Proceedings**

** **

In November 2004,Chapman Spira & Carson, LLC (“Chapman Spira”), an investment bankingfirm, filed a lawsuit in the Supreme Court of the State of New York for theCounty of New York against Advanced BioChem (the Predecessor), Power3 andSteven Rash. The suit alleges that Advanced BioChem and Power3 are liable toChapman Spira for damages allegedly resulting from the breach of a letteragreement between Chapman Spira and Advanced BioChem relating to theperformance of strategic and investment banking services. Chapman Spira isseeking damages in the amount of $1,522,000 plus interest. The Company hasfiled an answer in the lawsuit. The Company believes that Chapman Spira’sclaims are without merit; however, the Company cannot be assured it willprevail or if the outcome of the action will adversely affect the Company’sbusiness, financial position or results of operations. Settlement negotiationsare ongoing between the parties and their attorneys, however no resolution hasbeen achieved thus far.

 

An equipment vendor filed a complaint, regardingequipment which the Company acquired in its May 18, 2004 transaction withAdvanced BioChem, now known as Industrial Enterprises of America, and againstAdvanced BioChem in April of 2002 in a California court alleging breach ofcontract and seeking damages. Advanced BioChem reached a settlement agreementin April of 2003 under which Advanced BioChem would pay the vendor $40,000in installments through August, 2003. At December 31, 2003, AdvancedBioChem had a balance remaining of $20,000. In April, 2005, the equipmentvendor filed a lawsuit against Advanced BioChem, certain former officers ofAdvanced BioChem and against Power3 in order to enforce its claim for theremaining balance which is past due and may have been assumed by theCompany as part of the settlement of the dispute with Advanced BioChem.Settlement negotiations are ongoing, however no resolution has been achievedthus far.

 

On May 17, 2005, the Law Offices of Jerry Scheff,Spencer and Associates and Proteomic Research Services filed suit against theCompany seeking recovery of amounts billed to Power3 for services and legalfees invoiced in November, 2004. In February, 2006, a settlement was reachedbetween all parties and all legal actions between the parties have beencompleted.

 

In June, 2005, Charles Caudle et al filed a lawsuit inHarris County, Texas, against Advanced BioChem, Power3 and the officers anddirectors of both companies. The suit alleges that Advanced BioChem, Power3 andthe officers and directors of Power3, are liable to Charles Caudle et al fordamages resulting from funds loaned to Advanced BioChem and which weresubsequently converted into common stock of Advanced BioChem. It is unclear asto the specific dollar amount of the claim. The Company, and its officers anddirectors, has filed an answer denying all claims in the lawsuit. The Companybelieves that Charles Caudle et al’s claims are without merit, however theCompany cannot be assured it will prevail or if the outcome of the action willadversely affect the Company’s financial position or results of operations.Settlement negotiations between the parties are ongoing, however no resolutionhas been achieved thus far.

 

On June 27, 2005, theCompany received a subpoena for documents regarding the SEC’s Division ofEnforcement investigation In The Matter of Maui General Store, Inc. It isthe Company’s understanding that the Maui General Store matter relates to apromotional scheme by certain individuals to promote the stock and stock priceof certain companies, during 2004. The Company provided all documents in itspossession pursuant to the subpoena and complied fully with the subpoena on July 11,2005. In February, 2006, Steven B. Rash and Dr. Ira Goldknopf gavetestimony regarding this matter to the SEC’s Division of Enforcement inWashington, D.C.

 

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TheCompany has received no further correspondence from the Enforcement Division ofthe SEC. The Company has not been notified that it is a subject of thisinvestigation.

 

On August 8, 2005,Advanced BioChem, now known as Industrial Enterprises of America, filed suitagainst Power3, Steven B. Rash and Ira Goldknopf claiming damages of at least$3,000,000 including the costs of litigation and of addressing the claims ofthe creditors of Advanced BioChem that remain unpaid. Advanced BioChem had, inits public reports, announced their assertion that the parties to the law suitare responsible for all of the liabilities of Advanced BioChem, at the date ofthe asset purchase transaction on May 18, 2004. On October 25, 2005,this action was dismissed, without prejudice, by Industrial Enterprises ofAmerica. Power3 has consulted with its attorneys on this matter and has beeninformed that no further action will be filed on this matter, based oninformation received from Industrial Enterprises of America.

 

On May 19, 2005, Quinn Capital Consulting, Inc.filed suit against Power3 and Steven B. Rash claiming breach of contractregarding payment for services claimed to be issued to Power3, with payment tohave been made by issue of 500,000 shares to Quinn Capital, for which Power3later cancelled or otherwise converted the shares from Quinn Capital. Webelieve that we are not liable for the issuance of any shares to Quinn Capitalregarding the service performed under any such agreement, however we cannot beassured we will prevail or if the outcome of this action will affect ourfinancial position or results of operations.

 

In January of 2005,Kamy Behzadi, a previous employee of Advanced BioChem and Power3, filed suitagainst Advanced BioChem and Power3 claiming his entitlement to 1,000,000common shares of Power3 per an Employment Agreement with the Company. In May,2005, Power3 filed a countersuit against Behzadi regarding his employment withthe Company. On March 22, 2006, both lawsuits were settled and all actionsbetween the parties have been completed, assuming fulfillment of the SettlementAgreement clauses, which specify that Behzadi is to retain 25,000 shares ofcommon stock of Power3 and Power3 agreed to compensate Behzadi for his legalfees.

 

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**On October 28, 2005,Centigrade Services, Inc. filed suit against Power3 to collect anoutstanding debt of $2,117.09 plus court costs. The Company believes that thislawsuit will be settled prior to the court date, however no resolution has beenachieved thus far. The debt is recorded in accounts payable by Power3.**

** **

**On September 12, 2005, FocusPartners LLC filed suit against David Zazoff and Power3 alledging that Power3breached its agreement with Focus Partners in that it failed to issue stock tothe Plaintiff according to the terms of their agreement, that the stock inquestion was issued to Zazoff and that Zazoff later sold the stock in questionfor $480,000. Settlement discussions between the Power3 and Focus Partners areongoing, however no resolution has been achieved thus far.**

** **

**On August 30, 2005, CarlottaLansford, a previous consultant for Advanced BioChem, now known as IndustrialEnterprises of America, filed suit against Advanced BioChem and Power3,claiming $3,295 in unpaid consulting and accounting fees. The Company believesthis lawsuit will be settled prior to the court date, however no resolution hasbeen achieved thus far. The debt is recorded in accounts payable by Power3.**

** **

**On February 15, 2006, Bowneof Dallas LP filed suit against Power3 to collect a debt for services in theamount of $17,315.03. The Company believes this lawsuit will be settled priorto the court date, however no resolution has been achieved thus far. The debtis recorded in accounts payable by Power3.**

** **

**On October 28, 2005, Power3received notice of a Petition to Enforce Foreign Judgement citation filedagainst the Company by KForce regarding an employment fee adjudicated inDecember, 2003 in the state of Florida against the Company, in the amount of$15,872.77, together with $4,735.02 in interest. Power3 does not agree with theForeign Judgement and is attempting to resolve the issue prior to enforcement.No resolution has been achieved on this issue at this time, however the Companyis endeavoring to resolve the petition. This debt is recorded and outstandingin accounts payable by the Company.**

** **

**Item 4. Submission of Matters to a Vote ofSecurity Holders**

** **

There were no matters submitted to the vote of thesecurity holders during 2005.

 

**PART II**

** **

**Item 5. Market for Common Equity and RelatedStockholder Matters**

** **

**MarketInformation**

** **

During 2004, the Company’s common stock was traded onthe OTC Bulletin Board under the symbol “PWRM.” As of June, 2005, as reported previously, the Company’s common stock hasbeen quoted on the Pink Sheets. The high and low bid information for eachquarter for the years ending December 31, 2005 and 2004, as reported byNational Quotation Bureau, Inc., are as follows:

 
| **Quarter**          | ** ** | **Pre or Post Split  Price(1)** | ** ** | **High Bid** | ** ** | **Low Bid** | ** ** |
|----------------------|------------|------------------------------------------------|------------|-------------------|------------|------------------|------------|
|                 |       |                                           |       |              |       |             |       |
| First  Quarter 2005  |       | Post-Split                                     |       | $                 | 0.89       |             | $          | 0.48 |   |
| Second  Quarter 2005 |       | Post-Split                                     |       | $                 | 0.695      |             | $          | 0.14 |   |
| Third  Quarter 2005  |       | Post-Split                                     |       | $                 | 0.85       |             | $          | 0.14 |   |
| Fourth  Quarter 2005 |       | Post-Split                                     |       | $                 | 0.26       |             | $          | 0.10 |   |
|                 |       |                                           |       |              |       |             |       |
| First  Quarter 2004  |       | Post-Split                                     |       | $                 | 0.87       |             | $          | 0.15 |   |
| Second  Quarter 2004 |       | Post-Split                                     |       | $                 | 2.87       |             | $          | 0.28 |   |
| Third  Quarter 2004  |       | Post-Split                                     |       | $                 | 7.79       |             | $          | 1.70 |   |
| Fourth  Quarter 2004 |       | Post-Split                                     |       | $                 | 2.23       |             | $          | 0.67 |   |

 

28

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(1)  On September 24, 2003, the Company effected a1-for-50 reverse stock split of its common stock.

 

The quotations above reflect inter-dealer prices,without adjustment for retail mark-up, markdown or commissions and may notreflect actual transactions.

 

During 2005, upon the Company’s failure to timely fileits Form 10-KSB, the OTCBB appended the symbol “E” to the Company’strading symbol and notified the Company of its jeopardy of having itssecurities no longer quoted on the OTCBB, pending the Company’s filing of its Form 10-KSBfor 2004. On June 14, the Company was notified of the OTCBB’s action tonot allow the Company’s securities to be quoted on the OTCBB, as of June 16,2005, pending the filing of the Company’s Form 10-KSB for 2004.Accordingly, the Company’s securities are no longer eligible for quotation onthe OTCBB, as of June 16, 2005, all quotations of the Company’s securitiesare deleted from the OTCBB and the Company’s common stock is traded on the PinkSheets under the symbol PWRM.PK.

 

**Holders**

** **

As of December 31, 2005, there were 1,109shareholders of record of the Company’s common stock. The transfer agent forthe Company’s common stock was Cottonwood Stock Transfer, through June 30,2005. In early July, 2005, the management and Board of Directors of Power3terminated its relationship with Cottonwood Stock Transfer and contractuallyagreed to employ Integrity Stock Transfer as its new stock transfer agent.

 

**Dividends**

** **

The Company has not paid or declared any dividends onits common stock for the last two fiscal years and does not anticipate payingcash dividends in the foreseeable future. There are no limitations on theability of the Company to declare dividends; except those set forth in § 510of the New York Business Corporation Laws which prohibits dividends if theCompany is insolvent or would be made insolvent by the declaration of adividend and all dividends must be made out of surplus only.

 

**RecentSales of Securities under the 2004 Stock Compensation Plan**

** **

The following summarizes information relating to theCompany’s sale of equity securities that were not registered under theSecurities Act of 1933 during the period covered by this annual report andwhich have not been previously disclosed by the Company in a Quarterly Reporton Form 10-QSB or a Current Report on Form 8-K.

 

On September 1, 2005, the Company issued 140,000shares of restricted common stock to John P. Burton, according to the terms ofhis Employment Agreement. The shares were issued according to the 2004 StockCompensation Plan, allowing issuance of shares to employees and consultants.

 

On October 31, 2005, the Company issued 300,000shares of common stock to Billings & Solomon, a law firm representingthe Company in debt settlement negotiations. The shares were issued accordingto the 2004 Stock Compensation Plan, allowing issuance of shares to employeesand consultants.

 

On November 11, 2005, the Company issued 250,000shares of common stock to Sichenzia Ross Friedman and Ferrence, a law firmrepresenting the Company as an SEC attorney and in legal matters. The shareswere issued according to the 2004 Stock Compensation Plan, allowing issuance ofshares to employees and consultants.

 

29

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On December 6, 2005, the Company issued 300,000shares of common stock to Billings & Solomon, a law firm representingthe Company in debt settlement negotiations. The shares were issued accordingto the 2004 Stock Compensation Plan, allowing issuance of shares to employeesand consultants.

 

**Item 6. Management’s Discussion and Analysis orPlan of Operation**

** **

**Overview**

** **

The Company is an early stage development companyengaged in the early detection, monitoring, and targeting of diseases throughthe analysis of proteins. As previously stated, the Company’s previousoperating assets were abandoned and spun off to a trustee for the shareholdersof record as of May 17, 2004, prior to the date of the asset purchasetransaction on May 18, 2004. Coincident with the acquisition, the Companysignificantly changed its business activity from being an operating company andreturned to being a development stage company with its focus on commercializingthe intellectual properties it acquired in the asset purchase transaction. TheCompany’s business objective is to focus on disease diagnosis, protein andbiomarkers identification, and drug resistance in the areas of cancers,neurodegenerative and neuromuscular diseases. The Company has established ascientific advisory board to assist in the research and development of itsproducts. The members of the scientific advisory board are recognized leadersin their chosen fields, and the Company is working with them in the developmentof effective early diagnosis and drug targets for early treatment of cancers,neurodegenerative and neuromuscular diseases.

 

On May 18, 2004, the Company acquiredsubstantially all the assets and intellectual properties of Advanced BioChemand assumed a set of liabilities in exchange for the issuance of 15,000,000shares of the Company’s common stock. As of May 18, 2004, the Companyestablished the new business direction described in the “Business of Issuer” section ofthis document, completely changed its business activity and became an advanced proteomicscompany applying existing certain proprietary methodologies to discover andidentify protein biomarkers associated with diseases. The Company currently hasno products or services for sale and is principally focused on research anddevelopment activities and, to a certain extent, initiating the “proof ofconcept” of its technologies.

 

The Company has had significant losses during 2004 and2005. The Company anticipates that it will continue to incur substantialoperating losses in future years as it progresses in its research anddevelopment activities as well as the commercializing of its technologies. TheCompany does not expect to produce revenues from operations in the near termand expects that its revenues will be limited to research grants, collaborationagreements, and other strategic alliances which the Company is able to obtain.The Company has an immediate need for capital to continue its currentoperations. Assuming the Company successfully closes the final stage of itsprivate placement, the Company anticipates that it will need to raiseadditional capital prior to May, 2006, to meet its operating costs. At December 31,2005, the Company had an accumulated Stockholder’s equity of $9,182,565. Thefollowing discussion should be read in conjunction with the Company’s auditedfinancial statements as of December 31, 2005 and for the years ended December 31,2005 and 2004, including the notes to those financial statements. The followingdiscussion contains forward-looking statements that reflect the Company’splans, estimates and beliefs. Actual results could differ materially from thosediscussed in the forward-looking statements. See “Item 1. Description ofBusiness – Risk Factors” for additional discussion of these factors and risks.

 

**Resultsof Operations**

** **

*YearEnded December 31, 2005 as Compared to Year Ended December 31, 2004*

* *

Revenues from operations for the year ended December 31,2005 were $-0- compared to $15,491 for the prior year, resulting in a decreaseof $15,491.

 

Cost of Goods Sold for the year ended December 31,2005 were $-0-, compared to $5,174 for the prior year, resulting in a decreaseof $5,174.

 

30

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Operating expenses were $15,027,193 for 2005 ascompared to a restated Operating Expenses figure of 19,671,709, a decrease of$4,644,516. The decrease in operating expenses was primarily due to a$9,039,014 reduction in professional and consulting fees in 2005, compared to2004, offset by a $3,973,375 increase in stock-based compensation due toamortizing 12 full months of stock compensation compared to only 7 months in2004..

 

Employee compensation and benefits were $1,278,633 in2005 compared to $938,195 in 2004, the increase primarily due to employeecompensation increases and costs associated with hiring additional employees tohandle administrative, laboratory, financial and governmental compliancemeasures.

 

Occupancy and equipment expenses were $135,903 in2005. This resulted primarily from the Company’s office lease and utilitiesduring 2005.

 

Derivative income (expense) amounted to $2,019,884 and$1,570,348 during the years ended December 31, 2005 and 2004,respectively, and arises from both freestanding derivatives (warrants) andembedded derivatives (embedded conversion features). We generally don’t use derivative financialinstruments to hedge exposures to cash-flow risks or market-risks that may affectthe fair values of its financial instruments. However, certain other financialinstruments, such as warrants and embedded conversion features that are indexedto our common stock, are classified as liabilities when either (a) theholder possesses rights to net-cash settlement or (b) physical ornet-share settlement is not within our control. In such instances, net-cashsettlement is assumed for financial accounting and reporting, even when theterms of the underlying contracts do not provide for net-cash settlement. Suchfinancial instruments are initially recorded at fair value and subsequentlyadjusted to fair value at the close of each reporting period. We willexperience fair value adjustements to our derivative financial instruments,which amounts will result in charges or credits to our income, until wereaquire the ability to settle these instruments with our common stock.

 

Interestexpense amounted to $505,647 and $23,489 for the years ended December 31,2005 and 2004, respectively. Interest expense increased due to (i) increasesin our average borrowings and (ii) amortizations associated with ourdiscounted debt and deferred financing costs.

 

The above matters result in net loss decreasing from($13,512,696) in 2005 as compared to a restated loss of ($17,471,463) in 2004.

 

**Liquidityand Capital Resources**

** **

Our financial statements are presented on a goingconcern basis, which contemplates the realization of assets and satisfaction ofliabilities in the normal course of business. We are in the development stageand have primarily been involved in research and development and capitalraising activities; as such we have incurred significant losses from operationsduring both 2004 and 2005.

 

We have an immediate need for capital to continueour operations, and we will need to raise significant additional funds toimplement our business plan. This cash will have to come from equity salesand/or borrowings as management has projected that we will need significantadditional capital for development and other ongoing operational activitiesbefore we will have any anticipated revenue generating products. The actualamount of funds that we will need will be determined by many factors, some ofwhich are beyond our control. These factors include:

 

•                  Theextent to which we enter into licensing arrangements, collaborations or jointventures;

•                  Theprogress and results of research and product development;

•                  Thecosts and timing of obtaining new patent rights;

•                  Theextent to which we require or license other technologies; and

•                  Regulatory changes and competitionand technological developments in the market.

 

We have financed our operations primarily through thenet proceeds generated from the sale of common stock and the recent sale ofconvertible debentures. From the date of the Advanced Bio/Chem transaction to

 

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December 31, 2004,the Company raised approximately $**1,000,000.**Thenin January, 2005, the Company raised an additional $400,000 from a limited setof the original convertible debenture holders. As described in “RecentFinancing” below, the Company intends to sell an additional $1,600,000 inaggregate principal amount of convertible debentures following theeffectiveness of the Registration Statement on Form SB-2 filed by theCompany for the resale of certain shares of the Company’s stock by thepurchasers of the Company’s convertible debentures.

 

Net cash in from operating activities was ($1,984,464)for the year ended December 31, 2005, compared to ($924,632) for the yearended December 31, 2004. The decrease in net cash from operatingactivities during 2004 was primarily due to an adjustment to stock-basedcompensation expense from cancellation of previously-issued stock to employees.

 

Net cash used in investing activities during 2005 was($89,246) as compared to ($226,473) in 2004. Net cash provided by financingactivities approximated $1,916,808 for the year ended December 31, 2005,as compared to $1,308,888 for the year ended December 31, 2004. Theincrease in net cash provided by financing activities is primarily due to netproceeds received from the closing of the Company’s 2nd tranche ofconvertible debentures in January, 2005 and borrowings made by the Companyduring 2005 as Notes Payable. In addition, cash proceeds from the sales ofstock decreased from $449,817 for the year ended December 31, 2004 to $198,000for the year ended December 31, 2005.

 

As of December 31, 2005, the Company’s principalsource of liquidity was approximately $1,399 in cash. As of the date of filingthis report, the Company has approximately $100,000 on hand to pay operatingexpenses. We also have no confirmed source of funds for the next twelve months,although we expect that after filing this report and an amended SB-2registration statement, additional debt and equity capital will becomeavailable to the Company.

 

Pursuant to the financing described below, it isanticipated that the Company will receive an additional $1,600,000 upon thesale and issuance of $1,600,000 in aggregate principal amount of debentures atthe final closing of the private placement, which is to occur on or before thefifth trading day after the effective date of the registration statement filedby the Company for the resale of securities by the investors. In addition, theCompany has received several bridge loans and officer advances during 2005. Itis expected that a portion of the proceeds received by the Company from theissuance and sale of the $1,600,000 aggregate principal amount of debentureswill be used to repay certain bridge loans received during 2005. The Companyhas thus far, been unable to complete the funding of the convertibledebentures, described below in “Recent Financing” due to its failure to obtaineffectiveness of its SB-2 to register the shares associated with thedebentures, the warrants and additional investment rights covered in thesecurities purchase agreements.

 

***Recent Financing***

*** ***

The Company entered into a securities purchaseagreement, dated as of October 28, 2004, with certain investors. Pursuantto the securities purchase agreement, the investors agreed to purchase from theCompany convertible debentures due three (3) years from the date ofissuance in the aggregate principal amount of $3,000,000. Effective January 26,2005, the Company entered into an amendment to the securities purchaseagreement with a sub-group of the original investors. This sub-group invested a2nd tranche of monies, as part of their original commitment.The securities purchase agreement, as amended, also provides for the issuanceto the investors of warrants to purchase shares of the Company’s common stockand additional investment rights to purchase additional convertible debentures.In connection with the securities purchase agreement, the Company entered intoa registration rights agreement which requires the Company to file aregistration statement registering on behalf of the investors the resale of theshares of common stock issuable upon conversion of the debentures and theexercise of the warrants. The Company will also file a registration statementregistering on behalf of the investors the resale of shares of common stock issuableupon conversion of the debentures issued upon exercise of the additionalinvestment rights previously issued by the Company.

 

Effective October 28, 2004, the Company issuedand sold to the investors the first $1,000,000 in aggregate principal amount ofsuch debentures at the initial closing under the securities purchase agreement.

 

32

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Pursuant to thesecurities purchase agreement, as amended, effective January 26, 2005 theCompany issued and sold, as a 2nd tranche of investment, to certaininvestors $400,000 aggregate principal amount of convertible debentures.Subject to the Company’s satisfaction of the conditions set forth in thesecurities purchase agreement (which includes the effectiveness of theregistration statement) the investors are required to purchase the remaining$1,600,000 in aggregate principal amount of such debentures at the finalclosing, which is to occur on or before the fifth trading day after theeffective date of the registration statement.

 

The $1,000,000 aggregate principal amount ofdebentures issued on October 28, 2004 and the $400,000 aggregate principalamount of debentures issued January 26, 2005 are due and payable in fullthree (3) years after issuance and do not bear interest. The $1,600,000aggregate principal amount of debentures issuable at the final closing will bedue and payable in full three (3) years after the date of their issuance,and will not bear interest. The aggregate cash purchase price for the debentureswill be $3,000,000, which is equal to the full face amount of the debentures.At any time from the closing date until the maturity date of the debentures,the purchasers have the right to convert the debentures, in whole or in part,into common stock at the then effective conversion price. The conversion pricefor the previously issued $1,400,000 aggregate principal amount of debenturesis $0.90 per share, provided however if the lessor of (i) 75% of theaverage of the 5 consecutive Closing Prices immediately prior to the EffectiveDate, as defined in the Purchase Agreement, and (ii) the Closing Price onthe Effective Date (the lessor of (i) and (ii) being referred to asthe “Effective Date Price”) is less than the Conversion Price, the ConversionPrice shall be reduced to equal the Effective Date Price, the now designatedEffective Date Price. The remaining 3rd tranche, when and if made,of $1,600,000 aggregate principal amount of debentures issuable at the finalclosing will have a conversion price equal to the above. The debentures containcovenants that will limit the Company’s ability to, among other things: incuror guarantee additional indebtedness; incur or create liens; amend the Company’scertificate of incorporation, bylaws or other charter documents so as toadversely affect any rights of the holders of the debentures; and repay orrepurchase more than a de minimis number of shares of common stock other thanas permitted in the debentures and other documents executed with thepurchasers.

 

If Power3, at any time while the debentures areoutstanding, shall offer, sell or grant any option to purchase or offer, sellor grant any right to reprice its securities, or otherwise dispose of or issueany common stock or common stock equivalents, entitle any person to acquireshares of common stock at an effective price per share less than the theneffective Conversion Price, as calculated by the formula described above, thenthe Conversion Price for the convertible debenture shares shall be reduced toequal any such new effective Conversion Price, as defined in the Agreement,regardless of whether or not such common stock or common stock equivalents areissued to convertible debenture holders. In case of any such adjustment in theeffective Conversion Price for the convertible debenture shares, this couldsignificantly dilute existing investors.

 

The debentures include default provisions and an eventof default includes, among other things, a change of control of the Company,the sale of all or substantially all of the Company’s assets, the failure tohave the registration statement declared effective on or before the 180th dayafter the initial closing date, and the lapse of the effectiveness of theregistration statement for more than 30 consecutive trading days during any12-month period (with certain exceptions), the Company’s failure to timelydeliver certificates to holders upon conversion and a default by the Company inany obligations under any indebtedness of at least $150,000 which results insuch indebtedness being accelerated. Upon the occurrence of an event ofdefault, each debenture may become immediately due and payable, eitherautomatically or by declaration of the holder of such debenture. The aggregateamount payable upon an acceleration by reason of an event of default shall beequal to the greater of 130% of the principal amount of the debentures to beprepaid or the principal amount of the debentures to be prepaid, divided by theconversion price on the date specified in the debenture, multiplied by theclosing price on the date set forth in the debenture. Specific provisions existin the Securities Purchase Agreement which subject the Company to liabilitiesfor liquidated damages if the registration statement covering the shares doesnot become effective within 180 days after the October 28, 2004 purchase,which they did not, or if the registration statement does not remain effective.In addition, if the Company is not able to deliver said share certificates,upon conversion, the Company becomes subject to partial liquidated damages, asspecified in the Notes to the Financial Statements section of this report,based on the number of days required to deliver said shares.

 

33

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Because the Company’s investors could be significantlydiluted in their ownership position, the Company is further bound, by theSecurities Purchase Agreement covering the debentures and the warrants, to notoffer, sell or grant shares to other persons or companies at prices below theeffective conversion prices available to the convertible debenture holders inthe Agreements. In such case, the specific details of the conversion priceformulas can be found in the Notes to the Financial Statements in this reportor in the actual Securities Purchase Agreement documents as previously filed inpublicly-filed reports.

 

Concurrent with the issuance of the initial $1,000,000aggregate principal amount of debentures dated October 28, 2004, thepurchasers also received warrants to purchase an aggregate of up to 2,500,000shares of common stock and additional investment rights to purchase up to anadditional $2,500,000 principal amount of convertible debentures. On January 26,2005, an amendment to the Securities Purchase Agreement was executed with fourof the original purchasers of the initial $1,000,000 debenture purchase.Pursuant to the terms of the amendment, concurrent with the issuance of the$400,000 aggregate principal amount of convertible debentures, the Companyissued additional warrants to purchase an aggregate of up to 333,333 shares ofits common stock, but no additional investment rights. The warrants areexercisable at a price of $1.44 per share (subject to adjustment), for a periodof five (5) years from October 28, 2004. If Power3, at any time thewarrants are outstanding, pays a stock dividend or other distribution on itsshares; subdivides outstanding shares into a larger number of shares; combinesoutstanding shares into a smaller number of shares; or issues by reclassificationany shares of capital stock of the Company, then the Exercise Price of thewarrants shall be adjusted by a formula based on the number of common sharesthen outstanding, and the number of shares issuable upon exercise of thewarrants shall be proportionately adjusted. In addition, if the Company shalloffer, sell, grant any option to purchase or reprice its securities, orotherwise dispose of or issue any common stock, at an effective price per shareless than the then existing Exercise Price of the warrants, then the ExercisePrice shall be reduced to equal this lower Base Share Price, as defined in theSecurities Purchase Agreement for the warrants.

 

The additional investment rights are exercisable at aprice equal to the principal amount of the debentures for a period until theearlier of (1) nine months following the effective date of theregistration statement, or (2) April 28, 2006, whichever comes first.The debentures to be purchased upon the exercise of the additional investmentrights will have the same terms as the debentures described above, except thatthe conversion price will be equal to $1.08, subject to adjustment according tothe terms of the Agreement.

 

Each selling shareholder has contractually agreed torestrict its ability to convert the debentures, exercise the warrants andadditional investment rights and receive shares of the Company’s common stocksuch that the number of shares of common stock held by them and theiraffiliates after such conversion or exercise does not exceed 4.99% of thenumber of shares of the Company’s common stock outstanding immediately aftergiving effect to such conversion or exercise.

 

Additional terms and specifics of the ConvertibleDebenture agreements, including Events of Default and the consequences thereof,are detailed in the Notes to the Financial Statements.

 

Other Recent Financing 

 

On April 5, 2005, the Company received a bridgeloan in the amount of $251,000. This bridge loan was due and payable on thesooner of August 15, 2005 or one business day following the closing of theCompany’s sale and issuance of the remaining $1,600,000 aggregate principalamount of debentures. The Company expects to use proceeds from the sale andissuance of such debentures to repay this bridge loan. The bridge loan bearsinterest at a rate of 10% per annum which, at the holder’s option, may bepaid in (a) cash, or (b) that number of shares of the Company’scommon stock determined by dividing $251,000 by the common stock price on dateof payment and multiplying the quotient so obtained by 20%. This note is indefault and remains outstanding at this time and no payments of principal orinterest have been made thus far on this loan, either in cash or shares. At thetime of this report, the note holder has not made demand for payment ofprincipal or interest on this note.

 

On September 1, 2005, the Company received abridge loan in the amount of $200,000. This bridge loan is due and payable onthe sooner of November 15, 2005 or immediately following the closing ofthe Company’s sale and issuance of the remaining $1,600,000 aggregate principalamount of debentures. The

 

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Company expects to usethe proceeds from the sale and issuance of such debentures to repay this bridgeloan. The loan bears interest at rate of 10% until payment, however theinterest rate increases to 12% after an event of default. The note contains aprovision that the accrued interest on this note shall be considered paid infull upon issuance of 166,000 shares of restricted stock at $0.00 cost basisper share to the note holder. In addition, the Note contains a provision forthe issue of Penalty Shares to the note holder, in an event of default,calculated as 8,300 shares per month for each 30-day period the note is indefault. This note is in default and remains outstanding and neither principal,interest, nor penalty shares have been paid or issued on this note. At the timeof this report, the note holder has not made demand for payment of principal orinterest on this note.

 

**On May 31, 2005, the Company received anOfficer Advance in the amount of $ 55,000. This advance is in the form ofa short-term Note Payable, to the Officer, Mr. Steven Rash, President andCEO, by the Company. The Note Payable was originally due on June 30, 2005,and bears interest at 6 % per annum until paid. The Company used the proceedsfrom this note as working capital. The Company expects to use the proceeds fromlater permanent financing obtained from issuing additional debentures to repaythis Officer Advance. This note is in default, however the Officer has agreedto allow the Company an indefinite extension of time to repay this NotePayable.**

** **

On June 3, 2005, the Company received anOfficer Advance in the amount of $ 50,000. This advance is in the form ofa short-term Note Payable, to the Officer, Dr. Ira Goldknopf, ChiefScientific Officer, by the Company. The Note Payable was due on June 30,2005, and bears interest at 6% per annum until paid. The Company used theproceeds from this note as working capital. The Company expects to use theproceeds from later permanent financing obtained from issuing additionaldebentures to repay this Officer Advance. This note is in default, however theOfficer has agreed to allow the Company an indefinite extension of time torepay this Note.

 

On March 31, 2005, the Company received anOfficer Advance in the amount of $35,000 from the Chief Financial Officer. ThisNote was due on April 30, 2005, and bears interest at a rate of 6% perannum until paid. The Company expects to use the proceeds from later permanentfinancing obtained from issuing additional debentures to repay this OfficerAdvance. This note is in default, however the note holder has agreed to allowthe Company an indefinite extension of time to repay this Note.

 

**On June 13, 2005, the Company received a bridgeloan in the amount of $ 396,500. This bridge loan was due and payable on thesooner of August 11, 2005 or the fifth day following the effective date ofthe Company’s registration statement on Form SB-2. The Company expects touse the proceeds from the sale and issuance of the remaining $1,600,000 ofconvertible debentures to repay the loan. The note is secured by a Stock PledgeAgreement, entered into on June 17, 2005, by Steven B. Rash, Chairman andCEO of Power3, wherein Mr. Rash pledged 6,000,000 shares of common stockas security for the performance of the Company under the note. On September 30,2005, in consideration of an additional $50,000 added to the principal amountof the Note, which was expensed to Interest Expense, and making the totalprincipal due $446,500, the payee of this Note agreed to allow the Company anextension of time to repay such bridge loan, until October 31, 2005. Thisnote is in default and no payments of principal or interest have been made onthis loan by Power3. It is the Company’s understanding that the Note holder hassold a certain number of the common shares pledged to him and individuallyowned by Steve Rash and the note is no longer in default.**

** **

During the latter half of 2005, the Company’s ChiefScientific Officer advanced the Company $159,231 as short-term Officer Advancesin order to enable the Company to meet certain payment obligations. Theseadvances were in the form of short-term 180 day notes and bear interest ata rate of 6% per annum. None of these short-term Officer Advances were due asof December 31, 2005 and the Company expects to use the proceeds fromlater permanent financing obtained from issuing additional debentures to repaythese Officer Advances.

 

On November 2, 2005, the Company received abridge loan in the amount of $150,000 from Trinity Financing Investments. Thisbridge loan is due and payable on March 2, 2006 and bears interest at arate of 11% until maturity and 18% thereafter until the loan is repaid. Inaddition to the note, the holder received

 

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1,000,000warrants to purchase common shares of the Company at $.25 per share. This noteis secured by a pledge of common shares individually owned by Steven B. Rashand Dr. Ira L. Goldknopf.

 

On December 12, 2005, the Company received abridge loan in the amount of $150,000 from Trinity Financing Investments. Thisbridge loan is due and payable on April 9, 2006 and bears interest at arate of 11% until maturity and 24% thereafter until the loan is repaid. Inaddition to the note, the holder received 1,000,000 warrants to purchase commonshares of the Company at $.14 per share. This note is secured by a pledge ofcommon shares owned individually by Dr. Ira Goldknopf.

 

On December 14, 2005, the Company received anOfficer Advance in the amount of $50,000 from the Chief Scientific Officer.This Note is due on June 15, 2006 and bears interest at a rate of 6% perannum until paid. The Company expects to use the proceeds from later permanentfinancing obtained from issuing additional debentures to repay this OfficerAdvance.

 

**Planof Operations and Cash Requirements**

** **

The Company currently does not have operating revenuesfrom product sales or the performance of services and it continues toexperience net operating losses. The Company is actively pursuing third partylicensing agreements, collaboration agreements and similar businessarrangements in order to establish a revenue base utilizing its capabilities indisease diagnosis based on protein and biomarker identification, and drugresistance in the areas of cancers, neurodegenerative and neuromusculardiseases. The Company has undertaken clinical validation studies to demonstratethe diagnostic capabilities of its technologies. However, there can be noassurances that revenue generating agreements will be in place in the nexttwelve months.

 

Absent a source of revenues, the Company will requirefunding in order to carry out its business plan until such time as it is ableto generate sustained revenues. The Company’s current cash requirements areapproximately $300,000 per month and the Company anticipates that it willrequire approximately $3,950,000 for the twelve months ended March 31,2007 to continue its development activities, undertake and perform clinicalvalidation studies, continue its marketing efforts and maintain itsadministrative infrastructure, broken down as follows:

 

**ExpendituresRequiredDuring Next Twelve Months**

 
| General and  Administrative               |   | $      | 2,750,000 |   |
|-------------------------------------------|--------|--------|-----------|--------|
|                                      |   |   |      |
| Capital  Expenditures                     |   | $      | 250,000   |   |
|                                      |   |   |      |
| Patent  filings and intellectual property |   | $      | 200,000   |   |
|                                      |   |   |      |
| NAF clinical  validation studies          |   | $      | 500,000   |   |
|                                      |   |   |      |
| Testing for  Research Agreements          |   | $      | 250,000   |   |
|                                      |   |   |      |
| Total                                     |   | $      | 3,950,000 |   |

 

The Company has no significant capital expenditurerequirements and does not plan to increase its monthly expenditure rate absentan increase in revenues or additional funding.

 

As noted in “Liquidity and Capital Resources” above,the Company entered into a securities purchase agreement and an amendment tothe securities purchase agreement pursuant to which certain investors agreed topurchase convertible debentures in the aggregate principal amount of$3,000,000. The securities purchase agreement, as amended, also provides forthe issuance of warrants to purchase shares of the Company’s

 

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----

 

common stock andadditional investment rights to purchase additional convertible debentures. Onthe initial closing under the securities purchase agreement, which occurredeffective as of October 28, 2004, the investors purchased the first$1,000,000 in aggregate principal amount of the convertible debentures of whichthe Company received approximately $860,000 after payment of fees and expenses.Pursuant to the securities purchase agreement, as amended, a sub-group of theoriginal investors purchased an additional $400,000 aggregate principal amountof convertible debentures on January 26, 2005 as a second tranche of thetotal investment. Subject to the Company’s satisfaction of the conditions setforth in the securities purchase agreement (which includes the effectiveness ofthe registration statement), the investors previously agreed to purchase theremaining $1,600,000 in aggregate principal amount of such convertibledebentures on or before the fifth trading day after the effective date of theregistration statement. Assuming the completion of the remaining closing andsale and issuance of the remaining $1,600,000 in aggregate principal amount ofthe convertible debentures, the Company estimates that, after repayment of thebridge note of $446,500, the bridge note of $251,500 and the bridge note of$200,000, immediately following the sale and issuance of such debentures, theCompany will have adequate cash to allow it to meet its funding requirementsthrough the third quarter of 2006. In the event the sale and issuance of suchdebentures occurs and the investors exercise their warrants and additionalinvestment rights, the Company anticipates it will have adequate cash to meetits funding requirements through the first quarter of 2007.

 

In addition to the convertible debentures, the Companyalso issued warrants to purchase up to 2,500,000 shares of common stock, withan exercise price equal to $1.44. The Company issued additional warrants topurchase up to 333,333 shares of common stock concurrent with its issuance ofthe $400,000 aggregate principal amount of debentures. Full exercise of thewarrants would generate funds in excess of $3,000,000. The Company also issuedadditional investment rights, which give the investors the right to purchase upto an aggregate of $2,500,000 of convertible debentures with a conversion priceof $1.08. However, the exercise of these warrants and additional investmentrights is at the discretion of the purchasers and there are no assurances thatthe purchasers will exercise their rights under such securities.

 

The Company will continue to require additional debtor equity financing for its operations which may not be readily available.The Company’s ability to continue as a going concern is subject to its abilityto generate a profit or obtain necessary funding from outside sources.Management believes that even though the Company currently has limited cashresources and liquidity, assuming exercise of the warrants and additionalinvestment rights, the net funds available from the final closing under theSecurities Purchase Agreement financing, after repayment of the bridge loans,****will allow the Company to continueoperations through October 2006. In the event the final closing and saleof $1,600,000 in aggregate principal amount of debentures occurs but thewarrants and additional investment rights are not exercised, the Companyanticipates that it will need to raise additional capital prior to October 2006to meet its operating costs. The Company’s actual results may differmaterially from these estimates, and no assurance can be given that additionalfunding will not be required sooner than anticipated or that such additionalfunding will be available when needed or on terms acceptable to the Company.Insufficient funding will require the Company to curtail or terminateoperations.

 

**Off-BalanceSheet Arrangements**

** **

At December 31, 2005, with the exception of thelease for its operating facility, and employment agreements entered with itsthree principal officers, the Company did not have any significant off balancesheet commitments.

 

**CriticalAccounting Policies**

** **

**Stock-BasedCompensation**

** **

The Company accounts for equity instruments issued toemployees that are fully vested and non-forfeitable based on the market valueof the stock issued as of the effective date of the agreement, per SECrequirement. Equity instruments issued to non-employees for services are alsomeasured at market value on the effective date of the agreement.

 

37

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The Company has adopted Statement of FinancialAccounting Standards No. 148 “Accounting for Stock-Based Compensation -Transition and Disclosure” (SFAS No. 148). This statement amends FASBstatement No. 123, “Accounting for Stock Based Compensation”. It providesalternative methods of transition for an entity that voluntarily changes to thefair value based method of accounting for employee stock based compensation. Italso amends the disclosure provision of FASB statement No. 123 to requireprominent disclosure about the effects on reported net income of an entity’saccounting policy decisions with respect to stock-based employee compensation.As permitted by SFAS No. 123 and amended by SFAS No. 148, the Companycontinues to apply the intrinsic value method under Accounting Principles Board(“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees,” toaccount for its stock-based employee compensation arrangements.

 

In December 2004, the Financial AccountingStandards Board issued Statement Number 123 (“FAS 123 (R)”), Share-BasedPayments. FAS 123 (R) requires all entities to recognize compensation expensein an amount equal to the fair value of share-based payments such as stockoptions granted to employees. The Company will be required to apply FAS 123 (R)on a modified prospective method. Under this method, the Company will berequired to record compensation expense (as previous awards continue to vest)for the unvested portion of previously granted awards that remain outstandingat the date of adoption. In addition, the Company may elect to adopt FAS123 (R) by restating previously issued financial statements, basing the amountson the expense previously calculated and reported in the pro forma disclosuresthat had been required by FAS 123, effective for the first reporting periodduring which the Company has such compensation. The Company has not yet determinedthe impact that FAS 123 (R) will have on its financial statements; however, itdoes not believe the impact of adopting this Statement is material to thisreport as there are no unvested options and warrants at December 31, 2004or December 31, 2005.

 

Power3’s stock-based compensation expense consistsprimarily of amortized costs for stock issued to consultants, to employees andfor warrants, covered by the 2004 Stock Compensation Plan. Total stock-basedcompensation expense for 2004 amounted to $8,215,241 compared to $12,188,616 in2005. The increase is primarily due to the amortization, over 12 full months in2005 compared to only approximately 7 full months in 2004, since most of thestock was originally issued on or about May 18, 2004. Most of the stockissued to employees is being amortized over 24 months, and since this is thebulk of the stock compensation expense, most of the stock-based compensationwill be fully amortized to deferred compensation expense during 2006.

 

Stock-based compensation expense during 2005 amountedto:

 

| **Stock-based Expense to:** | ** ** | **1st Quarter** | ** ** | **2nd Quarter** | ** ** | **3rd Quarter** | ** ** | **4th Quarter** | ** ** |
|---------------------------------------|------------|----------------------|------------|----------------------|------------|----------------------|------------|----------------------|------------|
| Consultants                           |       | $                    | 136,875    |                 | $          | 109,786              |       |                 |       | $ | 45,000 |   |
| Employees                             |       | $                    | 3,181,443  |                 | $          | 3,181,443            |       | $                    | 3,129,629  |   | $ | 2,209,179 | * |
| Warrants                              |       | $                    | 47,208     |                 | $          | 47,208               |       | $                    | 47,208     |   | $ | 53,637 |   |

 

----

* Includes adjustment forstock returned to Power3 due to settlement and terminations of employment in2005 and credit to Stock Compensation Expense for$675,000+$2,820+$213,504=$891,324 for returned company stock.

 

38

----

 

Stock-basedcompensation expense during 2004 amounted to:

 

| ** **       | ** ** | **1st Quarter** | ** ** | **2nd Quarter** | ** ** | **3rd Quarter** | ** ** | **4th Quarter** | ** ** |
|------------------|------------|----------------------|------------|----------------------|------------|----------------------|------------|----------------------|------------|
| For  Consultants |       |                 |       | $                    | 42,708     |                 | $          | 128,124              |       | $ | 128,124 |   |
| For  Employees   |       |                 |       | $                    | 1,464,213  |                 | $          | 3,181,443            |       | $ | 3,181,443 |   |
| For Warrants     |       |                 |       | $                    | 10,055     |                 | $          | 35,841               |       | $ | 43,290 |   |

 

**Item 7. Financial Statements**

** **

**POWER3 MEDICAL PRODUCTS, INC.**

 

**FINANCIAL STATEMENTS**

**AS OF DECEMBER 31, 2005 AND2004 (RESTATED)**

**FOR THE YEARS ENDED DECEMBER 31,2005 AND 2004 (RESTATED)**

 
| ** **                                                                                                | ** ** | ** ** |
|-----------------------------------------------------------------------------------------------------------|------------|------------|
| Report of  Independent Registered Public Accounting Firm                                                  |       |       |
|                                                                                                      |       |       |
| Balance Sheet as of December 31, 2005 and  2004 (restated)                                           |       |       |
|                                                                                                      |       |       |
| Statements of Operation for the years ended  December 31, 2005 and 2004 (restated)                   |       |       |
|                                                                                                      |       |       |
| Statements of  Stockholders’ Deficit for the years ended December 31, 2005 and 2004  (restated) |       |       |
|                                                                                                      |       |       |
| Statements of Cash Flows for the years  ended December 31, 2005 and 2004 (restated)                  |       |       |
|                                                                                                      |       |       |
| Notes to Financial Statements                                                                             |       |       |

 

39

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**REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTINGFIRM**

 

TO THE SHAREHOLDERS ANDBOARD OF DIRECTORS OF POWER3 MEDICAL PRODUCTS, INC.:

 

We have audited the accompanying balance sheetsof Power3 Medical Products, Inc.. (a New York corporation in thedevelopment stage) (“the Company”) as of December 31, 2004 (restated) and2005, and the related statements of operations, changes in stockholders’ equityand cash flows for the years ended December 31, 2004 (restated) and 2005,and for the period from May 18, 2004 (date of entry into developmentstage) to December 31, 2005. These financial statements are theresponsibility of the Company’s management. Our responsibility is to express anopinion on these financial statements based on our audit. .

 

Weconducted our audits in accordance with the standards of the Public CompanyAccounting Oversight Board (United States). Those standards require that weplan and perform an audit to obtain reasonable assurance whether thefinancial statements are free of material misstatement. **The Company is not required to have, nor were weengaged to perform, an audit of its internal control over financial reporting.Our audit included consideration of internal control over financial reportingas a basis for designing audit procedures that are appropriate in thecircumstances, but not for the purpose of expressing an opinion on theeffectiveness of the Company’s internal control over financial reporting.Accordingly, we express no such opinion.**An audit includesexamining, on a test basis, evidence supporting the amounts and disclosures inthe financial statements. An audit also includes assessing the accountingprinciples used and significant estimates made by management, as well as evaluatingthe overall financial statement presentation. We believe that our auditsprovide a reasonable basis for our opinion.

 

Inour opinion, the financial statements referred to above present fairly, in allmaterial respects, the financial position of Power3 MedicalProducts, Inc.at December 31,2004 (restated) and 2005, and the related results of their operations and cashflows for the years ended December 31, 2004 (restated) and 2005 and forthe period from May 18, 2004 (date of entry into development stage) to December 31,2005 in conformity withaccounting principles generally accepted in the United States of America.

 

The accompanying financial statements have been prepared assuming that theCompany will continue as a going concern. As discussed in Note 1 to the financial statements, the Company is in the development stage and is primarilyinvolved in research and development and capital raising activities. There is noassurance that researchactivities that the Company is involved in will generate sufficient funds that willbe available for operations. The Company’s limited revenue history, itsdependence on a narrow customerbase and limited funding raise substantial doubt about the Company’s ability tocontinue as a going concern. Management’s plans in regard to these matters arealso described in Note 3. Theaccompanying financial statements do not include any adjustments that mightresult from the outcome of this uncertainty.

 

Asdiscussed in note 6 to the financial statements, the Company is the defendantin certain lawsuits and is involved in a dispute with Advanced Biochem. TheCompany believes these claims are without merit and intends to resolve them inthe best interest of the Company. Accordingly no provision for any liabilitiesrelated to the matters has been accrued. However, due to the uncertainties withthese legal issues, it is at least reasonably possible that adverse resultswill occur, although any such amount cannot be estimated.

 

John A. Braden & Company, PC

 

Houston, Texas

April 14, 2006

 

40

----

 

**POWER3MEDICAL PRODUCTS, INC.**

**(ADevelopment Stage Enterprise)**

**BALANCE SHEETS**

**AS OF DECEMBER 31,2005 AND 2004 (RESTATED)**

 
| ** **                                                                                              | ** ** | **2005**    | ** ** | **2004**       | ** ** |
|---------------------------------------------------------------------------------------------------------|------------|-------------|------------|----------------|------------|
| ** **                                                                                              | ** ** | ** **  | ** ** | **(Restated)** | ** ** |
| **ASSETS**                                                                                              |       |        |       |           |       |
|                                                                                                    |       |        |       |           |       |
| **CURRENT  ASSETS**                                                                                     |       |        |       |           |       |
| Cash and  cash equivalents                                                                              |       | $           | 1,399      |           | $          | 158,301 |   |
| Accounts  receivable                                                                                    |       |        |       | 2,350          |       |
| Prepaid  expenses and other current assets                                                              |       | 21,092      |       | 4,352          |       |
| Total  current assets                                                                                   |       | 22,491      |       | 165,003        |       |
|                                                                                                    |       |        |       |           |       |
| **OTHER  ASSETS**                                                                                       |       |        |       |           |       |
| Goodwill                                                                                                |       | 13,371,776  |       | 13,371,776     |       |
| Deferred  finance costs, net                                                                            |       | 290,027     |       | 239,682        |       |
| Intangible assets, net                                                                                  |       | 179,786     |       | 96,424         |       |
| Furniture,  fixtures and equipment, net                                                                 |       | 70,750      |       | 85,025         |       |
| Deposits                                                                                                |       | 25,900      |       | 25,900         |       |
|                                                                                                    |       |        |       |           |       |
| **TOTAL  ASSETS**                                                                                       |       | $           | 13,960,730 |           | $          | 13,983,810 |   |
|                                                                                                    |       |        |       |           |       |
| **LIABILITIES  AND STOCKHOLDER’S EQUITY**                                                          |       |        |       |           |       |
| **CURRENT  LIABILITIES**                                                                                |       |        |       |           |       |
| Accounts  payable and accrued liabilities                                                               |       | $           | 1,003,331  |           | $          | 609,867 |   |
| Notes  payable—in default                                                                          |       | 1,285,739   |       | 20,000         |       |
| Convertible  debentures—in default                                                                 |       | 75,279      |       | 14,251         |       |
| Other  current liabilities                                                                              |       | 916,857     |       | 112,480        |       |
| Derivative  liabilities                                                                                 |       | 1,454,936   |       | 2,877,919      |       |
| Total  current liabilities                                                                              |       | 4,736,142   |       | 3,634,517      |       |
|                                                                                                    |       |        |       |           |       |
| **STOCKHOLDERS’  EQUITY**                                                                          |       |        |       |           |       |
| Common  Stock-$0.001 par value:150,000,000 shares authorized; 65,215,121 shares  issued and outstanding |       | 65,215      |       | 65,345         |       |
| Additional  paid-in capital                                                                             |       | 57,773,506  |       | 58,884,351     |       |
| Deferred  compensation                                                                                  |       | (4,802,621  | )          | (18,301,588    | )          |
| Loss  accumulated before entering development stage                                                     |       | (11,681,500 | )          | (11,681,500    | )          |
| Loss  accumulated during the development stage                                                          |       | (32,130,011 | )          | (18,617,315    | )          |
| Total  stockholders’ equity                                                                        |       | 9,224,588   |       | 10,349,293     |       |
|                                                                                                    |       |        |       |           |       |
| **TOTAL  LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                    |       | $           | 13,960,730 |           | $          | 13,983,810 |   |

 

Seeaccompanying notes to the financial statements.

 

41

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**STATEMENT OF OPERATIONS**

** **

**POWER3 MEDICAL PRODUCTS, INC.**

**(ADevelopment Stage Enterprise)**

**STATEMENTSOF OPERATIONS**

**YEARS ENDEDDECEMBER 31, 2005 AND 2004 (RESTATED)**

 
| ** **                                          | ** ** | **2005**    | ** **  | **2004**       | ** ** | **Period from  May 18, 2004  December 31, 2005** | ** ** |
|-----------------------------------------------------|------------|-------------|-------------|----------------|------------|---------------------------------------------------------------------------|------------|
| ** **                                          | ** ** | ** **  | ** **  | **(Restated)** | ** ** | ** **                                                                | ** ** |
| **REVENUES:**                                       |       |        |        |           |       |                                                                      |       |
| ** **                                          |       |        |        |           |       |                                                                      |       |
| Sales                                               |       |        |        | 11,491         |       |                                                                      |       |
| Other  revenue                                      |       |        |        | 4,000          |       | 4,000                                                                     |       |
| Total  revenue                                      |       |        |        | 15,491         |       | 4,000                                                                     |       |
|                                                |       |        |        |           |       |                                                                      |       |
| **COST OF  GOODS SOLD:**                            |       |        |        |           |       |                                                                      |       |
| Production costs                                    |       |        |        | 5,174          |       |                                                                      |       |
|                                                |       |        |        |           |       |                                                                      |       |
| Total cost  of goods sold                           |       |        |        | 5,174          |       |                                                                      |       |
|                                                |       |        |        |           |       |                                                                      |       |
| **GROSS  PROFIT**                                   |       |        |        | 10,317         |       | 4,000                                                                     |       |
|                                                |       |        |        |           |       |                                                                      |       |
| **OPERATING  EXPENSES:**                            |       |        |        |           |       |                                                                      |       |
| Stock based  compensation                           |       | 12,188,616  |        | 8,215,241      |       | 20,403,857                                                                |       |
| Employee  compensation and benefits                 |       | 1,273,377   |        | 938,195        |       | 2,056,859                                                                 |       |
| Professional  and consulting fees                   |       | 593,632     |        | 9,629,546      |       | 8,055,312                                                                 |       |
| Occupancy  and equipment                            |       | 130,401     |        | 49,895         |       | 187,073                                                                   |       |
| Travel and  entertainment                           |       | 89,490      |        | 72,375         |       | 155,624                                                                   |       |
| Other  selling, general and administrative expenses |       | 751,677     |        | 766,457        |       | 959,634                                                                   |       |
| Total  operating expenses                           |       | (15,027,193 | )           | (19,671,709    | )          | (31,818,359                                                               | )          |
|                                                |       |        |        |           |       |                                                                      |       |
| **LOSS  FROM OPERATIONS**                           |       | (15,027,193 | )           | (19,661,392    | )          | (31,814,359                                                               | )          |
|                                                |       |        |        |           |       |                                                                      |       |
| **OTHER  INCOME AND (EXPENSE):**                    |       |        |        |           |       |                                                                      |       |
| Derivative  income (expense)                        |       | 2,019,884   |        | 1,570,348      |       | 3,590,232                                                                 |       |
| Interest  income                                    |       | 260         |        | 1,215          |       | 1,474                                                                     |       |
| Other income                                        |       |        |        | 641,855        |       |                                                                      |       |
| Interest  expense                                   |       | (505,647    | )           | (23,489        | )          | (526,384                                                                  | )          |
| Total other  income(expense)                        |       | 1,514,497   |        | 2,189,929      |       | 3,065,322                                                                 |       |
|                                                |       |        |        |           |       |                                                                      |       |
| **NET LOSS**                                        |       | $           | (13,512,696 | )              | $          | (17,471,463                                                               | )          | (28,749,037 | ) |
|                                                |       |        |        |           |       |                                                                      |       |
| **NET LOSS  PER SHARE**                             |       | $           | (0.21       | )              | $          | (0.42                                                                     | )          | $ | (0.45 | ) |
|                                                |       |        |        |           |       |                                                                      |       |
| Weighted  average number of shares outstanding      |       | 65,428,847  |        | 42,034,796     |       | 64,391,890                                                                |       |
|                                                     |            |             |             |                |            |                                                                           |            |  |  |  |

 

Seeaccompanying notes to the financial statements.

 

42

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**POWER3 MEDICALPRODUCTS, INC.**

**ADevelopment Stage Enterprise**

**STATEMENTS OF STOCKHOLDERS’ EQUITY**

**Years Ended December 31,2005, 2004 (RESTATED)**

 
| ** **                                                                                | ** ** | ** **            | ** ** | ** **               | ** ** | ** **       | ** ** | ** **         | ** ** | **Additional** | ** **     | **Deferred** | ** **      | ** ** | ** ** | ** **  | ** **      |
|-------------------------------------------------------------------------------------------|------------|-----------------------|------------|--------------------------|------------|------------------|------------|--------------------|------------|----------------|----------------|--------------|-----------------|------------|------------|-------------|-----------------|
| ** **                                                                                | ** ** | **Common Stock** | ** ** | **Preferred Stock** | ** ** | **Paid In** | ** ** | **Compensation**   | ** ** | ** **     | ** **     | ** **   | ** **      |
| ** **                                                                                | ** ** | **Shares**            | ** ** | **Par Value**       | ** ** | **Shares**       | ** ** | **Par Value** | ** ** | **Capital**    | ** **     | **Expense**  | ** **      | **Other**  | ** ** | **Deficit** | ** **      |
|                                                                                      |       |                  |       |                     |       |             |       |               |       |           |           |         |            |       |       |        |            |
| **BALANCES, DECEMBER 31, 2003**                                                      |       | 2,442,830             |       | 2,442                    |       | 3,870,000        |       | 3,870              |       | $              | 8,472,836      |         |            |       | 300        |        | (9,446,377      | ) |
|                                                                                      |       |                  |       |                     |       |             |       |               |       |           |           |         |            |       |       |        |            |
| Correct beginning balance per transfer agent                                              |       | 433                   |       | 1                        |       |             |       |               |       |           |           |         |            |       |       |        |            |
| Issued effective January 23, 2004, services                                          |       | 6,000,000             |       | 6,000                    |       |             |       |               |       | 3,055,327      |           |         |            |       |       |        |            |
| Issued effective April 1, 2004 for cash                                              |       | 583,334               |       | 583                      |       |             |       |               |       | 134,417        |           |         |            |       |       |        |            |
| Issued effective April 27,2004 for services                                          |       | 440,000               |       | 440                      |       |             |       |               |       | 197,560        |           |         |            |       |       |        |            |
| Issued effective May 10, 2004 to retire debt                                         |       | 300,000               |       | 300                      |       |             |       |               |       | 194,700        |           |         |            | (300       | )          |        |            |
| Issued effective May 11, 2004 for services                                           |       | 4,500,000             |       | 4,500                    |       |             |       |               |       | 2,065,500      |           |         |            |       |       |        |            |
| Issued effective May 17, 2004 for services                                           |       | 141,033               |       | 141                      |       |             |       |               |       | 105,634        |           |         |            |       |       |        |            |
| Issued effective May 18, 2004 compensation                                           |       | 27,805,000            |       | 27,805                   |       |             |       |               |       | 24,996,695     |           | (25,024,500  | )               |       |       |        |            |
| Issued effective May 18, 2004 for services                                           |       | 4,550,000             |       | 4,550                    |       |             |       |               |       | 4,090,450      |           |         |            |       |       |        |            |
| Issued effective May 18, 2004 for acquisition                                        |       | 15,000,000            |       | 15,000                   |       |             |       |               |       | 13,485,000     |           |         |            |       |       |        |            |
| Issued effective June 1, 2004 for services                                           |       | 125,000               |       | 125                      |       |             |       |               |       | 249,875        |           | (250,000     | )               |       |       |        |            |
| Issued effective June 11, 2004 for services                                          |       | 100,000               |       | 100                      |       |             |       |               |       | 211,900        |           |         |            |       |       |        |            |
| Record stock option expense                                                               |       |                  |       |                     |       |             |       |               |       | 626,100        |           | (626,100     | )               |       |       |        |            |
| Issued effective July 1, 2004 compensation                                           |       | 140,000               |       | 140                      |       |             |       |               |       | 426,860        |           | (427,000     | )               |       |       |        |            |
| Issued effective July 23, 2004 for services                                          |       | 125,000               |       | 125                      |       |             |       |               |       | 284,875        |           | (285,000     | )               |       |       |        |            |
| Issued November 10, 2004 for cash                                                    |       | 242,167               |       | 242                      |       |             |       |               |       | 314,575        |           |         |            |       |       |        |            |
| Issued November 10, 2004 for services                                                |       | 10,000                |       | 10                       |       |             |       |               |       | 12,990         |           |         |            |       |       |        |            |
| Cancelled November 15, 2004 (agreement)                                              |       | (160,000              | )          | (160                     | )          |             |       |               |       | (71,840        | )              |         |            |       |       |        |            |
| Issued November 17, 2004 to convert Series A  Preferred Shares to Common Shares |       | 1,031,316             |       | 1,031                    |       | (1,331,280       | )          | (1,330             | )          | 1,391,246      |           |         |            |       |       | (1,392,277  | )               |
| Issued November 23, 2004 to convert Series A  Preferred Shares to common shares |       | 1,969,008             |       | 1,970                    |       | (2,538,720       | )          | (2,540             | )          | 1,986,728      |           |         |            |       |       | (1,988,698  | )               |
| Stock based compensation expensed during the year                                         |       |                  |       |                     |       |             |       |               |       |           |           | 8,311,012    |            |       |       |        |            |
| Net reclassifications of derivative liabilities                                           |       |                  |       |                     |       |             |       |               |       | $              | (3,347,077     | )            |            |       |       |        |            |   |
| Net loss                                                                                  |       |                  |       |                     |       |             |       |               |       |           |           |         |            |       |       | (17,471,463 | )               |
| **Balances, December 31, 2004 (restated)**                                           | ** ** | **65,345,121**        | ** ** | **65,345**               | ** ** | **0**            | ** ** | **0**              | ** ** | **$**          | **58,884,351** | ** **   | **(18,301,588** | **)**      | ** ** | ** **  | **(30,298,815** | **)** |

 

43

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**POWER3MEDICAL PRODUCTS, INC.**

**ADevelopment Stage Enterprise**

**STATEMENT OF STOCKHOLDERS’ EQUITY**

**Years Ended December 31,2005, 2004 (RESTATED)**

 
| ** **                                       | ** ** | ** **            | ** ** | ** **         | ** ** | **Additional**   | ** **     | **Deferred** | ** **      | ** **  | ** **      |
|--------------------------------------------------|------------|-----------------------|------------|--------------------|------------|------------------|----------------|--------------|-----------------|-------------|-----------------|
| ** **                                       | ** ** | **Common Stock** | ** ** | **Paid In**   | ** ** | **Compensation** | ** **     | ** **   | ** **      |
| ** **                                       | ** ** | **Shares**            | ** ** | **Par Value** | ** ** | **Capital**      | ** **     | **Expense**  | ** **      | **Equity**  | ** **      |
| **Balances,  December 31, 2004 (restated)** | ** ** | **65,345,121**        | ** ** | **65,345**         | ** ** | **$**            | **58,884,351** | ** **   | **(18,301,588** | **)**       | **(30,298,815** | **)** |
| Cancelled  Shares from 7/01/04                   |       | (140,000              | )          | (140               | )          | (426,860         | )              |         |            |        |            |
| Issued  Shares on 9/14/05                        |       | 140,000               |       | 140                |       | 41,860           |           |         |            |        |            |
| Issued  Shares on 10/31/05                       |       | 300,000               |       | 300                |       | 65,700           |           |         |            |        |            |
| Issued  Shares on 11/11/05                       |       | 250,000               |       | 250                |       | 44,750           |           |         |            |        |            |
| Issued  Shares on 12/06/05                       |       | 300,000               |       | 300                |       | 44,700           |           |         |            |        |            |
| Cancelled  Shares on 12/31/05                    |       | (975,000              | )          | (975               | )          | (876,500         | )              |         |            |        |            |
| Cancelled  Shares on 12/31/05                    |       | (5,000                | )          | (5                 | )          | (4,495           | )              |         |            |        |            |
| Settlement  on Employee Stock                    |       |                  |       |               |       |             |           | 441,302      |            |        |            |
| Amortization                                     |       |                  |       |               |       |             |           | 13,057,665   |            |        |            |
| Net loss                                         |       |                  |       |               |       |             |           |         |            | (13,512,696 | )               |
| **BALANCES,  DECEMBER 31, 2005**            | ** ** | **65,215,121**        | ** ** | **65,215**         | ** ** | **$**            | **57,773,506** | ** **   | **(4,802,621**  | **)**       | **(43,811,511** | **)** |

** **

**44**

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** **

**POWER3 MEDICAL PRODUCTS, INC.**

**(ADevelopment Stage Enterprise)**

**STATEMENTS OF CASH FLOWS**

**YEARS ENDEDDECEMBER 31, 2005 AND 2004 (RESTATED)**

 
| ** **                                                                  | ** ** | **2005**       | ** ** | **2004**    | ** ** | **Period from  May 18, 2004  to December  31, 2005** | ** ** |
|-----------------------------------------------------------------------------|------------|----------------|------------|-------------|------------|-------------------------------------------------------------------------------|------------|
| ** **                                                                  | ** ** | **(Restated)** | ** ** |
| Operating Activities:                                                       |       |           |       |        |       |                                                                          |       |
| Net Loss                                                                    |       | (13,512,696    | )          | (17,471,463 | )          | (28,749,037                                                                   | )          |
| Adjustment to reconcile net loss to net  cash used in operating activities: |       |           |       |        |       |                                                                          |       |
| Derivative income (expense)                                                 |       | (2,019,884     | )          | (1,570,348  | )          | (3,590,232                                                                    | )          |
| Stock based services and compensation                                       |       | 12,188,616     |       | 17,932,787  |       | 27,344,105                                                                    |       |
| Stock issued to retire preferred stock and  debt                            |       |           |       | 4,236       |       | 4,236                                                                         |       |
| Gain on reversal of liabilities                                             |       |           |       |        |       |                                                                          |       |
| Amortization of debt discount and finance  charges                          |       | 105,446        |       | 16,728      |       | 122,174                                                                       |       |
| Depreciation and amortization                                               |       | 20,158         |       | 45,024      |       | 65,182                                                                        |       |
| Other                                                                       |       |           |       | (51,309     | )          | (34,935                                                                       | )          |
| Changes in operating assets and  liabilities:                               |       |           |       |        |       |                                                                          |       |
| Decrease(increase) in receivables                                           |       | 2,350          |       | 9,006       |       | 0                                                                             |       |
| Decrease(increase) in deposits                                              |       |           |       | (25,900     | )          | (25,900                                                                       | )          |
| Decrease(increase) in prepaids                                              |       | (16,740        | )          | (4,352      | )          | (21,092                                                                       | )          |
| Increase(decrease) in accrued interest                                      |       |           |       |        |       |                                                                          |       |
| Increase (decrease) in deferred finance  costs                              |       | 50,345         |       | 239,682     |       | 290,027                                                                       |       |
| Increase(decrease) in accounts payable and  accrued liabilities             |       | 1,197,941      |       | (48,723     | )          | 1,684,328                                                                     |       |
|                                                                        |       |           |       |        |       |                                                                          |       |
| Net cash (used in) Operating Activities                                     |       | (1,984,464     | )          | (924,632    | )          | (2,911,144                                                                    | )          |
|                                                                        |       |           |       |        |       |                                                                          |       |
| INVESTING ACTIVITIES                                                        |       |           |       |        |       |                                                                          |       |
| Capital expenditures, net                                                   |       | (5,884         | )          | (130,049    | )          | (135,933                                                                      | )          |
| Intellectual property                                                       |       | (83,362        | )          | (96,424     | )          | (179,786                                                                      | )          |
|                                                                        |       |           |       |        |       |                                                                          |       |
| Net cash used in Investing Activities                                       |       | (89,246        | )          | (226,473    | )          | (315,719                                                                      | )          |
|                                                                        |       |           |       |        |       |                                                                          |       |
| FINANCING ACTIVITIES                                                        |       |           |       |        |       |                                                                          |       |
| Proceeds from CD, warrants and rights, net  of issuance costs               |       | 338,000        |       | 859,041     |       | 1,197,041                                                                     |       |
| Proceeds from borrowings from notes payable                                 |       | 1,380,808      |       |        |       | 1,380,808                                                                     |       |
|                                                                        |       |           |       |        |       |                                                                          |       |
| Proceeds from sale of common stock, net                                     |       | 198,000        |       | 449,817     |       | 647,817                                                                       |       |
|                                                                        |       |           |       |        |       |                                                                          |       |
| Net cash provided by financing activities                                   |       | 1,916,808      |       | 1,308,858   |       | 3,225,666                                                                     |       |
|                                                                        |       |           |       |        |       |                                                                          |       |
| Net increase (decrease) in cash and cash  equivalents                       |       | (156,902       | )          | 157,753     |       | (1,197                                                                        | )          |
|                                                                        |       |           |       |        |       |                                                                          |       |
| Cash and cash equivalents, beginning of  period                             |       | 158,301        |       | 548         |       | 2,596                                                                         |       |
|                                                                        |       |           |       |        |       |                                                                          |       |
| Cash and cash equivalents, end of period                                    |       | 1,399          |       | 158,301     |       | 1,399                                                                         |       |
|                                                                        |       |           |       |        |       |                                                                          |       |
|                                                                        |       | 1,399          |       | 158,301     |       | 1399                                                                          |       |

 

 

45

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**POWER3 MEDICAL PRODUCTS, INC.**

**(ADevelopment Stage Enterprise)**

**STATEMENT OF CASH FLOWS**

**YEARS ENDEDDECEMBER 31, 2005 AND 2004 (RESTATED)**

 
| ** **                                                                    | ** ** | **2005**       | ** ** | **2004**   | ** ** | **Period from  May 18, 2004 to  December 31,  2005** | ** ** |
|-------------------------------------------------------------------------------|------------|----------------|------------|------------|------------|-------------------------------------------------------------------------------|------------|
| ** **                                                                    | ** ** | **(Restated)** | ** ** |
| Cash paid  for:                                                               |       |           |       |       |       |                                                                          |       |
| Interest                                                                      |       |           |       | $          | 59,840     |                                                                          | $          | 59,840 |   |
| Income taxes                                                                  |       |           |       |       |       | —                                                                        |       |
|                                                                          |       |           |       |       |       |                                                                          |       |
| Non-cash  transactions:                                                       |       |           |       |       |       |                                                                          |       |
| Conversion  of convertible notes payable and accrued interest to common stock |       |           |       |       |       |                                                                          |       |
| Conversion  of accrued payroll to preferred stock                             |       |           |       |       |       |                                                                          |       |
| Conversion  of stockholder advances to notes payable                          |       |           |       |       |       |                                                                          |       |
| Conversion  of notes payable to equity                                        |       |           |       |       |       | —                                                                        |       |
| Conversion  of preferred stock to common stock                                |       |           |       |       |       |                                                                          |       |
|                                                                          |       |           |       |       |       |                                                                          |       |
| Conversion  of other liabilities to stockholder advances                      |       |           |       |       |       |                                                                          |       |
| Exchange of  convertible preferred stock for common stock 3,000,324 shares    |       |           |       | 3,380,975  |       | 3,380,975                                                                     |       |
| Common stock  issued for services (At market, date of effective agreement):   |       |           |       |       |       |                                                                          |       |
| For  consulting contracts                                                     |       | $              | 156,000    |       | 10,156,775 |                                                                          | 10,312,775 |   |
| For asset  acquisition 15,000,000 shares                                      |       |           |       | 13,500,000 |       | 13,500,000                                                                    |       |
| For  compensation contracts                                                   |       | $              | (385,000   | )          | 25,451,500 |                                                                          | 25,066,500 |   |
| Issuance of  warrants in connection with services                             |       |           |       |       |       |                                                                          |       |
| Issuance of  warrants in connection with convertible debentures               |       |           |       |       |       |                                                                          |       |
| Asset  retirement obligation                                                  |       |           |       |       |       |                                                                          |       |
| Retirement  of common stock                                                   |       | $              | 882,000    |       |       |                                                                          | 882,000    |   |
|                                                                               |            |                |            |            |            |                                                                               |            |  |  |  |

 

See accompanying notes to the financial statements..

 

46

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**POWER3 MEDICAL PRODUCTS, INC**

**(A Development Stage Enterprise)**

**NOTES TO FINANCIALSTATEMENTS**

 

***Note 1. ORGANIZATION, PRINCIPALACTIVITIES AND BASIS OF PRESENTATION***

 

Power3 Medical Products, Inc. (the “Company” or “Power3“) was incorporated in the State of Florida on May 15, 1992 and mergedinto a New York Corporation in 1994, under the name Sheffield Acres, Inc..Power3 and its wholly owned subsidiaries, C5 Health, Inc. (C5), which wasofficially dissolved in the State of Delaware and the State of Florida effectiveDecember 31, 2003 and Power3 Medical, Inc., a Nevada Corporation, nowknown as Tenthgate, Inc., were engaged in product development, sales,distribution and services for the healthcare industry. On September 12,2003, Surgical Safety Products, Inc. amended its Certificate ofIncorporation to (a) declare a 1:50 reverse split of its common stock; (b) increaseits authorized capital to 150,000,000 shares of common stock and 50,000,000shares of preferred stock; and (c) change its name to Power3 MedicalProducts, Inc. All references to the number of shares in the accompanyingfinancial statements and notes thereto have been adjusted to reflect the stocksplit as if it occurred on January 1, 2004.

 

Prior to May 17, 2004, the Company had one directsubsidiary, Tenthgate, Inc. (“Tenthgate”), a Nevada corporation formerlyknown as Power3 Medical, Inc. Prior to this date, Tenthgate was accountedfor, by Power3, as a wholly-owned subsidiary, operating as a “development stagecompany”, under the cost method. As part of the transaction which involvedthe acquisition of substantially all the assets and certain liabilities fromAdvanced BioChem, now known as Industrial Enterprises of America, it was agreedthat Power3 would distribute the shares of its subsidiary, Tenthgate, to itsthen existing shareholders. To fulfill this obligation, the shares of Tenthgatewere transferred to a trustee for distribution to the shareholders of Power3 asof May 17, 2004. Tenthgate was spun off because the management of Power3,in place prior to May 17, 2004, desired to continue to own and eventuallyoperate this subsidiary. At the time of the spinoff, Tenthgate was granted therights to market a product line that had previously been marketed by Power3,but which the company had decided to abandon. Tenthgate had not been anoperating company, and their management has apparently abandoned any plans tomarket the product as evidenced by their SEC filings, specifically theiramended 10-QSB filed for the quarterly period ending January 31, 2005,wherein they specifically state that they are a “development stage company.”The prior operations of the company which are reflected in the financialstatements as occurring prior to reentering the development stage were theoperations the Company had decided to abandon and which were transferred to theprior shareholders under the control of prior management. Any activities since May 17,2004, are not consolidated from Power3 because Power3 does not now own orcontrol the operations or activities of Tenthgate, nor are their activitiesassociated with Power3 in any manner whatsoever.

 

In 2003, the Company was an operating company,marketing devices to aid surgical procedures. Prior to May 18, 2004, theproducts had received only minor market acceptance and sales had slowed to thepoint that Power3 was searching for other products and markets to increase itspresence in the healthcare industry. In early 2004, Power3 became aware of abiotech company that appeared to have a set of assets and intellectualproperties that it required to more effectively pursue its business model. Thatcompany, named Advanced BioChem, doing business as ProteEx, providedcontract-for-fee lab services analyzing protein biomarkers. At the conclusionof negotiations with Advanced BioChem, Power3 entered into an Asset PurchaseAgreement dated May 18, 2004, whereby it purchased substantially all theassets and intellectual properties of Advanced BioChem, and assumed certainliabilities, as scheduled in the agreement, from Advanced BioChem. After thetransaction, certain employees from Advanced BioChem became employees of Power3and were later issued Employment Agreements by Power3. As consideration in theAsset Purchase Agreement, Power3 issued 15,000,000 shares of common stock toAdvanced BioChem.

 

47

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Power3Medical Products, Inc. did not continue the business activity of AdvancedBioChem and never conducted any contract-for-fee lab service work. Subsequentto the asset purchase, the business model of Power3 was significantly changed,the Company entered into the development stage and began to commercialize theintellectual property it acquired in the transaction, with its focus in theearly detection, monitoring and targeting of diseases through the analysis ofproteins. Power3’s new developmental stage objective, and activity, is todevelop its intellectual properties by focusing on disease diagnosis, proteinand biomarker identification and early detection indicators in the areas ofcancers, neurodegenerative and neuromuscular diseases, as well as otherscientific areas of interest associated with protein biomarkers.

 

Coincidentwith the asset purchase transaction on May 18, 2004, the previousmanagement of Power3 resigned and left the employ of the Company. Immediatelythereafter, two employees of Advanced BioChem were granted employmentagreements by Power3. These two employees were Steven B. Rash as President andCEO and Dr. Ira Goldknopf as Chief Scientific Officer.

 

**Restatement of Financial Information**

 

Wehave restated our Financial Statements for the year ended December 31,2004 as a result of discoveries made by management that certain accountingprocedures and applications thereof had not fully considered all the facts ofthe situations and certain accounting errors and irregularities were identified.Specifically these areas included the recognition of embedded derivatives, therecognition of goodwill, the expensing of certain intangible assets acquired inthe Advanced BioChem transaction and the classification of liabilities ascurrent, rather than long term liabilities.

 

Thefollowing tabular presentation summarizes the net loss and net loss per shareas originally reported and as restated, and the quarterly effects of eachadjustement, for each year ended December 31, 2004 :

 

Detailsof the 2004 restatement adjustments are as follows:

 
| ** **                       | ** ** | **As Originally** | ** **  | **As**       | ** ** |
|----------------------------------|------------|------------------------|-------------|--------------|------------|
| ** **                       | ** ** | **Reported**           | ** **  | **Restated** | ** ** |
|                             |       |                   |        |         |       |
| Total Assets                     |       | $                      | 554,310     |         | $          | 13,983,810 | * |
|                             |       |                   |        |         |       |
| Total  Liabilities               |       | $                      | 839,597     |         | $          | 3,634,517 | ** |
|                             |       |                   |        |         |       |
| Total  Stockholder’s Equity |       | $                      | (285,287    | )            | $          | 10,349,293 | *** |
|                             |       |                   |        |         |       |
| Revenues                         |       | $                      | 15,491      |         | $          | 15,491 |   |
|                             |       |                   |        |         |       |
| Net Loss                         |       | $                      | (19,081,344 | )            | $          | (17,471,463 | ) |
|                             |       |                   |        |         |       |
| Net Loss per  share              |       | (0.45                  | )           | (0.42        | )          |

 

----

*The$13,429,500 increase in Total Assets is due to an increase in Goodwill of$13,371,776, reduction in Intangible Assets of ($50,376) due to expensingpreviously capitalized legal and licensing fees, removal of ($131,102) in DebtIssuance Costs previously capitalized, recording $239,682 in deferred financecosts and a ($480) correction to Cash to account for a check that nevercleared.

 

**The$2,794,920 increase in Total Liabilities is due to recognition of thederivative liabilities of $2,877,919, elimination of previous balance in theconvertible debentures of ($55,556), write off of a previous Note Payable of($20,001), a restatement of accrued liabilities of ($21,693) and recognition ofthe convertible debenture liability balance of $14,251.

 

48

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***The$10,634,580 increase in Stockholder’s Equity is due to an increased loss of$14,981,657 over the previously stated period offset by a reduction inadditional paid in capital of ($4,347,077) resulting from the recognition ofthe derivative liabilities and adjustment to the fair values of the notespayable and warrants.

 

TheCompany has restated its financial statements to correct its accounting for theissuance of convertible debentures, warrants and investment rights. The revisedfinancial statements provide for (i) the classification of warrants asliabilities, at fair value, (ii) the classification of embedded conversionand other features embedded in the convertible debentures and investment rightsas liabilities at fair value and (iii) the amortization of discounts thatresulted in the host instruments using the effective interest method. Thisrevised accounting is required because, under current accounting standards,financial instruments, such as warrants and embedded conversion features thatare indexed to a Company’s common stock, are classified as liabilities wheneither (a) the holder possesses rights to net-cash settlement or (b) physicalor net-share settlement is not within the control of the Company. In suchinstances, net-cash settlement is assumed for financial accounting andreporting, even when the terms of the underlying contracts do not provide fornet-cash settlement. Such financial instruments are initially recorded at fairvalue and subsequently adjusted to fair value at the close of each reportingperiod. This accounting will be utilized in the accounting for theseinstruments until the Company reaquires the ability to share settle theinstruments or physically settles the instruments through other means. Also seeNote 5.

 

OnMay 18, 2004, Power3 executed the Asset Purchase Agreement (“the Agreement”)referred to above, to purchase substantially all the assets of Advanced BioChemand assume certain liabilities in exchange for the issuance of 15,000,000shares of common stock of Power3. For financial statement purposes, thetransaction was treated, at the time, as a recapitalization of the equitystructure of Power3 and therefore, the accumulated deficit of Power3 waseliminated, no stock-based expenses were recorded as a result of thistransaction, and the assets and liabilities of Power3 and Advanced BioChem werecombined, based on the accounting treatment as recapitalization, in a reverseacquisition. Subsequent to the filing of Form 10-QSB for the quarter endedMarch 31, 2005, during its interim revue, Power3 determined that thepurchase of assets and the acquisition of certain liabilities of AdvancedBioChem, which occurred on May 18, 2004, is properly accounted for as apurchase transaction. In addition, management determined that, due to thespecific nature of the transaction and because Power3 did not continue thebusiness activity of Advanced BioChem whatsoever, Advanced BioChem cannot beconsidered a predecessor. In addition, because the asset acquisition by Power3was a purchase of equipment and intellectual property from an entity thatcontinued its existence and its previous business activity after the purchasetransaction, rather than being merged into Power3, and because the combinationdid not contain other elements of an equity merger of the two companies, theCompany determined that the facts of the transaction had been misapplied andthat purchase accounting is the more appropriate accounting treatment andAdvanced BioChem would not be presented as a predecessor. This accountingtreatment represents a restatement of the transaction referenced above, whichwas previously characterized as a recapitalization of Power3, as in a reverseacquisition. The Balance Sheet, Statement of Operations and the Statement of CashFlow shown in Part I, Item 1, display the financial statements of theCompany consistent with the restatement of the asset acquisition as purchaseaccounting. On August 10, 2005, the Company issued an 8-K reportingnon-reliance on previously issued financial statements for the quarter ended June 30,2004, September 30, 2004 and March 30, 2005, which had beenpreviously presented under the previous accounting treatment.

 

OnApril 12, 2006, during interim review of its previously issued financialstatements in preparation for production of the 10-KSB for 2005, managementdetermined that the following changes were necessary in its previouslypublished financial statements as follows:

 

•      Legal Fees, in the amount of $17,676,acquired in the transaction with Advanced BioChem discussed above andcapitalized in the 10-KSB previously issued for December 31, 2004, shouldbe expensed as of May 18, 2004;

 

•      Difference in the value of stock issued inthe transaction with Advanced BioChem discussed above

 

49

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and the assets and liabilities acquired fromAdvanced BioChem, previously accounted for as a deemed distribution, should beaccounted for as Goodwill in the amount of $13,371,776;

 

•      Licensing expenses in the amount of $50,000for 2004 and $38,767 in 2005, paid to Baylor College of Medicine and MDAnderson which had previously been capitalized, should be expensed;

 

•      The convertible debentures issued in October,2004 and January, 2005, which had previously been accounted for as Long TermLiabilities should, as of April 25, 2005, be reclassified as CurrentLiabilities on that date because as of that date, the debentures were indefault (due to our failure to have the SB-2 relating to the conversion option,the warrants and the additional investment rights associated with theconvertible debentures, effective within 180 days of the original issue ofdebenture date) and thereby became a current liability rather than a long termliability as of the date of this Event of Default;

 

•      Because the Event of Default discussed above,occurred for the convertible debentures we issued in October, 2004 and inJanuary, 2005, on April 25, 2005, the Mandatory Prepayment Amount of 130%of the original principal amounts, became due as of that date and recognitionof this $420,000 due, as a current liability, should have been effective as of April 25,2005; and

 

•      Additional evaluations were required toproperly value the conversion option issued with the Convertible Debentures,the warrants issued with these debenture, evaluation of the additionalinvestment rights and calculations to determine the fair value any embeddedderivatives existing in these agreements.

 

Duringinterim revue on April 12, 2005, and in preparation for the production ofour 10-KSB for 2005, management determined that these changes were necessarybecause the facts of each situation had been misapplied and each of the aboveitems needed to be restated in our financial statements, as they apply, for thepreviously published reports for June 30, 2004, September 30, 2004, December 31,2004, March 31, 2005, June 30, 2005, and September 30, 2005.

 

SincePower3’s planned principal operations have not yet commenced, it was and isconsidered to be in the developmental stage, as of May 18, 2004, asdefined in Financial Accounting Standards Board Statement No. 7. Accordingly,some of the Company’s accounting policies and procedures have not yet beenestablished. The Company has been in its current developmental stage since itsacquisition of its set of intellectual properties on May 18, 2004. Lossesincurred by Power3 are as follows, as of December 31, 2004 and 2005:

 
| ** **                                            | ** ** | **2004** | ** **  | **2005** | ** ** |
|-------------------------------------------------------|------------|----------|-------------|----------|------------|
| Losses  accumulated before entering development stage |       | $        | (11,681,500 | )        | $          | (11,681,500 | ) |
| Losses  accumulated during development stage          |       | $        | (18,617,315 | )        | $          | (32,130,011 | ) |

 

***Note 2.******SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES***

 

Financial Instruments and Concentrations of Credit Risk 

 

TheCompany’s financial instruments consist of cash and cash equivalents, accountsreceivable, accounts payable, and accrued expenses, notes payable, derivativefinancial instruments, other current liabilities, and convertible debentures.Management believes the carrying values of cash and cash equivalents, accountspayable, accounts payable and accrued expenses, notes payable, and othercurrent liabilities approximate their fair values due to their short-termnature. The fair value of convertible debentures, which have a face value and 

 

50

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carryingvalue of $75,279 and $1,400,000, respectively, is estimated to be approximately$987,000. The fair value of the Trinity notes payable, which have a face valueand carrying value of $302,750 and $135,873, respectively, is estimated to beapproximately $311,000.

 

TheCompany generally does not use derivative financial instruments to hedgeexposures to cash-flow risks or market-risks that may affect the fairvalues of its financial instruments. However, certain other financialinstruments, such as warrants and embedded conversion features that are indexedto the Company’s common stock, are classified as liabilities when either (a) theholder possesses rights to net-cash settlement or (b) physical ornet-share settlement is not within the control of the Company. In suchinstances, net-cash settlement is assumed for financial accounting andreporting, even when the terms of the underlying contracts do not provide fornet-cash settlement. Such financial instruments are initially recorded at fairvalue and subsequently adjusted to fair value at the close of each reportingperiod.

 

Thecaption Derivative Financial Instruments consists of (i) the fair valuesassociated with derivative features embedded in the Convertible Debentures and (ii) thefair values of the detachable warrants and additional investment rights thatwere issued in connection with the debenture financing arrangements. (See Item5. Financing Arrangements)

 

Financialinstruments that potentially subject the Company to significant concentrationsof credit risk consist primarily of cash and cash equivalents. The Companyoccasionally maintains cash and cash equivalents balances in excess offederally insured limits. The Company has not experienced any losses in suchaccounts.

 

Principles of Consolidation and Investments

 

During 2003, the Company accounted for itsinvestment in its subsidiary, Tenthgate, Inc. under the cost method. Asdescribed in Note 1, the Company’s former subsidiary, known as Tenthgate, Inc.,is not consolidated for periods after May 17, 2004, because the Company,in May of 2004, distributed its common stock ownership in Tenthgate to a trusteefor distribution to the shareholders of record as of May 17, 2004. Power3does not now own or control Tenthgate, Inc.’s activities or operations inany manner whatsoever. Since Tenthgate, Inc. was spun off in May, 2004, asdescribed in Item I, it is not consolidated for periods subsequent to thattransaction..

 

Use of Estimates

 

The preparation of financial statementsin conformity with accounting principles generally accepted in the UnitedStates of America requires management to make certain estimates and assumptionsthat affect the reported amounts of assets and liabilities and disclosure ofcontingent assets and liabilities at the date of the financial statements. Thereported amounts of revenues and expenses during the reporting period may beaffected by the estimates and assumptions management is required to make. Estimatesthat are critical to the accompanying financial statements include assessingthe impact of contingencies and the amortization periods for the debt issuancecosts and debt discount on the convertible debentures (see Note 8) as well asestimating depreciation and amortization periods of tangible and intangibleassets, and long-lived impairments, among others. The markets for the Company’sproducts are characterized by intense competition, evolving standards and pricecompetition, all of which could impact the future realizability of the Company’sassets. Estimates and assumptions are reviewed periodically and the effects ofrevisions are reflected in the financial statements in the period they aredetermined to be necessary.

 

Furniture, Fixtures and Lab Equipment

 

Furniture,fixtures and lab equipment are stated at cost. Major additions are capitalized,while minor additions and maintenance and repairs, which do not extend theuseful life of an asset, are expensed as incurred. 

 

51

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Depreciationand amortization are provided using the straight-line method over the assets’estimated useful lives. At December 31, 2005, certain lab equipment havinga net book value of approximately $37,500 serves as security for certainliabilities.

 

Debt Discounts and Deferred Finance Costs 

 

Debt discounts and deferred finance costs are beingamortized through periodic charges to interest expense over the maximum term ofthe convertible debentures of three years using the effective interest method.Amortization of debt discounts amounted to $93,801 and $14,251 during the yearsended December 31, 2005 and 2004, respectively.

 

Other Intangibles 

 

Legal fees incurred for patent protectionapplications, expended by Advanced BioChem and obtained in the May 18,2004 transaction with Advanced BioChem, were expensed.

 

Long-Lived Assets 

 

Statement of Financial AccountingStandards (SFAS) 144, “Accounting for the Impairment or Disposal of Long-LivedAssets” requires that long-lived assets, including certain identifiableintangibles, be reviewed for impairment whenever events or changes incircumstances indicate that the carrying value of the assets in question may notbe recoverable. The Company evaluated its long-lived assets at December 31,2005 and determined that certain impairment losses were necessary. As a result,operations were charged for $20,158 during the year ended December 31,2005. Management believes that the remaining balances of the Company’slong-lived assets are recoverable.

 

Statementof Financial Accounting Standards (SFAS) 142 “Accounting for Intangible Assets”provides that goodwill is not subject to periodic amortization, but isevaluated at least annually for impairments. The goodwill acquired by theCompany at the time of the May 18, 2004 transaction was evaluated at both December 31,2004 and 2005. Goodwill was determined to not be impaired because the fairvalue of the reporting unit, based on the market capitalization of the Company,exceeded the carrying value of the reporting unit, based on assets minusliabilities, at both December 31, 2004 and 2005.

 

Net Loss Per Share 

 

Net loss per share is computed inaccordance with SFAS No. 128 “Earnings per Share” (“SFAS No. 128”)and SEC Staff Accounting Bulletin No. 98 (“SAB 98”). Under the provisionsof SFAS No. 128 and SAB 98, basic net loss per share is computed bydividing the net loss available to common stockholders for the period by theweighted average number of common shares outstanding during the period. Dilutednet loss per share is computed by dividing the net loss, adjusted for using the“if-converted method” for convertible securities, for the period by theweighted average number of common and common equivalent shares (using the “treasury-stock”method) outstanding during the period. In periods in which common stock equivalentswould be anti-dilutive, such shares are ignored in the loss per sharecalculations because they would have an anti-dilutive effect.

 

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Reclassification of Liabilities

 

Based on the Event of Default, resultingfrom the Company’s failure to get an SB-2 effective for the shares involvedwith conversion of the debentures and warrant shares, that occurred on April 25,2005 for the convertible debentures issued in October, 2004 and January, 2005,Power3 has reclassified the convertible debentures as a Current Liability,rather than as a Long Term Liability as they were previously shown in ourfinancial statements in both the original 10-KSB filed for 2004 and inquarterly reports for June 30, 2005 and September 30, 2005.

 

In addition, since the Event of Defaultoccurred on April 25, 2005, Power3 has now recognized the MandatoryPrepayment Amount, as a Current Liability, as described in the debentureagreements as due in case an Event of Default occurs.

 

The only Accounts Payable amountextinguished during 2004 was a balance due to a CPA firm, dated January 10,2003, which totaled $19,961. On or about May 4, 2004, a settlement wasreached with this CPA firm in which they accepted $4,236 in cash as fullpayment for the balance due. While management has no written documentation asto why the vendor agreed to settle for less than the original amount billed,our understanding is that there was a dispute over the extent of the servicesactually rendered and it was agreed that the CPA firm would accept the lesseramount in full settlement of the bill.

 

No amounts from Accounts Payable werereclassified during 2005.

 

Stock – Based Compensation 

 

TheCompany accounts for equity instruments awarded to employees for services basedon the fair value of common stock issued and the intrinsic value of stockoptions and warrants. The accompany accounts for all equity instruments issuedto those other than employees based on the fair value of the considerationreceived or the fair value of the equity instruments, whichever is morereliably measurable. Fair value is measured based on the closing market priceof the common stock on the effective date of the agreement or Board resolution,using the Black Scholes valuation model.

 

During2005, three employees, who had previously been granted common stock in exchangefor services, left the employ of the Company. When this stock was returned tothe Company, and cancelled, the Company recognized a gain on the return of thisstock based on the difference between amounts amortized to deferredcompensation expense in 2004 and 2005 compared to amounts expensed to stockcompensation expense in 2004 and 2005, as follows...

 
| ** **                            | ** ** | **Total** | ** ** | **Amount**    | ** ** | **Net**  | ** ** |
|---------------------------------------|------------|-----------|------------|---------------|------------|----------|------------|
| ** **                            | ** ** | **Gain**  | ** ** | **Amortized** | ** ** | **Gain** | ** ** |
|                                  |       |      |       |          |       |     |       |
| Net Gain on  Bhezadi stock            |       | $         | 900,000    |          | $          | (673,874 | )          | $ | 226,126 |   |
| Net Gain on  Mosqueda stock           |       | $         | 4,500      |          | $          | (2,820   | )          | $ | 1,680 |   |
| Net Gain on  Rosinski stock           |       | $         | 427,000    |          | $          | (213,504 | )          | $ | 213,496 |   |
|                                  |       |      |       |          |       |     |       |
| Gain on  Settlement of Employee Stock |       |      |       |          |       | $        | 441,302    |   |

 

Income Taxes 

 

TheCompany computes income taxes using the asset and liability method inaccordance with Financial Accounting Standards Statement No. 109 “Accountingfor Income Taxes” (“SFAS 109”). Under SFAS 109, deferred taxes are recognizedfor the tax consequences of temporary differences by applying enacted statutoryrates applicable to future years to differences between the financial statementcarrying amounts and the tax basis of existing assets and liabilities. Also,the effect on deferred taxes of a change in tax rates is recognized in 

 

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incomein the period that included the enactment date. There were no significanttemporary differences at December 31, 2005.

 

Research and Development 

 

Research and development costs, whichapproximated $501,245 for the year ended December 31, 2005 are expensed asincurred.

 

In 2004, the Company paid $10,000 toBaylor College of Medicine and $40,000 to M.D. Anderson for research agreementswith both institutions. These research agreements covered the provision ofhuman tissue samples by Baylor (400 patient samples) and M.D. Anderson (60patient samples), the exchange of technology and the testing of the patientsamples provided using Power3’s biomarker technology. Power3 executed licensingagreements with both Baylor College of Medicine and M.D. Anderson to insurethat the research partnerships and cooperative technology would be continuedand eventually benefit both Power3 and the respective institutions, if and whenPower3 commercially developed its testing and diagnostic capabilities. Thesepayments were expensed under FAS guidelines for research and developmentaccounting.

 

Cash Equivalents

 

Forpurposes of the statements of cash flows, the Company considers all highlyliquid debt instruments purchased with a maturity of three months or less to becash equivalents.

 

Revenue Recognition

 

In2004, the Company shipped its product directly from the outsource manufacturerto the customer without taking ownership or possession of its products. Allshipments were FOB destination with freight allowed and payment terms were net30 days after shipment. Accordingly, revenue was recognized upon delivery.

 

TheCompany’s revenue recognition policy is consistent with the criteria set forthin Staff Accounting Bulletin 104-Revenue Recognition in Financial Statements(SAB 104) for determining when revenue is realized or realizable and earned. Inaccordance with the requirements of SAB 104 the Company recognizes revenue when(1) Persuasive evidence of an arrangement exists; (2) Delivery hasoccurred; (3) the Seller’s price is fixed or determinable; and (4) collectibilityis reasonably assured.

 

Advertising Costs

 

Advertisingcosts are expenses as incurred. Advertising expenses were $-0- for each of theyears ended December 31, 2005 and December 31, 2004.

 

Other Income

 

In2005, Other Income consisted of only one item which was $260 of Interest Incomeearned from deposits in a money market account as the Company’s primary bank.

 

In2004, Other Income consisted of $641,855 as follows:

 

•      $412,500 from write off of Accrued OfficerSalaries, as of May 17, 2004, originally due to the previous officers ofPower3, but agreed, by them, to be forgiven at the time of the May 18,2004 transaction which transferred control of the Company to the new owners andmanagement. These 

 

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two individuals were not controlling shareholders ofthe Company as of December 31, 2004;, nor were they members of managementat the time of the debt forgiveness.

 

•      $121,500 from write off ofpreviously-existing debt to consultant, as of May 17, 2004, due to forgivenessof the debt by the consultant on that date;

 

•      $19,961 from a settlement reached with aprevious consultant wherein the Company paid $4,236 in full payment of the debtobligation and the consultant agreed to accept this amount as full payment dueto a dispute over services performed;

 

•      $39,627 from a settlement reached with aprevious creditor, who was also a minority shareholder, to whom the Companypaid $47,188 in cash and issued 300,000 shares of common stock in fullsettlement of the $90,000 alledged obligation;

 

•      $20,267 from write off of interest that hadbeen accrued on the $90,000 obligation mentioned above;

 

•      $28,000 from write off of AccruedCompensation, as of May 17, 2004, that had been previously accrued to aconsultant which was settled in negotiations in exchange for a note for $2,000due to this consultant.

 

***Note 3. GOING CONCERN***

 

TheCompany’s financial statements are presented on a going concern basis, whichcontemplates the realization of assets and satisfaction of liabilities in thenormal course of business. The Company is in the development stage and hasprimarily been involved in research and development and capital raisingactivities; as such the Company has incurred significant losses from operationsduring 2004 and 2005.

 

Asa result, the Company has an immediate need for capital to continue itsoperations, and it will need to raise significant additional funds to implementits business plan. This cash will have to come from equity sales and/orborrowings as management has projected that the Company will need significantadditional capital for development and other ongoing operational activities beforeit will have any anticipated revenue generating products. The actual amount offunds that the Company will need will be determined by many factors, some ofwhich are beyond the Company’s control. These factors include:

 

•      The extent to which the Company enters intolicensing arrangements, collaborations or joint ventures;

•      The progress and results of research andproduct development;

•      The costs and timing of obtaining new patentrights;

•      The extent to which the Company requires orlicenses other technologies; and

•      Regulatory changes and competition andtechnological developments in the market.

 

Acurrent possibility available to the Company is to raise the remaining funds of$1,600,000 potentially available to them pursuant to the Securities PurchaseAgreement dated October 28, 2004 (the “Agreement”). These funds will beimmediately reduced by the payment of certain delinquent payables ofapproximately $251,000 and $200,000 of certain bridge financing received in April andNovember, 2005, the $446,500 of bridge loan financing and the Officer Advancesthat are to be repaid upon the receipt of the $1,600,000. The Company is inimmediate need for capital to continue its operations and as such its abilityto continue as a going concern is subject to its ability to generate a profitor obtain necessary funding from outside sources. Management believes that eventhough the Company currently has limited cash resources and liquidity, assumingexercise of the warrants and additional investment rights specified in theAgreement, that the net funds available from the final closing under suchAgreement will allow the Company to continue operations through 

 

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December 2006.In the event the final closing and sale of $1,600,000 in aggregate principalamount of debentures occurs, but the warrants and additional investment rightsare not exercised, the Company anticipates that it will need to raiseadditional capital prior to October 2006 to meet its operating costs. However,the Company is currently in default under the conditions set forth in theAgreement as well as the debentures and registration rights agreement andconsequently, there is no assurance that the Company will be successful incompleting the sale and issuance of the remaining $1,600,000 aggregateprincipal amount of debentures and/or the additional investments rightspursuant to the Agreement. If the Company is unsuccessful in the closing of thesale and issuance of the $1,600,000 aggregate principal amount of debentures atthe final closing, the Company will be required to obtain alternativefinancing, sell or license some of its technology, and/or curtail or cease itsoperations. Any such funding may significantly further dilute existingshareholders or may limit the Company’s rights to its technology. Moreover,the increase in the number of shares available in the public marketplace may reducethe market price for the Company’s common stock, and consequently, the priceinvestors may receive at the time of sale. The financial statements do notinclude any adjustments to reflect the possible future effects on therecoverability and classification of assets or the amounts and classificationof liabilities that may result from the possible inability of the Companyto continue as a going concern.

 

***LOSS PER SHARE***

 

AtDecember 31, 2005, common stock options were excluded from the fullydiluted loss per share calculations because the effects would beanti-dillutive:

 

•      2,500,000 warrants, and additional investmentrights having a value of $2,500,000, which were issued to certain accreditedinvestors on October 28, 2004 under the Agreement. In addition, pursuantto the Agreement, the investors purchased certain convertible debentures thatif exercised, will result in the issuance of an indeterminate number of sharesof common stock.

 

•      333,333 warrants which were issued to certainaccredited investors on January 26, 2005 under the Amended Agreement. Inaddition, pursuant to the Agreement, the investors purchased certainconvertible debentures that if exercised, will result in the issuance of anindeterminate number of shares of common stock

 

•      580,000 shares of warrants which were issuedto members of the Company’s Scientific Advisory Board and various other consultantsin 2004 (including 100,000 to the agent that placed the convertible debenturesdiscussed above). The warrants, which expire three to five years from the datesof the respective grants and were issued at no cost to such personnel, may beconverted to a like number of shares of the Company’s common stock at any timeprior to their expiration(s). As a result, during the period May 18, 2004(date of acquisition) to December 31, 2005, the Company has recorded$284,447 of stock based compensation as a result of the issuance of thesewarrants.

 

•      2,000,000 shares of warrants were issued in November andDecember of 2005 to Trinity Finance Investments associated with two Notes,1,000,000 warrants each, for invested funds. The warrants which expire in 7-8years may be converted to a like number of shares at any time prior totheir expiration date. As a result the Company recorded $6,429 of stock-basedcompensation as a result of the issuance of these warrants during 2005.

 

Inaddition, at December 31, 2005, loss per share excludes 34,222,222 sharesthat are indexed to convertible debentures and investment rights. Theseinstruments would also have an anti-dilutive effect on loss per share.

 

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***Note 4*****.*INCOME TAXES***

 

TheCompany recognized losses for both financial and tax reporting purposes duringeach of the periods in the accompanying statements of operations. Accordingly,no provisions for income taxes and/or deferred income taxes payable have beenprovided for in the accompanying financial statements.

 

Basedon the Company’s 2004 tax return, the Company has net operating losscarryforwards for income tax purposes of approximately $12,957,858 arisingprimarily from stock based expenses that are considered to be permanentdifferences. These net operating loss carryforwards expire at various timesthrough the period ended December 31, 2022 however because the Company hasexperienced changes in control and has incurred significant operating losses,utilization of the income tax loss carryforwards are not assured. As a result,the non-current deferred income tax asset arising from these net operating losscarryforwards is not recorded in the accompanying balance sheet because theCompany established a valuation allowance to fully reserve such assets as theirrealization did not meet the required asset recognition standard established bySFAS 109. The tax return for 2005 has not been finalized at the time of thisreport, however it is expected that additional net operating loss carryforwardswill result from the Company’s 2005 operations.

 

***Note 5*****.*RELATED PARTY TRANSACTIONS***

 

Asreported earlier in “General and Corporate History”, on May 18, 2004, theCompany purchased substantially all the assets of Advanced BioChem in exchangefor 15,000,000 shares of common stock of Power3 and assumed certain liabilitiesas part of the purchase transaction. During 2004, employment agreementswere issued to two former employees of Advanced BioChem, specifically Steven B.Rash, the new Chief Executive Officer of Power3 and Dr. Ira Goldknopf asChief Scientific Officer of Power3. These agreements are specifically discussedin “Employment Agreements” later.

 

OnOctober 13, 2004, the Chief Financial Officer loaned the Company $75,000as a short-term bridge loan, with no interest and no maturity date specified. OnNovember 11, 2004, the loan was paid back with no interest.

 

OnMarch 31, 2003, the Company’s Board of Directors authorized 4,000,000shares of Series A Preferred Stock. Simultaneously, the Company issued2,660,000 shares of Series A Preferred Stock in consideration of accruedand unpaid salary totaling $200,000 to two officers of the Company and1,330,000 shares of Series A Preferred Stock in consideration of $100,000cash by an individual investor. The Company recorded $1,695,000 of non-cashcompensation expense as a result of this transaction during 2003. Thetransaction was recorded in the fourth quarter of 2003 based on the value ofthe Company’s stock immediately subsequent to the stock split discussedpreviously. On December 31, 2003 the two officers mentioned aboveconverted a total of 120,000 shares of their Series A Preferred Stock into1,200,000 common shares. In November, 2004, the Series A Preferredstockholders converted their remaining preferred shares into 3,000,324 sharesof common stock. The stock was issued to previous officers of the Company, bothrelated parties and an outside consultant, for past compensation due. When thecompensation was originally recorded, accrued compensation was charged, withthe offset to preferred stock. The entry to record the preferred stock was madein the fourth quarter of 2003 because it was discovered as part of the2003 audit, by the audit firm, and a decision was made by previous management,not to amend the 10-QSB for the three month period ending March 31, 2003. Theconversion terms at the date of the original issuance were 10:1. However,subsequently the Board of Directors and the shareholders agreed to change theconversion factor to .7752:1, did a Board Resolution to that effect and thepreferred stock was converted to common stock, in 2004, in accordance with therevised conversion terms.

 

Duringthe three months ended March 31, 2005 the chief financial officer advanced$35,000 to the Company. The advance, which is due on demand and unsecured,bears interest at 6% per annum. At June 30, 2005, the balance of theadvance is included in accounts payable and accrued and other liabilities inthe accompanying condensed balance sheet.

 

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OnMay 31, 2005, the Company received an Officer Advance in the amount of $55,000. This advance is in the form of a short-term Note Payable to theOfficer, is payable on June 30, 2005, and bears interest at a rate of 6 %per annum until paid. The Officer has agreed to allow the Company an indefiniteextension of time to repay this Note.

 

OnJune 3, 2005, the Company received an Officer Advance in the amount of $50,000. This advance is in the form of a short-term Note Payable to theOfficer, is payable on June 30, 2005, and bears interest at a rate of 6 %per annum until paid. The Officer has agreed to allow the Company an indefiniteextension of time to repay this Note.

 

During the latter half of 2005, the Chief ScientificOfficer advanced the Company $159,231 as short-term Officer Advances in orderto enable the Company to meet certain payment obligations. These advances werein the form of 180 day notes and bear interest at a rate of 6% per annumuntil the outstanding balance is paid in full. None of these short-term OfficerAdvances were due as of December 31, 2005.

 

On December 14, 2005, the Company received anOfficer Advance in the amount of $50,000 from the Chief Scientific Officer. Thisnote is due on June 13, 2006 and bears interest at a rate of 6% per annumuntil paid.

 

**Note 6. *OTHER COMMITMENTS ANDCONTINGENCIES***

 

Operating Lease for Office and Laboratory Space

 

InAugust 2004, the Company entered into a new lease which expires on August 31,2009, has an initial term of sixty-three months, and requires base monthlyminimum lease payments ranging from approximately $6,000 to $9,600 (plusutilities and operating expenses) over the lease term. The lease contains aprovision which allows the Company to extend the lease for two additional termsof sixty months. Rent expense (for the office lease) approximated $68,944during the year ended December 31, 2005 and $28,952 during the year ended December 31,2004.

 

Other Leases

 

InJune, 2004, the Company entererd into a new lease for a telephone system whichexpires in June, 2009, has an initial term of 60 months and requires basemonthly minimum lease payments in the amount of $184.51 per month over thelease term. The Company paid $2,269 on this lease during the year ended December 31,2005.

 

InOctober, 2004, the Company entered into a new lease for computers which expiresin September, 2006, has an initial term of 24 months and requires base monthlyminimum lease payments in the amount of $344 per month over the lease term. TheCompany paid $4,136 on this lease during the year ended December 31, 2005.

 

Futurelease commitments are as follows:

 
| 2006 |   | $ | 96,129  |   |
|------|--------|---|---------|--------|
| 2007 |   | $ | 106,420 |   |
| 2008 |   | $ | 114,800 |   |
| 2009 |   | $ | 39,434  |   |

 

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Employment Agreements 

 

TheCompany is obligated under amended and restated employment agreements with itsChief Executive Officer, Chief Scientific Officer and Chief Financial Officer. Thesignificant terms of the agreements are as follows:

 

ChiefExecutive Officer – The amended and restated employment agreement is effectiveas of May 18, 2004 and has an initial term of five years, subject to eachparty’s termination rights. The agreement provides for a base salary of$250,000 per year and the opportunity to receive cash bonuses based onperformance upon the discretion of the board of directors. The agreement alsoincludes participation in employee benefit plans offered to employees, as wellas a grant of 13,250,000 shares of restricted common stock and 1,500,000 sharesof restricted Series B preferred stock (the Series B preferred shareshave not yet been issued). Either party may terminate the Chief ExecutiveOfficer’s employment under the contract, either with or without cause upongiving the other party at least thirty days notice. If the Company terminatesthe chief executive officer’s employment at any time during the initial termwithout cause, he will be entitled to receive compensation provided under theagreement for the remaining initial term of employment. In addition, in theevent of a change in control as defined in the agreement, the Company may waive,in whole or in part, any and all remaining restrictions on the restrictedshares of common stock and Series B preferred stock granted to him.

 

ChiefScientific Officer – The amended and restated employment agreement is effectiveas of May 18, 2004 and has an initial term of five years, subject to eachparty’s termination rights. The agreement provides for a current base salary of$125,000 through December 18, 2004 and $100,000 thereafter and theopportunity to receive cash bonuses based on performance upon the discretion ofthe board of directors. The agreement also includes participation in employeebenefit plans offered to employees, as well as a grant of 13,250,000 shares ofrestricted common stock and 1,500,000 shares of restricted Series Bpreferred stock (the Series B preferred shares have not yet been issued). Eitherparty may terminate the chief scientific officer’s employment under thecontract, either with or without cause upon giving the other party at leastthirty days notice. If the Company terminates the Chief Scientific Officer’semployment at any time during the initial term without cause, he will beentitled to receive compensation provided under the agreement for the remaininginitial term of employment. In addition, in the event of a change in control asdefined in the agreement, the Company may waive, in whole or in part, anyand all remaining restrictions on the restricted shares of common stock and Series Bpreferred stock granted to him.

 

Chief Financial Officer – The employment agreement is effective as of September 1,2005 and has an initial term of three years, subject to each party’stermination rights. The agreement provides for a base salary of $100,000 peryear and the opportunity to receive cash bonuses based on performance upon thediscretion of our board of directors. The agreement also includes participationin employee benefit plans offered by us to our employees, as well as a grant of140,000 shares of restricted common stock. Either party may terminate theChief Financial Officer’s employment under the contract, either with or withoutcause upon giving the other party at least thirty days notice. If the Companyterminates the chief financial officer’s employment at any time during theinitial term without cause, he will be entitled to receive compensationprovided under the agreement for the remaining initial term of employment. Inaddition, in the event of a change in control as defined in the agreement, theCompany may waive, in whole or in part, any and all remaining restrictionson the restricted shares of common stock granted to him.

 

Other Common Stock Grants

 

Inaddition to the above common stock grants, during 2004, the Company granted1,445,000 shares of its common stock to various other employees. Because all ofthe shares were granted at no cost to the employees, and because the sharesgenerally vest over a period of two years, the total value of the grants, toall employees, was recorded as $25,451,500 of deferred compensation expenseupon the date of the grant (which amount was determined based on the totalnumber of shares granted times the trading values of the shares on the datesthe 

 

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stockgrants were made). This amount is being amortized to stock based compensationexpense over the vesting period.

 

Duringthe quarter ended September 30, 2004, Power3 amortized three months ofemployee stock grants, three months of the first-mentioned consulting contractand 2.3 months of the second-mentioned consulting contract. However, at thetime of our end of year audit, it was determined that an adjusting entry wasmade, as of September 30, 2004, which credited stock compensation expensefor $1,533,505, credited consulting fees for $455,633 and debited deferredcompensation expense for the offset. At the time of the end of year audit, itwas determined that this entry was erroneous and was based on amisunderstanding of the transactions involved. As soon as this was noted, as part ofthe year end audit, the correction was made and the total shown for stockcompensation expense for 2004 is correctly reported.

 

Theonly stock grant made during 2005 was 140,000 shares to the Chief FinancialOfficer which represented a -0- net increase in the number of sharesoutstanding, because the shares previously granted to the previous ChiefFinancial Officer had been returned. There was, however, a significantdifference in the Deferred Compensation Expense because the unamortized portionof the previous grant was offset by the significantly lower new DeferredCompensation Expense debit, resulting from the replacement issue of shares in2005. This resulted from the difference in the value of the shares as being$3.05 in July of 2004 when the original 140,000 shares were issued ascompared to the shares being valued at $.30 when those 140,000 shares werereissued to the incoming Chief Financial Officer.

 

Asmentioned above, the Company has agreed to issue a total of 3,000,000 shares ofSeries B Preferred Stock to two of its officers. However, for variousreasons, including certain restrictions required by the indebtedness (whichpreclude the shares from being issued for at least 90 days after the effectivedate of the registration statement that has been filed to cover the resale ofthe shares of common stock that will be issued upon the conversion or exerciseof the securities issued by the Company for such indebtedness), the shares havenot yet been issued. The Company intends to issue such shares of the Series BPreferred Stock at such time as it is permitted.

 

Futurerequired payments for base compensation under all of the employment agreementsdiscussed above are approximately as follows:

 
| **Periods Ending  December 31,** | ** ** | **Amounts** | ** ** |
|--------------------------------------------|------------|-------------|------------|
|                                       |       |        |       |
| 2005                                       |       | $           | 470,000    |   |
| 2006                                       |       | 470,000     |       |
| 2007                                       |       | 410,000     |       |
| 2008                                       |       | 350,000     |       |
| 2009                                       |       | 131,250     |       |
|                                       |       |        |       |
| Total                                      |       | $           | 1,831,250  |   |

 

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Other Contingencies

 

Inthe normal course of business, the Company is involved in certain litigation,including one matter in which the plaintiff is seeking $1,522,000 in damages. Managementbelieves the claim is without merit, and intends to vigorously contest suchclaim. This matter is currently in ongoing negotiations between the parties andtheir attorneys and accordingly its ultimate resolution cannot be determined atthis time. As such, no effect has been given to any loss that might result fromthe outcome of this litigation in the accompanying financial statements.

 

Inaddition, an equipment vendor filed a complaint against Advanced BioChem (whichrelated to equipment acquired by Power3 in the May 18, 2004 transaction)in April of 2002 in a California court alleging breach of contract andseeking damages. Advanced BioChem reached a settlement agreement in April of2003 under which Advanced BioChem agreed to pay the vendor $40,000 ininstallments through August of 2003. At December 31, 2003, AdvancedBioChem had a balance remaining of $20,000. In April 2005 the equipmentvendor filed a lawsuit against Advanced BioChem and certain former officers ofAdvanced BioChem, and against Power3, in order to enforce its claim for theremaining balance which is past due and may be assumed by the Company as part ofthe settlement of the dispute with Advanced BioChem as to liabilities assumedin the May 18, 2004 transaction.

 

InSeptember, 2005, a New York corporation filed suit against Power3 alledgingbreach of an agreement and damages totaling approximately $480,000 plus courtcosts and legal fees. Settlement discussions are currently ongoing, however noresolution has been achieved thus far. The Company does not believe it willultimately be held liable for this claim and has not made any provision forthis claim on its balance sheet.

 

TheCompany is involved in several other debt collection lawsuits totalingapproximately $38,600 plus court costs and interest. Since none of thesematters has come to court, or is expected to within a short amount of time, theCompany cannot be certain how any of these four matters will be resolved. Theoriginal debt amounts are recorded in accounts payable on the balance sheet ofthe Company.

 

*Subpoena from the SEC, Division of Enforcement*

 

OnJune 27, 2005, the Company received a subpoena for documents regarding theSEC’s Division of Enforcement investigation In The Matter of Maui General Store, Inc.It is the Company’s understanding that the Maui General Store matter relates toa promotional scheme by certain individuals to promote the stock and stockprice of certain entities during 2004. The Company provided all documents inits possession pursuant to the subpoena and complied fully with the subpoena onJuly 11, 2005. In February, 2006, Steven B. Rash and Dr. Ira Goldknopfappeared before a Grand Jury in Washington, D.C., as witnesses, for the SECDivision of Enforcement. The Company has received no further correspondencefrom the Enforcement Division of the SEC. The Company has not been notifiedthat it is a subject of this investigation.

 

**Note 7. FINANCING ARRANGEMENTS:**

 

**SecuritiesPurchase Agreement—Convertible Debentures**

 

TheCompany entered into a Securities Purchase Agreement, dated October 28,2004 (the “Agreement”) with certain accredited investors (the “Purchasers”).Pursuant to the Agreement, the Purchasers agreed to purchase convertibledebentures due three (3) years from the date of issuance in the aggregateprincipal amount of $3,000,000. The Agreement also provides for the issuance tothe Purchasers, at no additional cost to the 

 

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purchasers,warrants to purchase shares of the Company’s common stock and additionalinvestment rights to purchase additional convertible debentures. In connectionwith the Agreement, the Company also entered into a Registration RightsAgreement with the Purchasers that requires the Company to (i) file aregistration statement with the SEC registering the resale of the shares ofcommon stock issuable upon conversion of the debentures and the exercise of thewarrants, (ii) achieve effectiveness within a stated period and (iii) maintaineffectiveness of the registration statement. Failure to meet these requirementswill require the Company to incur liquidating damages amounting to 2.0% foreach month.

 

OnOctober 28, 2004, the Company issued the Purchasers the first $1,000,000in aggregate principal amount of such debentures at the initial closing underthe Agreement. Effective January 26, 2005, the Company issued and sold, toa sub-group of the original investors, a second tranche of $400,000 aggregateprincipal amount of debentures. Subject to the conditions set forth in theAgreement, all purchasers are required to purchase the remaining $1,600,000 inaggregate principal amount of such debentures at the final closing, which is tooccur on or before the fifth trading day after the effective date of theregistration statement. The Company is currently in default under the Agreementand the previously issued debentures and related registration rights agreement,and therefore the conditions of the Agreement will not be satisfied orotherwise met on a timely basis. Consequently, there are no assurances that thePurchasers will purchase all or any portion of the remaining $1,600,000 aggregateprincipal amount of debentures. The $1,000,000 aggregate principal amount ofdebentures issued in the initial closing and the $400,000 aggregate principalamount of debentures issued on January 19, 2005 are due and payable inaccordance with their original terms in full three years after the date ofissuance and do not bear interest. The debentures which may be issued atthe final closing will be due and payable in full three (3) years afterthe date of their issuance, and will also not bear interest. At any time fromthe closing date until the maturity date of the debentures, the Purchasers havethe right to convert the debentures, in whole or in part, into common stock ofthe Company at the then effective conversion price, which varies relative tothe Company’s trading stock price, as follows: $0.90 per share, providedhowever if the lesser of (i) 75% of the average of the 5 consecutiveClosing Prices immediately prior to the Effective Date, as defined in theSecurities Purchase Agreement, and (ii) the Closing Price on the EffectiveDate (the lesser of (i) and (ii) being referred to as the “EffectiveDate Price”) is less than the Conversion Price, the Conversion Price shall bereduced to equal the Effective Date Price.

 

The debentures also affordthe Purchasers anti-dilution protection should, at any time while thedebentures are outstanding, the Company offer, sell or grant any option topurchase or offer, sell or grant any right to reprice its securities, orotherwise dispose of or issue any common stock or common stock equivalents,entitle any person to acquire shares of common stock at an effective price pershare less than the then effective Conversion Price, as calculated by theformula described above; then, in such instance, the Conversion Price for theconvertible debenture shares shall be reduced to the lower price. In case ofany such adjustment in the effective Conversion Price for the convertibledebenture shares, this could significantly dilute existing investors.

 

Under the Agreement, thePurchasers also received warrants to purchase an aggregate of up to 2,500,000shares of common stock and additional investment rights to purchase up to anadditional $2,500,000 principal amount of convertible debentures. The warrantsare exercisable at a price of $1.44 per share, subject to adjustment, includingunder anti-dilution protection similar to that described above.

 

Theadditional investment rights are exercisable at a price equal to the principalamount of the debentures to be purchased, for (1) a period of nine monthsfollowing the effective date of the registration statement to be filed pursuantto the Registration Rights Agreement, or (2) a period of 18 months fromthe date of issuance of the additional investment rights, whichever is shorter.The rights debentures will have the same terms as the debentures describedabove, except that the conversion price will be equal to $1.08.

 

Thedebentures contain covenants that limit the Company’s ability to, among otherthings: incur or guarantee additional indebtedness; incur or create liens;amend the Company’s certificate of incorporation, bylaws or other 

 

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charterdocuments so as to adversely affect any rights of the holders of thedebentures; and repay or repurchase more than a de minimus number of shares ofcommon stock other than as permitted in the debentures and other documentsexecuted with the purchasers.

 

Theconvertible debentures contain consequences in case of default. Events ofdefault which could subject the Company to penalties and liabilities asspecified in the Agreement include:

 

•      Any default in the payment of the principalamount of the debentures or the liquidated damages;

 

•      Any untrue or incorrect representation orwarranty in the Transaction document or any other report, financial statementor certificate made to Holder(s);

 

•      Any case or action of bankruptcy orinsolvency commenced by the Company, against the Company or adjudicated by acourt against the Company for the benefit of creditors;

 

•      Any default in its obligations under amortgage or debt in excess of $150,000;

 

•      Any cease in the eligibility of the Company’sstock to be quoted on a Trading Market;

 

•      Any Change in Control or sale or disposal of33% or more of the assets of the Company;

 

•      Any lapse in the effectiveness of theRegistration Statement covering the shares related to the debenture conversionoption, the warrants or the additional investment rights as described andtransacted in the Securities Purchase Agreement and accompanying documents;

 

•      Any failure to deliver certificates withinthe specified time; and

 

•      Any failure, by the Company, to pay in fullthe amount of cash due pursuant to a Buy-In or failure to pay any amounts owedon account on account of an Event of Default within 10 days of the date due.

 

Uponthe occurrence of an event of default, each debenture may becomeimmediately due and payable, either automatically or by declaration of theholder of such debenture. The aggregate amount payable upon an acceleration byreason of an event of default shall be equal to the greater of 130% of theprincipal amount of the debentures to be prepaid or the principal amount of thedebentures to be prepaid, divided by the conversion price on the date specifiedin the debenture, multiplied by the closing price on the date set forth in thedebenture.

 

Otherprovisions included in the Securities Purchase Agreement include the following:

 

•      The debenture may be exchanged for anequal aggregate principal amount of debentures in different authorizeddenominations;

 

•      The debenture is convertible into commonstock, at the option of the Holder, at any time after the effective date of thedebenture, any time after an event of default and from time to time subject tolimitations on conversion specified in the Agreement;

 

•      Conversions can be made in smaller incrementsand from time to time. If smaller amounts of the debentures are converted, theHolder will not be required to physically surrender the debentures;

 

•      The Company has 1 business day after receiptof conversion notice to object to any such request to convert;

 

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•      The Holder shall not have the right toconvert any portion of his debenture if such conversion would enable him to ownin excess of 4.99% of the outstanding common stock of the Company;

 

•      No later than 3 trading days after anyconversion date, the Company will deliver a certificate representing theconverted shares, free of any legends and trading restrictions for the numberof shares converted;

 

•      If the Company fails to deliver saidcertificates, liquidated damages of $1,000 per day will be paid;

 

•      The Company will reserve and keep availableauthorized and unissued registered shares available to be issued uponconversion;

 

•      Holder will not be responsible for anytransfer taxes relative to issuance of shares;

 

•      If the Company pays a stock dividend or otherdistribution on its shares, or splits or subdivides its shares or issue byreclassification or any such change in its common shares outstanding, then thenumber of shares available to Holder shall be adjusted proportionally;

 

•      If the Company shall offer, sell, grant anyoption or otherwise distribute shares to holders of common stock, the number ofshares available to Holder shall be adjusted proportionally;

 

•      If the Company is involved in any merger oracquisition, the conversion price of the stock shall be adjusted to reflect theeffects of such previous adjustment;

 

•      During the term of the debentures, theCompany is not permitted to do certain things unless approved by the holders of2/3 majority of the debentures such as create any indebtedness senior to theCompany’s debenture obligations, amend its certificate of incorporation or buyback any amount of its common stock;

 

•      If the Company offers, sells or grants stockat an effective per share price less than the then Conversion Price, then theConversion Price shall be reduced to equal the effective conversion, exchangeor purchase price for such common stock or common stock equivalents;

 

•      If the Company offers, sells or grantssecurities that have a price less than the otherwise calculated ConversionPrice, then the current exercise price of the warrants is thereby adjusted tobe the lower of the offered or sold price or the otherwise calculatedConversion Price;

 

•      If there is an Event of Default, all amountsbecome due in the form of a Mandatory Prepayment Amount (discussed asfollows), with maximum interest and penalty payments; and

 

•      Miscellaneous other provisions such as noticein writing, governing law, waiver and severability.

 

As mentioned above, theCompany is in default under the provisions of the Agreement, RegistrationRights Agreement and previously issued debentures. The events of defaultprincipally relate to the Company’s inability to have its registrationstatement declared effective within the time period required by the agreements.Although the Company intends to seek waivers or forbearance agreements from theholders of its debentures, there is no assurance that the Company will receivesuch concessions. As such, the indebtedness has been classified as a currentliability in the accompanying balance sheet. If the Company is unable to obtainsuch concessions, the aggregate amount payable under the outstanding debenturesdue to the acceleration thereof by reason of the default is equal to the “MandatoryPrepayment Amount” as specified in the debentures. The Mandatory PrepaymentAmount equals the sum of (i) the greater of:  (a) 130% of the principal amount of thedebentures to 

 

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be prepaid, or (b) theprincipal amount of the debentures to be prepaid, divided by the conversionprice on (x) the date the payment is demanded or otherwise due, or(y) the date the payment is paid in full, whichever is less, multiplied bythe closing price of the Company’s common stock on (x) the date thepayment is demanded or otherwise due, or (y) the date the payment is paidin full, whichever is greater, and (ii) all other amounts, costs, expensesand liquidated damages due in respect of the debentures.

 

The Company is in default onthe Convertible Debentures with regard to the deadline for having theregistration statement be effective, the withdrawal of the Company’s stock fromtrading on the OTCBB and several other default clauses. Besides the provisionsfor the Mandatory Prepayment provisions which become effective if the Companyis in default on these debentures and the liquidated damages resulting from theregistration statement not being effective, as discussed immediately above, theCompany is also subject to partial liquidated damages for not being able todeliver share certificates, if such were demanded in a conversion action by adebenture holder. These partial liquidated damages amount to $10 per tradingday, for each $1,000 of principal amount being converted, increasing to $20 pertrading day after 5 trading days from when such damages begin to accrue, untilthe share certificates are delivered by the Company.

 

The Company has receivednotice from one of the Purchasers informing the Company that it is in defaultunder the debentures and demanding payment of the Mandatory Prepayment Amount,together with the liquidated damages, to which it is entitled pursuant to theagreement. The Company has filed an SB-2 to register the shares of stockassociated with the convertible debenture agreements and is endeavoring to haveit declared effective as soon as practicable. The Company is in discussion withits debenture holders regarding a resolution of this matter.

 

Inconnection with such financing, the Company issued, a warrant to purchase100,000 shares of common stock at an exercise price of $3.00 to its placementagent, Westor Online and Kogan and Associates. If any investor exercises theiradditional investment rights and purchases additional debentures, the placementagent will be entitled to receive additional warrants to purchase up to anumber of shares of common stock equal to ten percent (10%) of the exerciseprice paid upon exercise of the additional investment rights divided by ninetypercent (90%) of the market price as of the initial closing. The Companyaccounted for the warrants as deferred financing costs and is amortizing thefair values thereof ($101,000) through periodic charges to interest expenseusing the effective method.

 

Convertible Debentures, Warrants and Additional Investment Rights:

 

Thecarrying values of the Company’s convertible debentures amounted to $14,251 and$75,279, at December 31, 2004 and 2005, respectively. Convertibledebentures consist of face value $1,000,000 and $1,400,000, as of December 31,2004 and 2005, respectively, non-interest bearing convertible debentures due intwo traunches: $1,000,000 on October 28, 2007 and $400,000 due on January 26,2008. The convertible debentures arose from the aforementioned financing, wherethe proceeds were allocated among the components of the financing arrangement,as follows:

 
| ** **                    | ** ** | **Traunch 1**             | ** ** | **Traunch 2**             | ** ** | ** ** | ** ** |
|-------------------------------|------------|--------------------------------|------------|--------------------------------|------------|------------|------------|
| **Instrument:**               | ** ** | **October 28, 2004** | ** ** | **January 26, 2005** | ** ** | **Total**  | ** ** |
| Convertible  debentures (1)   |       | $                              | —     |                           | $          | —     |       | $ | — |   |
| Common stock  warrants (2)    |       | 3,070,750                      |       | 135,000                        |       | 3,205,750  |       |
| Embedded  conversion feature  |       | 882,556                        |       | 266,592                        |       | 1,149,148  |       |
| Additional  investment rights |       | 606,867                        |       | 225,415                        |       | 832,282    |       |
| Derivative  loss              |       | (3,560,173                     | )          | (227,006                       | )          | (3,787,179 | )          |
| Total gross  proceeds (3)     |       | $                              | 1,000,000  |                           | $          | 400,000    |       | $ | 1,400,000 |   |

 

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(1)     The discount to the face value of theconvertible debentures that resulted from the allocation is being amortizedthrough periodic charges to interest expense using the effective method.Amortization of the discount amounted to $14,251 and $61,028 during the yearsended December 31, 2004 and 2005, respectively.

 

(2)     The Company issued additional warrants topurchase 333,333 share of common stock in connection with Traunch 2, which wasnot contemplated in the initial financing agreement. Current accountingstandards require that these warrants be allocated between the debt (andrecorded as deferred financing costs) and the derivative instruments (andallocated directly to derivative expense). Since the initial allocation ofproceeds did not result in any initial value allocated to the debt, the fairvalue of these warrants was charged to derivative expense, as reflected in thetable.

 

(3)     Direct financing costs associated with theofferings amounted to $140,959 and $62,000 for Traunch 1 and Traunch 2,respectively. Deferred financing costs are being amortized through periodic chargesto interest expense using the effective method. Amortization of the deferredfinancing costs amounted to $2,009 and $8,071 during the years ended December 31,2004 and 2005, respectively.

 

Derivativefinancial instruments arising from the financing are initially recorded andcontinuously carried at fair values. The following tabular presentationreflects the components of derivative financial instruments on the Company’sbalance sheet at December 31, 2004 and 2005:

 
| **(Assets) Liabilities:**    | ** ** | **2004** | ** ** | **2005** | ** ** |
|-----------------------------------|------------|----------|------------|----------|------------|
| Common stock  warrants            |       | $        | 1,227,250  |     | $          | 57,250 |   |
| Embedded  conversion feature      |       | 464,941  |       | 632,000  |       |
| Additional  investment rights     |       | 423,137  |       | 537,778  |       |
| Other  derivative instruments (1) |       | 762,591  |       | 229,124  |       |
|                              |       | $        | 2,877,919  |     | $          | 1,454,936 |   |

 

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(1)   The fair values of certain other derivativefinancial instruments (warrants and convertible preferred stock) that existedat the time of the initial Debenture Financing were reclassed from stockholders’equity to liabilities when, in connection with the Debenture Financing, theCompany no longer controlled its ability to share-settle these instruments.These derivative financial instruments had a fair value of $5,835,443 on October 28,2004, when the Company no longer controlled its ability to share-settle theinstruments. Prior to December 31, 2004, the Company settled the preferredstock with the issuance of common stock. As a result, the derivative liabilityassociated with the preferred stock was adjusted to fair value immediatelybefore the settlement and reclassed to common equity. The remaining instrumentswill be reclassified to stockholders’ equity when the Company reacquires theability to share-settle the instruments.

 

Thefollowing tabular presentation reflects the number of common shares into whichthe aforementioned derivative financial instruments are indexed at December 31,2004 and 2005:

 
| **Shares of common stock** | ** ** | **2004**  | ** ** | **2005**   | ** ** |
|-------------------------------------------|------------|-----------|------------|------------|------------|
| Common stock  warrants                    |       | 2,500,000 |       | 2,833,333  |       |
| Embedded  conversion feature (1)          |       | 2,039,216 |       | 18,666,666 |       |
| Additional  investment rights (1)         |       | 1,699,346 |       | 15,555,555 |       |
| Other  derivative instruments (2)         |       | 1,480,000 |       | 3,480,000  |       |
|                                      |       | 7,718,562 |       | 40,535,556 |       |

 

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(1)   The terms of the embedded conversion featuresin the debentures and additional investment rights provide for variableconversion rates that are indexed to the Company’s trading common stock price.As a result, the number of indexed shares is subject to continuous fluctuation.The substantial increase in the number of shares from December 31, 2004 toDecember 31, 2005 is indicative of a significant decline in the Company’strading common stock prices.

 

(2)   During November and December 2005,the Company issued the Trinity notes payable that had detachable warrants forthe purchase of 2,000,000 shares of common stock. These warrants constitute theincremental increase in other derivative instruments. Because share settlementof these warrants is not within the control of the Company, the warrants wereclassified as derivative financial instruments at their initial fair value. SeeTrinity Notes Payable, below.

 

Derivativeincome (expense) for the years ended December 31, 2004 and 2005 associatedwith adjustments recorded to reflect the aforementioned derivatives at fairvalue (in addition to the initial allocation, above) amounted to $5,130,521 and$2,246,890, respectively.

 

Fair value considerations for derivative financial instruments:

 

Freestandingderivative financial instruments, consisting of warrants that arose from thedebenture financing, are valued using the Black-Scholes-Merton valuationmethodology because that model embodies all of the relevant assumptions thataddress the features underlying these instruments. Significant assumptionsincluded in this model are as follows:

 
| ** **            | ** ** | **Traunch 1** | ** ** | **Traunch 2** | ** ** |
|-----------------------|------------|--------------------|------------|--------------------|------------|
| **Instrument**        | ** ** | **Warrants**       | ** ** | **Warrants**       | ** ** |
| Exercise  prices      |       | $                  | 1.44       |               | $          | 1.44 |   |
| Initial term  (years) |       | 5.0                |       | 5.0                |       |
| Volatility            |       | 84.90              | %          | 84.90              | %          |
| Risk-free  rate       |       | 3.34               | %          | 3.73               | %          |
|                       |            |                    |            |                    |            |  |  |

 

Embeddedderivative financial instruments, arising from the debentures and theadditional investment rights, consist of multiple individual features that wereembedded in the convertible debentures. The Company evaluated all significantfeatures of the hybrid instruments and, where required under current accountingstandards, bifurcated features for separate report classification. Thesefeatures were, as attributable to each convertible debenture and additionalinvestment right, aggregated into one compound derivative financial instrumentfor financial reporting purposes. The compound embedded derivative instrumentsare valued using the Flexible Monte Carlo methodology because that modelembodies certain relevant assumptions (including, but not limited to, interestrate risk, credit risk, and conversion/redemption privileges) that arenecessary to value these complex derivatives.

 

Assumptionsincluded exercise estimates/behaviors and the following other significantestimates:

 
| ** **                                  | ** ** | **Traunch 1** | ** ** | **Traunch 2** | ** ** |
|---------------------------------------------|------------|--------------------|------------|--------------------|------------|
| **Instrument**                              | ** ** | **Features**       | ** ** | **Features**       | ** ** |
| Conversion  prices                          |       | $0.10—$0.90   |       | $0.10—$1.08   |       |
| Remaining  terms (years)                    |       | 1.6—4.5       |       | 1.8—4.5       |       |
| Equivalent  volatility                      |       | 78.17%—81.53% |       | 78.17%—81.53% |       |
| Equivalent  interest-risk adjusted rate     |       | 5.18%—5.43%   |       | 5.20%—5.24%   |       |
| Equivalent  credit-risk adjusted yield rate |       | 23.1%—45.7%   |       | 12.8%—14.2%   |       |

 

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Equivalentamounts reflect the net results of multiple modeling simulations that the MonteCarlo Simulation methodology applies to underlying assumptions.

 

Otherderivative financial instruments consist of warrants and Series APreferred stock that were issued prior to and subsequent to the debenturefinancing and were reclassified from stockholders’ equity or initiallyaccounted as liabilities, at fair values, since share-settlement was not withinthe Company’s control after the debenture financing. The other warrants arevalued using the Black-Scholes-Merton valuation methodology because that modelembodies all of the relevant assumptions that address the features underlyingthose instruments. The preferred stock was determined by management to containsimple, non-complex conversion features and was, therefore, also valued usingBlack-Scholes-Merton methodology. Significant assumptions included in thismodel are as follows:

 
| **Instrument**        | ** ** | **Other Warrants** | ** ** | **Preferred Stock** | ** ** |
|-----------------------|------------|-------------------------|------------|--------------------------|------------|
| Exercise  prices (1)  |       | $0.14—$3.00        |       | $                        | 1.00       |   |
| Initial term  (years) |       | 5.0—8.0            |       | 5.0                      |       |
| Volatility            |       | 84.90%—171.12%     |       | 84.90                    | %          |
| Risk-free  rate       |       | 3.34%—3.73%        |       | 3.34                     | %          |
|                       |            |                         |            |                          |            |  |

 

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(1)   The weighted average exercise price of theother 3,480,000 common stock warrants is $0.61. As previously discussed, thepreferred stock was converted to common stock before the close of the 2004 yearend.

 

Trinity Notes Payable

 

DuringNovember and December 2005, the Company issued $300,000 face value,11% notes payable and detachable warrants to purchase 2,000,000 shares ofcommon stock to Trinity Financing Investments Corporation. Principal andinterest on the notes are payable $150,000 in March and $150,000 in April 2006.The warrants have eight-year terms and strike prices of $0.25 for 1,000,000shares and $0.14 for 1,000,000 shares.

 

Theproceeds from the Trinity financing were allocated first to the warrants, basedupon their fair values, with the balance of $103,100 allocated to the notes.The allocation of proceeds to the fair value to the warrants was performedbecause, as discussed in the previous section, share settlement is not withinmanagement’s control. Such amount was initially classified as a derivativeliability. The resulting note discount is being amortized through periodic chargesto interest expense using the effective method. Amortization of note discountamounted to $32,773 during the period from issuance of the notes to December 31,2005.

 

TheCompany did not make its required debt service payments in March and April 2006.As a result of this default, the Company is required to accrue interest at acomposite rate of 21%.

 

**Note 8. Other Significant Equity Transactions**

 

Duringthe year ended December 31, 2003, Power3 owed a stockholder for previousadvances made to the Company, and had agreed to issue common stock to thestockholder to settle this outstanding obligation, thereby resulting in 300,000shares of common stock being entered as Common Stock Subscribed in the Company’sEquity secion of its Balance Sheet. In May, 2004, an agreement was completedwith the stockholder, wherein he agreed to accept $47,188 in cash and theissuance of the subscribed 300,000 shares of common stock in full settlement ofthe $90,000 owed to him by the Company. These shares were not issued as of December 31,2003, and accordingly the par value of such shares is reflected as common stocksubscribed as of December 31, 2003. The common shares were issued in May,2004 and the amount in Common Stock Subscribed was thereby eliminated.

 

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Series APreferred Stock

 

OnMarch 31, 2003, the Company’s Board of Directors authorized 4,000,000shares of Series A Preferred Stock. Simultaneously, the Company issued2,660,000 shares of Series A Preferred Stock in consideration of accruedand unpaid salary totaling $200,000 to two officers of the Company and1,330,000 shares of Series A Preferred Stock in consideration of $100,000cash by an individual investor. The Company recorded $1,695,000 of non-cashcompensation expense as a result of this transaction during 2003. Thetransaction was recorded in the fourth quarter of 2003 based on the value ofthe Company’s stock immediately subsequent to the stock split discussedpreviously. On December 31, 2003 the two officers mentioned aboveconverted a total of 120,000 shares of their Series A Preferred Stock into1,200,000 common shares. In November, 2004, the Series A Preferredstockholders converted their remaining preferred shares into 3,000,324 sharesof common stock.

 

Thestock was issued to previous officers of the Company, both related parties andan outside consultant, for past compensation due. When the compensation wasoriginally recorded, accrued compensation was charged, with the offset topreferred stock. The entry to record the preferred stock was made in the fourthquarter of 2003 because it was discovered as part of the 2003 audit, bythe audit firm, and a decision was made by previous management, not to amendthe 10-QSB for the three month period ending March 31, 2003. Theconversion terms at the date of the original issuance were 10:1. However,subsequently the Board of Directors and the shareholders agreed to change theconversion factor to .7752:1, did a Board Resolution to that effect and thepreferred stock was converted to common stock, in 2004, in accordance with therevised conversion terms.

 

Stock Option Plans

 

The Company has various stock option andwarrant plans outstanding. Options granted under the 1998 stock option plansare exercisable only after the respective vesting period, which is determinedby the Company’s stock option committee. Options expire seven years from thedate of grant. Under the 1999 stock option plan, options granted to employeesvested ratably over three years as determined by the Company’s stock optioncommittee for options granted to officers, directors, and consultants. Optionsexpire ten years from the date of grant. A total of 6,360 options remained ineffect for warrants granted in 2000. The fair value of these warrants wasestimated at the date of grant using a Black-Scholes option pricing model withthe following assumptions for warrants granted in 2000:  risk-free interest rate of 6.03%;dividendyield of 0%; volatility factor of the expected market price of the Company’scommon stock of $.34; and a weighted-average expected life of the options of2.7 years.

 

InMarch 2003, the Company’s board of directors approved a 2003 StockCompensation Plan. On September 25,2003, the Company filed a Post-Effective Amendment No. 1, to it’spreviously filed Form S-8 Registration Statement for the 2003 StockCompensation Plan, to deregister the 2003 Stock Compensation Plan as well asthe 8,000,000 shares of Power3’s common stock previously registered in theprevious S-8 filed and the warrants that had been previously issued werecancelled by mutual consent.

 

In January 2004, the Company’s Boardof Directors approved the 2004 Directors, Officers and Consultants StockOption, Stock Warrant, and Stock Award Plan (the 2004 Plan). Pursuant to the2004 Plan, initially 10,000,000 shares of common stock, warrants, options,preferred stock or any combination thereof may be optioned. After thegrant of any option, warrant or share of preferred stock, the number of sharesthat may be optioned under the 2004 Plan will be increased. The number ofshares of such increase shall be an amount such that immediately following suchincrease, the total number of shares issuable under this plan and reserved forissuance upon exercise of options, warrants, or conversion of shares ofpreferred stock will equal 15% of the total number of issued and outstandingshares of the Company’s common stock. The Company has issued 38,926,466 sharesof common stock and 580,000 warrants under the 2004 Plan. Based upon the automatic

 

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increase provisions above, the number ofshares available for issue under the Plan is 9,929,269, based upon 15% of theoutstanding shares as of December 31, 2005.

 

Pro forma information regarding net income andearnings per share is required by SFAS 123, and has been determined as if theCompany had accounted for all of its options and warrants (the “Warrants”)under the fair value method of that Statement. The fair value for the Warrantswas estimated at the date of grant using a Black-Scholes option pricing modelwith the following assumptions for Warrants granted in 2000: risk-free interestrate of 6.03%; dividend yield of 0%; volatility factor of the expected marketprice of the Company’s common stock of .34; and a weighted-average expectedlife of the options of 2.7 years. The following assumptions were used forWarrants granted in 2004: Risk-free interest rate of 5.0%; dividend yield of0%; volatility factor of the expected market price of the Company’s commonstock of 1.86 and a weighted-average expected life of the options of -0- years(as all were immediately vested). The following assumptions were used forWarrants granted in 2005:  Risk-freeinterest rate of 5.5%; dividend yield of 0%, volatility factor of the expectedmarket price of the Company’s common stock of 1.86 and a weighted-averageexpected life of the 2005 options for 7 years. The Black-Scholes optionvaluation model was developed for use in estimating the fair value of tradedWarrants that have no vesting restrictions and are fully transferable. Inaddition, option valuation models require the input of highly subjectiveassumptions including the expected stock price volatility. Because the Company’sWarrants have characteristics significantly different from those of tradedWarrants, and because changes in the subjective input assumptions canmaterially affect the fair value estimate, in management’s opinion, theexisting models do not necessarily provide a reliable single measure of thefair value of its stock options.

 

Allof the Company’s warrants were recorded at their fair values; accordingly stockbased compensation actually recorded and stock based compensation that would berecorded using a fair value based method are identical. For purposes of proforma disclosures, the estimated fair value of the options is charged toexpense over the options’ vesting period.

 

TheCompany’s pro forma information for the years ended December 31, 2005 and2004 is as follows:

 
| ** **                                             | ** ** | **2005**   | ** **  | **2004**          | ** ** |
|--------------------------------------------------------|------------|------------|-------------|-------------------|------------|
| ** **                                             | ** ** | ** ** | ** **  | **(as restated)** | ** ** |
| Net Loss:                                              |       |       |        |              |       |
| As reported                                            |       | $          | (13,512,696 | )                 | $          | (17,471,463 | ) |
| Stock based  employee compensation expense             |       |       |        |              |       |
| Determined  under fair value based methods, net of tax |       |       |        |              |       |
| Option  Expense                                        |       | $          | (360,000    | )                 | $          | (626,100 | ) |
|                                                   |       |       |        |              |       |
| Pro forma  net loss                                    |       | $          | (13,872,696 | )                 | $          | (18,097,563 | ) |
|                                                   |       |       |        |              |       |
| Loss per  share, basic and diluted:                    |       |       |        |              |       |
| As reported                                            |       | $          | (0.21       | )                 | $          | (0.42 | ) |
| Pro forma                                              |       | $          | (0.23       | )                 | $          | (0.44 | ) |

 

Asummary of the Company’s warrant activity and related information for the yearsended December 31, 2005 and 2004 is as follows:

 

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| ** **                         | ** ** | **2005**     | ** ** | **2004**     | ** ** |
|------------------------------------|------------|--------------|------------|--------------|------------|
| ** **                         | ** ** | ** **   | ** ** | **Weighted** | ** ** | ** ** | ** ** | **Weighted** | ** ** |
| ** **                         | ** ** | ** **   | ** ** | **Average**  | ** ** | ** ** | ** ** | **Average** | ** ** |
| ** **                         | ** ** | ** **   | ** ** | **Exercise** | ** ** | ** ** | ** ** | **Exercise** | ** ** |
| ** **                         | ** ** | **Warrants** | ** ** | **Price**    | ** ** | **Warrants** | ** ** | **Price** | ** ** |
|                               |       |         |       |         |       |   |   |   |   |
| Outstanding at beginning of year   |       | 3,086,360    |       | 1.46         |       | 6,360 |   | 12.50 |   |
|                               |       |         |       |         |       |   |   |   |   |
| Cancelled                          |       | —       |       | —       |       | — |   | — |   |
|                               |       |         |       |         |       |   |   |   |   |
| Granted                            |       | 2,333,333    |       | .32          |       | 3,080,000 |   | 1.44 |   |
|                               |       |         |       |         |       |   |   |   |   |
| Exercised                          |       | —       |       | —       |       | — |   | — |   |
|                               |       |         |       |         |       |   |   |   |   |
| Outstanding at end of year         |       | 5,419,693    |       | .97          |       | 3,086,360 |   | 1.46 |   |
|                               |       |         |       |         |       |   |   |   |   |
| Exercisable at the end of the year |       | 5,419,693    |       | .97          |       | 3,086,360 |   | 1.46 |   |

 

Thefollowing table summarizes information about the Company’s Warrants outstandingat December 31, 2005:

 
| ** **          | ** ** | ** **              | ** ** | ** **                                                                       | ** ** | **Weighted**                 | ** ** |
|---------------------|------------|-------------------------|------------|----------------------------------------------------------------------------------|------------|------------------------------|------------|
| **Exercise  Price** | ** ** | **Number  Outstanding** | ** ** | **Weighted Average  Remaining Contractual  Life (in years)** | ** ** | **Average  Exercise  Price** | ** ** |
| $                   | .14        |                    | 1,000,000  |                                                                             | 8.0        |                         | $          | .14 |   |
| $                   | .25        |                    | 1,000,000  |                                                                             | 7.0        |                         | $          | .25 |   |
| $                   | .98        |                    | 300,000    |                                                                             | 2.0        |                         | $          | .98 |   |
| $                   | 1.00       |                    | 100,000    |                                                                             | 1.5        |                         | $          | 1.00 |   |
| $                   | 1.08       |                    | 333,333    |                                                                             | 2.0        |                         | $          | 1.08 |   |
| $                   | 1.43       |                    | 50,000     |                                                                             | 1.8        |                         | $          | 1.43 |   |
| $                   | 1.44       |                    | 2,500,000  |                                                                             | 1.9        |                         | $          | 1.44 |   |
| $                   | 2.77       |                    | 30,000     |                                                                             | 2.0        |                         | $          | 2.77 |   |
| $                   | 3.00       |                    | 100,000    |                                                                             | 1.9        |                         | $          | 3.00 |   |
| $                   | 6.50       |                    | 5,460      |                                                                             | 5.0        |                         | $          | 6.50 |   |
| $                   | 50.00      |                    | 900        |                                                                             | 2.0        |                         | $          | 50.00 |   |
|                |       |                    |       |                                                                             |       |                         |       |
|                |       | 5,419,693               |       |                                                                             |       | $                            | .97        |   |

 

***Note*****9. *RECENTPRONOUNCEMENTS***

 

*FIN 46 – Consolidation ofVariable Interest Entities*

 

InJanuary 2003, the FASB issued FIN 46, (revised in December 2003 as FIN46R) “Consolidationof Variable Interest Entities,” which clarifies the application of AccountingResearch Bulletin (“ARB”) 51, Consolidated Financial Statements, to certainentities (called variable interest entities) in which equity investors do nothave

 

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thecharacteristics of a controlling financial interest or do not have sufficientequity at risk for the entity to finance its activities without additionalsubordinated financial support from other parties. The disclosure requirementsof this Interpretation are effective for all financial statements issued afterJanuary 31, 2003. The consolidation requirements apply to all variable interestentities created after January 31, 2003. In addition, public companies mustapply the consolidation requirements to variable interest entities that existedprior to February 1, 2003 and remain in existence as of the beginning of annualor interim periods beginning after June 15, 2003. The adoption of FIN 46R hadno impact on the financial statements of the Company as the Company has novariable interests in variable interest entities.

 

*SFAS 150 - Accounting forCertain ‘Financial Instruments with Characteristics of Both Liabilities andEquity*

 

InMay 2003, SFAS No. 150 “Accounting for Certain Financial Instruments withCharacteristics of Both Liabilities and Equity,” was issued to establish newstandards for how an entity classifies and measures certain financialinstruments with characteristics of both liabilities and equity. It requiresthat an entity classify a financial instrument that is within its scope as aliability (or an asset in some circumstances). Many of these instruments werepreviously classified as equity. This statement was effective when issued forfinancial instruments entered into or modified after May 31, 2003, andotherwise is effective for calendar year public companies for the third quarterof 2003. The adoption of SFAS 150 had no impact on the financial statements ofthe Company.

 

*SFAS 132 - Employers’Disclosures about Pensions and Other Postretirement Benefits*

 

InDecember 2003, FASB Statement No. 132 (revised) was issued which prescribes therequired employers’ disclosures about pension plans and other postretirementbenefit plans; but it does not change the measurement or recognition of thoseplans. The Statement retains and revises the disclosure requirements containedin the original Statement 132. It also requires additional disclosures aboutthe assets, obligations, cash flows, and net periodic benefit cost of definedbenefit pension plans and other postretirement benefit plans. The Statementgenerally is effective for fiscal years ending after December 15, 2003. Sincethe Company does not have any types of pension plans or other postretirementbenefits, the adoption of this Statement did not have an effect on the Company’sfinancial statements.

 

*SFAS 123(R) ‘Share-Based Payments’*

 

InDecember 2004, the Financial Accounting Standards Board issued StatementNumber 123 (“FAS 123 (R)”), Share-Based Payments. FAS 123 (R) requires allentities to recognize compensation expense in an amount equal to the fair valueof shared-based payments such as stock options granted to employees. TheCompany will be required to apply FAS 123 (R) on a modified prospective method.Under this method, the Company is required to record compensation expense (asprevious awards continue to vest) for the unvested portion of previouslygranted awards that remain outstanding at the date of adoption. In addition,the Company may elect to adopt FAS 123 (R) by restating previously issuedfinancial statements, basing the amounts on the expense previously calculatedand reported in the pro forma disclosures that had been required by FAS 123.FAS 123 (R) is effective for the first reporting period beginning afterJune 15, 2005. The Company does not believe the impact of adopting thisStatement will be material as there are no unvested options and warrants atDecember 31, 2004.

 

*SFAS 153 - Exchanges of Non-monetary Assetsan Amendment of APB Opinion No. 29*

 

In December 2004, FASB Statement No. 153 wasissued amending APB Opinion No. 29 to eliminate the exception allowingnon-monetary exchanges of similar productive assets to be measured based on thecarrying value of the assets exchanged as opposed to at their fair values. Thisexception was replaced with a general exception for exchanges of non-monetaryassets that do not have commercial substance. A non-monetary

 

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exchange has commercial substance if thefuture cash flows of the entity are expected to change significantly as aresult of the exchange. The provisions of this statement are effective fornon-monetary asset exchanges occurring in fiscal periods beginning after theJune 15, 2005. The adoption of this statement did not have a material impact onthe Company’s financial statements.

 

*FIN- 45Guarantor’s Accounting and Disclosure Requirements for Guarantees, IncludingIndirect Guarantees of Indebtedness of Others*

 

InNovember 2002, the FASB issued FASB Interpretation (“FIN”) 45 “Guarantor’sAccounting and Disclosure Requirements for Guarantees, Including IndirectGuarantees of Indebtedness of Others,” which elaborates on the disclosures tobe made by a guarantor in its interim and annual financial statements about itsobligations under certain guarantees that it has issued. It also clarifies thata guarantor is required to recognize, at the inception of the guarantee, aliability for the fair value of the obligation undertaken in issuing theguarantee. The initial recognition and initial measurement provisions of thisInterpretation are applied prospectively to guarantees issued or modified afterDecember 31, 2002. The adoption of these recognition provisions will result inrecording liabilities associated with certain guarantees provided by us. Thedisclosure requirements of this Interpretation are effective for financialstatements of interim or annual periods ending after December 15, 2002. FIN 45has no impact on the Company’s financial statements

 

***Note 10. SUBSEQUENT EVENTS***

 

Eventsthat have occurred since December 31, 2005 include the following:

 

On March 1, 2006, Power3 Medical Products,Inc. (“the Company” or “Power3”) executed a promissory note in the principalamount of $80,000 payable to Steven B. Rash, CEO of Power3 (“the Payee”.)  Under the terms of the note, the principalamount of Eighty thousand dollars ($80,000.00), the (“Principal”) shall be dueand payable on or before September 1, 2006 (the “Maturity Date”). Should thePrincipal not be repaid as of September 1, 2006, interest of 6% per year on anyunpaid Principal amount will be earned by the Payee until such time as all ofthe Principal amount is repaid. This Note may be repaid at any time prior toSeptember 1, 2006, without interest or penalty.

 

On March 1, 2006, Power3 Medical Products,Inc. executed a promissory note in the principal amount of $50,000 payable toDr. Ira L. Goldknopf, the Chief Scientific Officer of Power3 (“the Payee”). Underthe terms of the note, the principal amount of Fifty thousand dollars($50,000), “the Principal”) shall be due and payable on or before September 1,2006 (the “Maturity Date”). Should the Principal not be repaid as of September1, 2006, interest of 6% per year on any unpaid Principal amount will be earnedby the Payee until such time as all of the Principal amount is repaid. ThisNote may be repaid at any time prior to September 1, 2006, without interest orpenalty.

 

On January 5, 2006, Power3 Medical Products,Inc. executed an Agreement with Glocap Advisors LLC (“Glocap”) wherein theCompany engaged Glocap to act as financial advisors and provide the Companywith financial advice and strategic consulting services. The Company agreed toprovide Glocap with a Retainer equal to $30,000 in free-trading common stock ofthe Company upon the signing of the engagement letter. In confirmation of thisagreement, the Company issued 226,415 shares of common stock to Glocap, as S-8shares issued under its 2004 Stock Compensation Plan. In addition, the Companyagreed to compensate Glocap Advisors with a cash success fee based on capitalinput secured by Glocap based upon an agreed-upon formula, but completelydependent on success and not payable to Glocap unless capital is actuallyinvested in the Company by an outside investor sourced by Glocap.

 

On January 3, 2006, Power3 Medical Products,Inc. executed an Agreement with Stonemill Consulting Company (“Stonemill”)wherein the Company engaged Stonemill to find and bring in investor capitalfrom a

 

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thirdparty investor. The Company agreed to provide Stonemill with 50,000 shares ofcommon stock of Power3, together with warrants to purchase up to 500,000 sharesof the Company’s common stock with an exercise price of $0.18 per share. Thewarrants will be exercisable for a period of five years from January 3, 2006. TheCompany issued 50,000 shares of common stock to Stonemill as S-8 stock issuedunder its 2004 Stock Compensation Plan. In February, Power3 issued anadditional 71,428 shares to Stonemill for services.

 

On February 9, 2006, Power3 Medical Products,Inc. executed an Agreement with The Kaminer Group wherein the Company engagedThe Kaminer Group to create and implement programs designed to generateawareness, credibility, media coverage and interest from strategic partners andinvestors. The Agreement covers a 12-month period commencing January 1, 2006through December 31, 2006 and may be terminated by either rparty by a one-monthwritten notice to terminate. As compensation for the above-described services,the Company agreed to a monthly retainer fee of $3,000 in cash. In addition theKaminer Group will receive the equivalent of $2,000 in options per month topurchase Power3 common shares at the average daily closing market price forshare during the previous month. In addition, Power3 will be billed forexpenses incurred on its behalf at the close of each month during the Agreement.

 

On February 17, 2006, Power3 received noticefrom UT MD Anderson Cancer Center confirming that the License Agreementsbetween Power3 and UT MD Anderson Cancer Center were terminated under Section13.3 of the License Agreement for breach of certain payment obligations asoutlined in the License Agreement. The letter further described maintenancefees, license documentation fees and patent costs due to UT MD Anderson in theamounts of $46,945.62, prior to the termination date. In addition, the letterstated that Power3 was obligated to grant UT MD Anderson a nonexclusiveroyalty-bearing license to improvements made by Power3 and asked the Company toimmediately disclose those improvements so that UT MD Anderson could considerwhether it wished to license them.

 

On January 6, 2006, Power3 sold 500,000shares of S-8 common stock to Congregation Beth Joseph in exchange for cash.

 

In January and February, 2006, Power3 issued370,000 shares of common stock to a law firm for services, under the 2004 StockCompensation Plan.

 

In January, 2006, Power3 issued 864,911shares of common stock to its employees for services, under the 2004 StockCompensation Plan.

 

In February, 2006, Power3 sold 1,114,286shares of common stock to 4 individuals and to Congregation Beth Joseph andCongregation Beth Shmiel.

 

In February, 2006, Power3 issued anadditional 201,539 shares of common stock to its employees for services, underthe 2004 Stock Compensation Plan.

 

In March, 2005, Power3 sold an additional800,000 shares of S-8 stock to 6 individuals for working capital.

 

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***Item 8. Controls and Procedures***

 

*DisclosureControls and Procedures*

* *

Under the supervision and with the participation ofthe Company’s management, including its Chief Executive Officer and ChiefFinancial Officer, the Company conducted an evaluation of its disclosurecontrols and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of theExchange Act). Based on this evaluation and for the reasons set forth below,the Chief Executive Officer and Chief Financial Officer concluded that theCompany’s disclosure controls and procedures were ineffective as of December31, 2005, the end of the period covered by this annual report.

 

As reported in the Company’s Quarterly Reports on Form10-QSB for the quarterly periods ended September 30, 2004 and March 31, 2005,the Company identified certain deficiencies which caused management to concludethat the Company’s disclosure controls were ineffective as of September 30, 2004.The Company has undertaken steps and implemented actions as disclosed in itsprevious Form 10-QSB’s in an effort to resolve these deficiencies. While theactions identified in the previously filed Form 10-QSB’s and the actionsidentified below have addressed many of these deficiencies, the Companycontinued to have deficiencies with respect to its disclosure controls andprocedures at December 31, 2005 including the following:

 

Althoughthe Company has hired accounting personnel as reported in its previous Form 10-QSB,the Company’s limited financing and available capital have restricted theCompany’s ability to fully implement its procedures for the improvement of itsinternal control over financial reporting and to engage outside professionalsand advisors to the extent the Company has desired to support the Company’saccounting personnel in the preparation and/or audit of financial statementsand reports to be filed with the SEC.

 

The Company continues to believe that the deficienciesare attributable to many factors including issues relating to the quality ofthe Company’s disclosure controls and procedures at the time of the AdvancedBio/Chem transaction and the transition following the transaction. Managementis committed to a sound disclosure control and internal control environment andis continuing its efforts to improve the Company’s infrastructure, personnel,processes and controls to help ensure that the Company is able to produceaccurate financial statements on a timely basis.

 

In addition, during the past year, Power3 facedstaffing issues relative to its cash flow situation. The Company has retainedoutside consultants, on an interim basis, to provide accounting and legalexpertise

 

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directed toward improving its reporting and control procedures. TheCompany has implemented additional controls over its daily operations and hasdrafted various Internal Controls memoranda.

 

Limitations on Effectiveness of Controls

 

Internal control over financial reporting cannotprovide absolute assurance of achieveing financial reporting objectives becauseof its inherent limitations. Internal control over financial reporting is aprocess that involves human diligence and compliance and is subject to lapsesin judgement and breakdowns resulting from human failures. Internal controlover financial reporting also can be circumvented by collusion or impropermanagement override. Because of such limitations, there is a risk that materialmisstatements may not be prevented or detected on a timely basis by internalcontrol over financial reporting. However, these inherent limitations are knownfeatures of the financial reporting process. Therefore, it is possible todesign into the process, safeguards to reduce, though not eliminate, this risk.

 

*Changesin Internal Control Over Financial Reporting*

* *

As previously disclosed in the Company’s QuarterlyReport on Form 10-QSB for the quarterly period ending September 30, 2004, theCompany implemented several actions during the third quarter of 2004 in aneffort to improve its internal control over financial reporting. During thefourth quarter of 2004, the Company continued the implementation of morerigorous policies with respect to its disclosure and financial reporting reviewprocess including improvements of its infrastructure and processes to improveits internal control over financial reporting. The Company also is continuingits implementation of procedures to improve its review and processing ofnon-accounting documentation and contracts.

 

During 2005, the Company changed its auditing firm andimplemented additional internal controls over documents and accounting that aredesigned to improve its reporting. Further, in mid-summer of 2005, Power3changed its auditing firm to further improve its financial reporting.

 

Other than the changes described above, there were nochanges in the Company’s internal control over financial reporting thatoccurred during the Company’s fiscal quarter ended December 31, 2005 that havematerially affected, or are reasonably likely to materially affect, the Company’sinternal controls over financial reporting.

 

***Item 9. CHANGES IN ACCOUNTANTS AND FINANCIALDISCLOSURE***

 

On July 28, 2005, themanagement of Power3 Medical Products, Inc. (“the Company”) decided upon achange in its independent public accounting firm and confirmed that the Companywould no longer engage Kingery & Crouse, P.A. as its independent publicaccounting firm. On that same date, the Company engaged the services of John A.Braden & Company, PC, as its independent public accounting firm for itsfiscal year ending December 31, 2004. The Company’s Board of Directorsauthorized the engagement of John A. Braden & Company, PC as the Company’sindependent public accounting firm.

 

Theaudit report of Kingery & Crouse on the Company’s financial statements asof and for the fiscal year ended December 31, 2003 did not contain any adverseopinion or disclaimer of opinion, nor was it qualified or modified as touncertainty, audit scope or accounting principles, but did containmodifications as to the Registrant’s ability to continue as a going concern. Fromthe date of Kingery & Crouse’s appointment through the date of theirdismissal on July 28, 2005, there were no disagreements between the Company andKingery & Crouse, P.A. on any matter listed under Item 304, Section (a) (1)(iv) A to E of Regulation S-B, including accounting principles or practices,financial statement disclosure or auditing scope or procedure which, if notresolved to the satisfaction of Kingery & Crouse, P.A. would have causedthem to make reference to the matter in its reports on the Company’s financialstatements.

 

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Indeciding to select John A. Braden & Company, the Board of Directors ofPower3 reviewed auditor independence issues and existing commercialrelationships with John A. Braden & Company and concluded that John A.Braden & Company has no commercial relationship with the Company that wouldimpair its independence.

 

Duringthe two most recent fiscal years ended December 31, 2003 and December 31, 2004,and the subsequent interim period through July 28, 2005, the Company did notconsult with John A. Braden & Company, PC, regarding any of the matters orevents set forth in Item 304(a)(2)(i) and (ii) of Regulation S-K.

 

**PART III**

 

***Item 10. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERSAND CONTROL PERSONS; COMPLIANCE WITH SECTION (16a) OF THE EXCHANGE ACT***

 

**Directors, ExecutiveOfficers, Promoters and Control Persons**

 

Set forth below is certain information concerning eachof the Company’s directors, executive officers and significant employees. Alldirectors of the Company hold office until the next annual meeting ofshareholders or until their successors have been elected and qualified. Theofficers of the Company are appointed by the board of directors and hold officeuntil their death, resignation or removal from office. The Company’s directors,executive officers, significant employees, and their ages, positions held andduration as such are as follows:

 
| **Name**          | ** ** | **Position  Held  with the Company**   | ** ** | **Age**    | ** ** | **Date  First Elected  or Appointed** | ** ** |
|-------------------|------------|----------------------------------------|------------|------------|------------|---------------------------------------|------------|
| ** **        | ** ** | ** **                             | ** ** | ** ** | ** ** | ** **                            | ** ** |
| Steven  B. Rash   |       | Chief  Executive Officer and Director  |       | 58         |       | May  18, 2004                         |       |
| Ira  L. Goldknopf |       | Chief  Scientific Officer and Director |       | 60         |       | May  18, 2004                         |       |
| Brian  R. Folsom  |       | Director  of Laboratory Operations     |       | 49         |       | July  12, 2004                        |       |
| John  P. Burton   |       | Chief  Financial Officer               |       | 60         |       | June 3, 2005                          |       |

 

Certain additional information concerning theindividuals named above is set forth below. This information is based oninformation furnished by each director, executive officer and significantemployee.

 

Steven B. Rash joined the Company in May 2004 asChairman of the Board of Directors and Chief Executive Officer. Mr. Rash wasChairman of the Board of Directors and Chief Executive Officer of AdvancedBio/Chem, Inc. from September 2003 to May 2004. Prior to that time he was anindependent consultant from February 2003 until September 2003. In April 2001,Mr. Rash was employed as a consultant to Global Water Technologies, Inc. andwas hired as President and interim CFO of the company in January 2002 andretained that position until February 2003. From April 2000 until April 2001,he was an independent consultant. From June 1995 until March 2000, Mr. Rash wasemployed as President and CEO of American Biomed, Inc., a publicly tradedmedical device company. Mr. Rash has a B.S. in Business Administration from theUniversity of Delaware and an M.B.A. from Southern Illinois University.

 

Ira L. Goldknopf, Ph.D. joined the Company in May 2004as Chief Scientific Officer and Director. From August 2000 until May 2004, Dr.Goldknopf was Chief Scientific Officer of Advanced Bio/Chem, which heco-founded in 2000. From August 1997 until August 2000, Dr. Goldknopf was abiotechnology consultant. Dr. Goldknopf has a B.A. in Chemistry from HunterCollege and a Ph.D. in Biochemistry from Kansas State

 

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University. Dr. Goldknopf spent ten years on the faculty of BaylorCollege of Medicine and is the author of over 70 publications and a principalinventor of the Company’s intellectual property. Dr. Goldknopf also serves onthe Company’s Scientific Advisory Board.

 

On June 3, 2005, John P. Burton was named Chief Accounting Officer andController of the Company. On September 15, 2005, the Company executed anEmployment Agreement with Mr. Burton, effective September 1, 2005. TheEmployment Agreement named Mr. Burton as Chief Financial Officer of the Companyand granted Mr. Burton 140,000 shares of restricted common stock. Prior tojoining the Company, Mr. Burton was employed at Affiniscape, Inc. where heserved as Chief Financial Officer from December, 2003 until August, 2004. FromDecember, 1999 to March, 2003, he was employed at Bob Johnson & Associates,Inc. as Controller. Mr. Burton has a BBA and MBA from The University of Texasat Austin.

 

Brian R. Folsom, Ph.D. joined the Company on July 12,2004 as Director of Laboratory Operations. From January 2001 to July 2003, hewas a Staff Engineer at Diosynth-RTP. From July 2003 until July 2004 he was anindependent consultant. From March 1995 until January 2001, he was the Manager,Process Development for Enchira Biotechnology Corporation. In his priorpositions, Dr. Folsom has been responsible for the management of laboratoriesinvolved in the development of biotechnological intellectual property over thepast ten years. Dr. Folsom has a B.A. in Chemistry from MacAlester College anda Ph.D. in Biochemistry from Washington State University. Dr. Folsom is theauthor of 15 scientific publications and holds two patents.

 

There are no family relationships among any of thedirectors or executive officers of the Company. Except as disclosed below withrespect to the amended and restated employment agreements of Messrs. Rash,Goldknopf and Rosinski, no arrangement or understanding exists between anydirector or executive officer and any other person pursuant to which anydirector or executive officer was elected to serve.

 

Mr. Rash has many years of experience in corporatereorganizations, finance and new business development. Mr. Rash was hired byAmerican Biomed, Inc. in June 1995 to assist in the reorganization andturnaround of the company. Mr. Rash remained with American Biomed until March2000 as president and CEO during which time the company was restructured. InJuly 2000, approximately four (4) months after Mr. Rash’s departure, AmericanBiomed filed for Chapter 7 bankruptcy proceedings. Mr. Rash was initiallyretained as a consultant in April 2001 to assist Global Water Technologies,Inc. and its Chairman/CEO in formulating a turnaround strategy for the company.Mr. Rash was subsequently employed as president and interim CFO in January 2002.Global Water was declared in default of its bank loan in January 2003 and soldits operating division in February 2003. Mr. Rash resigned in February 2003and, in May 2003, Global Water filed for Chapter 11 bankruptcy proceedings.

 

Except as described above with respect to Mr. Rash,none of the Company’s directors, executive officers, promoters or controlpersons have been involved in any of the following events during the past fiveyears:

 

•      anybankruptcy petition filed by or against any business of which such person was ageneral partner or executive officer either at the time of the bankruptcy orwithin two years prior to that time;

 

•      anyconviction in a criminal proceeding or being subject to a pending criminalproceeding (excluding traffic violations and other minor offenses);

 

•      beingsubject to any order, judgment or decree, not subsequently reversed, suspendedor vacated, of any court of competent jurisdiction, permanently or temporarilyenjoining, barring, suspending or otherwise limiting his involvement in anytype of business, securities or banking activities; or

 

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•      beingfound by a court of competent jurisdiction (in a civil action), the SEC or theCommodity Futures Trading Commission to have violated a federal or statesecurities or commodities law, and the judgment has not been reversed,suspended or vacated.

 

The board of directors has not established an auditcommittee or any committee performing similar functions. Consequently, theCompany does not have an audit committee financial expert as defined in Item401(3) of Regulation S-B. Management believes that in light of the Company’scurrent size and its status as a company with no operations, the establishmentof an audit committee and the retention of an audit committee financial expertis not necessary at this time and is cost-prohibitive. The Company also doesnot have a standing nominating committee of its board of directors or anycommittee performing a similar function.

 

**Scientific AdvisoryBoard**

 

The Company’s Scientific Advisory Board provides assistancein the research and development of the Company’s products. Unlike members ofthe Company’s Board of Directors, members of the Scientific Advisory Board,other than Dr. Goldknopf, are not involved in the management or operations ofthe Company. The members of the Scientific Advisory Board are as follows:

 

Dr. Stanley H. Appel, M. D. is Professor and Chair ofNeurology at the Methodist Hospital Neurological Institute,  Professor of Neurology at Baylor College ofMedicine, Director of the Vicki Appel MDA/ALS Clinic, and past-Director of theAlzheimer’s Disease Research Center at Baylor College of Medicine in Houston,Texas. He also serves as the Director of the Jerry Lewis Neuromuscular ResearchCenter. Dr. Appel is a leading authority on degenerative neurological diseases,such as Parkinson’s, Alzheimer’s and ALS. Specifically, Dr. Appel focuses onthe importance of neurotrophic factors and immune mechanisms, including therole of inflammatory cytokines in these diseases. He has served as an AdvisoryBoard member of the Alzheimer’s Disease and Related Disorders Association andas a Council member of the American Society of Neurochemistry.

 

Dr. Zouhair Atassi, Ph. D. is the current Robert A.Welch Chair of Chemistry and the Professor of Biochemistry and MolecularBiology at Baylor College of Medicine, Houston, Texas. After completing hisPh.D. in Chemistry, University of Birmingham, England, Dr. Atassi started hiscareer in 1960 as Postdoctoral Research Fellow in Chemistry at the Universityof Birmingham. Dr. Atassi was the 2003 President of the Institute ofImmunobiology and he is the current Editor-in-Chief for The Protein Journal,Protein Reviews and Critical Reviews in Immunology. Dr. Atassi has published 14books and several volumes in Immunochemistry of Proteins and Immunobiology ofProteins and Peptides. He has given more than 150 lectures in national andinternational conferences and more than 180 invited seminars in U.S. andforeign universities and research institutions. In addition Dr. Atassi has morethan several hundred scientific publications and has been awarded five UnitedStates patents between 1996 and 2000.

 

Dr. Ira L. Goldknopf, Ph. D. began his scientificcareer over 30 years ago, pioneering the field that is now known as Proteomics.More than a decade before the start of the Human Genome Project, Dr. Goldknopfmade the earliest proteomic discovery at Baylor College of Medicine with HarrisBusch, the isolation, identification, and sequencing of a new protein from atwo-dimensional gel, Protein A24. During the course of these investigations, hediscovered that protein A24 was the first known conjugate of two very importantproteins, Histone H2A, a part of the subunit structure that packages DNA in thecell nucleus, and Ubiquitin. Through the work of Dr. Goldknopf and many others(over 9,000 publications in the ensuing years) – including Drs. Avram Hershko,Aaron Ciechanover, and Alex Varshavsky, who shared the 2000 Lasker Award fortheir achievements – the Ubiquitin Conjugation System is now known to play amajor role in the management of the inventories of proteins in the cell, cellproliferation, programmed cell death, and most if not all major regulatoryfunctions in health and disease at the cellular level.

 

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Dr. Thomas E. Watts, M. D. received his M.D. in 1975from Baylor College of Medicine. Dr. Watts is board certified, from AmericanBoard of Family Practice since 1972 and practiced medicine at Blue EarthMedical Center in Minnesota from 1975 to 1996 and is now practicing at theKelsey-Seybold Clinic, The Woodlands, Texas. As a physician with more than 30years of practice experience, Dr. Watts provides the Company with insights fromthe perspective of the end user of the Company’s products.

 

Dr. Alan B. Hollingsworth, M. D. received his M.D.with Distinction from the University of Oklahoma College of Medicine in 1975where he served as First Vice-President of Alpha Omega Alpha Honor MedicalSociety. In addition to his general surgery residency at the University ofOklahoma, he completed a one-year fellowship in surgical pathology at U.C.L.A. Inthe 1980s, he joined the first wave of surgeons who chose to limit theirpractices to breast cancer. He was the Founding Medical Director of the Universityof Oklahoma Institute for Breast Health in 1993 where he held the G. RaineyWilliams Chair of Surgical Breast Oncology. Currently, he serves as MedicalDirector of Mercy Women’s Center (Mercy Health Center, Oklahoma City) andMedical Director, Breast MRI of Oklahoma. His interest in breast cancer riskassessment led to the publication of the first lay book on the subject, TheTruth About Breast Cancer Risk Assessment, and he served as lead author for themulti-institutional consensus paper published in the American Journal ofSurgery by the national breast cancer risk assessment working group.

 

**Section 16(a) BeneficialOwnership Reporting Compliance**

 

Section 16(a) of the Exchange Act requires the Company’sdirectors, executive officers, and the persons who beneficially own more thanten percent (10%) of the Company’s common stock to file reports of ownershipand changes in ownership with the SEC. Copies of all filed reports are requiredto be furnished to the Company. Based solely on the reports received by theCompany and on representations of the reporting persons, the Company determinedthat there were a number of transactions that were not timely reported. Withrespect to its current directors, executive officers, and persons beneficiallyowning more than ten percent (10%) of the Company’s common stock, the Companyundertook to file forms throughout the year. The Company has implemented newprocedures to ensure improved compliance with the reporting requirements on anon-going basis. To the Company’s knowledge, based solely on its review of thereports received and on representations of the reporting persons, the Companybelieves that these persons have complied with all applicable filingrequirements during the fiscal year ended December 31, 2004, except:  (i) Mr. Rash did not timely file a Form 3which was subsequently filed with the SEC; (ii) Dr. Goldknopf did not timelyfile a Form 3 which was subsequently filed with the SEC; (iii) Mr. Rosinski didnot timely file a Form 3 and Form 4, each of which was subsequently filed withthe SEC; (iv) Advanced Bio/Chem, Inc. did not timely file a Form 3 which wassubsequently filed with the SEC; (v) Mr. Behzadi, a former executive officer ofthe Company, did not timely file a Form 3 which was subsequently filed with theSEC; and (vi) Mr. Novak, a former executive officer and director of theCompany, reported several transactions on five Form 5s rather than on Form 4after he was no longer an executive officer or director of the Company and hasnot corrected such filings.

 

**Code of Ethics**

 

The Company has adopted a code of ethics applicable toits principal executive officer and principal financial officer, a copy ofwhich is filed with this Annual Report.

 

***Item 11. EXECUTIVE COMPENSATION***

 

The following table sets forth information concerningthe compensation for services in all capacities rendered to us for the threefiscal years ended December 31, 2005, of our Chief Executive Officer and ourother executive officers:

 

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**Summary Compensation Table**

 
| ** **                                     | ** ** | ** ** | ** ** | **Annual**          | ** ** | **Long Term Compensation** | ** ** | ** **                              | ** ** |
|------------------------------------------------|------------|------------|------------|---------------------|------------|--------------------------------------|------------|-----------------------------------------|------------|
| ** **                                     | ** ** | ** ** | ** ** | **Compensation(1)** | ** ** | **Awards**                           | ** ** | ** **                              | ** ** |
| **Name and Principal Position** | ** ** | **Year**   | ** ** | **Salary  ($)**     | ** ** | **Bonus  ($)**                       | ** ** | **Restricted  Stock  Award(s)(2)  ($)** | ** ** | **Securities  Underlying  Options/SARs  (#)** | ** ** | **All Other  Compensation** | ** ** |
| Steven B.  Rash, Chairman of the               |       | 2005       |       | 248,426             |       | 0                                    |       | 0                                       |       | 0 |   | 0 |   |
| Board and  Chief Executive                     |       | 2004       |       | 190,623             |       | 0                                    |       | 11,925,000                              | (4)        |   |   | 0 |   |
| Officer(3)                                     |       |       |       |                |       |                                 |       |                                    |       |   |   |   |   |
|                                           |       |       |       |                |       |                                 |       |                                    |       |   |   |   |   |
| Ira L.  Goldknopf, Chief Scientific Officer(6) |       | 2005       |       | 78,948              |       | 0                                    |       | 0                                       |       | 0 |   | 0 |   |
|                                           |       | 2004       |       | 96,214              |       |                                 |       | 11,925,000                              | (7)        | 0 |   | 0 |   |
|                                           |       |       |       |                |       |                                 |       |                                    |       |   |   |   |   |
| John P. Burton, Chief Financial Officer        |       | 2005       |       | 57,138              |       | 0                                    |       | 42,000                                  |       | 0 |   | 0 |   |
|                                           |       |       |       |                |       |                                 |       |                                    |       |   |   |   |   |
| Michael J.  Rosinski, Chief                    |       | 2004       |       | 60,000              |       | 0                                    |       | 483,000                                 | (8)        | 0 |   | 0 |   |
| Financial  Officer(8)                          |       |       |       |                |       |                                 |       | (483,000)                               | (9)        |   |   |   |   |
|                                           |       |       |       |                |       |                                 |       |                                    |       |   |   |   |   |
| Timothy S.  Novak, Former                      |       | 2004       |       | 13,706              |       | 0                                    |       | 0                                       |       | 0 |   | 0 |   |
| Chairman of  the Board and Chief               |       | 2003       |       | 157,500             | (11)       | 0                                    |       | 0                                       |       | 0 |   | 0 |   |
| Executive  Officer  (10)                  |       | 2002       |       | 139,000             |       | 0                                    |       | 0                                       |       | 0 |   | 0 |   |
|                                           |       |       |       |                |       |                                 |       |                                    |       |   |   |   |   |
| R. Paul  Gray, Former Chief                    |       | 2004       |       | 4,960               |       | 0                                    |       | 0                                       |       | 0 |   | 0 |   |
| Financial  Officer, Secretary and              |       | 2003       |       | 157,500             | (11)       | 0                                    |       | 0                                       |       | 0 |   | 0 |   |
| Treasurer(10)                                  |       | 2002       |       | 87,500              |       | 0                                    |       | 0                                       |       | 0 |   | 0 |   |

 

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(1)   Other annualcompensation provided to the named executive officers did not exceed theapplicable disclosure requirements.

(2)   At December 31,2004 the aggregate number and value of all restricted shares held by each ofthe named executive officers was as follows: Rash – 13,250,000 restricted shares, $12,190,000 value; Goldknopf –13,250,000 restricted shares, $12,190,000 value; and Rosinski – 140,000restricted shares, $128,800 value. The values are based on the closing price of$0.90 of the Company’s common stock on May 18, 2004. Although the Company doesnot expect to pay dividends on its common stock, any dividends which may bepaid on its common stock will not be paid on the restricted stock unless anduntil such time as the restricted stock becomes nonforfeitable.

(3)   Mr. Rash joinedthe Company in May 2004 with the completion of the acquisition of assets fromAdvanced Bio/Chem. Mr. Rash was the Chairman of the Board and Chief ExecutiveOfficer of Advanced Bio/Chem. Mr. Rash has entered into an employment agreementwith the Company which is described below.

(4)   Pursuant to Mr.Rash’s employment agreement, he was awarded 13,250,000 shares of restrictedcommon stock. The value is based upon a closing price of $0.90 of the Company’scommon stock on May 18, 2004. All of the shares are restricted stock and shallvest on May 18, 2006 if Mr. Rash continues to be employed by the Company onsuch date. In addition, Mr. Rash is entitled to receive 1,500,000 shares ofrestricted Series B preferred stock to be designated by the Company.

(5)   In 2003, Mr.Rash was granted by Advanced Bio/Chem pursuant to his employment agreement825,000 shares of Advanced Bio/Chem’s common stock and the option to purchase200,000 shares of common stock at $0.80 per share. At the time the 825,000shares were granted, the fair market value of such stock was $0.80 per sharefor a total of $660,000. Mr. Rash continues to hold such shares and the valueof such restricted stock holdings at December 31, 2004 was $206,250. Advanced Bio/Chem

 

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was to enterinto an option agreement with Mr. Rash; however, no such option agreement hasbeen executed nor is it expected since Mr. Rash is no longer an officer ofAdvanced Bio/Chem.

(6)   Dr. Goldknopfjoined the Company in May 2004 with the completion of the acquisition of theassets of Advanced Bio/Chem. Dr. Goldknopf was the Chief Scientific Officer ofAdvanced Bio/Chem. Dr. Goldknopf has entered into an employment agreement withthe Company described below.

(7)   Pursuant to Dr.Goldknopf’s employment agreement, he was awarded 13,250,000 shares ofrestricted common stock. The value is based upon a closing price of $0.90 ofthe Company’s common stock on May 18, 2004. All of the shares are restrictedstock and shall vest on May 18, 2006 if Dr. Goldknopf continues to be employedby the Company on such date. In addition, Dr. Goldknopf is entitled to receive1,500,000 shares of restricted Series B preferred stock to be designated by theCompany.

(8)   Mr. Rosinskijoined the Company on a full-time basis in July 2004.

(9)   Pursuant to Mr.Rosinski’s employment agreement, he was awarded 140,000 shares of restrictedcommon stock. The value is based upon a closing price of $3.45 of the Company’scommon stock on July 2, 2004. On June 3, 2005, Mr. Rosinski resigned and terminatedhis employment with the Company. Therefore, according to his EmploymentAgreement, his shares were returned to the Company.

(10)Timothy S. Novakand R. Paul Gray each resigned from their respective positions with Power3Medical at the time of the Company’s acquisition of the assets of AdvancedBio/Chem in May 2004. Messrs. Novak and Gray continue to be the president, andsecretary/treasurer, respectively, of Tenthgate.

(11)On March 31,2003, each of Messrs. Novak and Gray were issued 1,330,000 shares of Series APreferred Stock in consideration of accrued and unpaid salary. At the time ofsuch issuance, the Series A Preferred Stock issued to each had a value of$100,000 which is reflected in the salary figure for 2003.

 

**Director Compensation**

 

Mr. Rash and Dr. Goldknopf are the Company’s directorsat this time. Except for the compensation to which each is entitled pursuant tothe terms of their respective employment agreements, neither Mr. Rash nor Dr.Goldknopf receive any further compensation for service as directors. TheCompany has no formal plan for compensating outside directors at this time. However,at such time as the Company has outside directors, the Company expects tocompensate its outside directors and to reimburse them for reasonable traveland other out-of-pocket expenses incurred in connection with the attendance atmeetings.

 

**Option Grants in LastFiscal Year**

 

No options were granted to the above named officers in2004 or 2005.

 

**Employment Agreements**

 

The Company has entered into an amended and restatedemployment agreement with Mr. Rash. The employment agreement is effective as ofMay 18, 2004 and has an initial term of five years, subject to each party’stermination rights. The agreement provides for a base salary of $250,000 peryear and the opportunity to receive cash bonuses based on performance upon thediscretion of the Company’s board of directors. The agreement also includesparticipation in employee benefit plans offered by the Company to itsemployees, as well as a grant of 13,250,000 shares of restricted common stockand 1,500,000 shares of restricted Series B preferred stock. The agreementcontains a covenant not to compete with the Company during the period ofemployment and for a period of two years following the termination orexpiration of his employment. The employment agreement also contains anon-disclosure and non-use of proprietary information clause and anon-interference clause covering the period of employment and for a period offive (5) years thereafter. Either party may terminate Mr. Rash’s employmentunder the contract, either with or without cause upon giving the other party atleast thirty days notice. If the Company terminates Mr. Rash’s employment atany time during the initial term without cause, Mr. Rash will be entitled toreceive compensation provided under the agreement for the remaining initialterm of employment. In addition, in the event of a change in control as definedin the

 

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agreement, the Company may waive, in whole or in part, any and allremaining restrictions on the restricted shares of common stock and Series Bpreferred stock granted to Mr. Rash.

 

The Company has entered into an amended and restatedemployment agreement with Dr. Goldknopf. The employment agreement is effectiveas of May 18, 2004 and has an initial term of five years, subject to each party’stermination rights. The agreement provides for a base salary of $125,000 peryear through December 18, 2004 and $100,000 per year thereafter, with anopportunity to receive cash bonuses based on performance upon the discretion ofthe Company’s board of directors. The agreement also includes participation inemployee benefit plans offered by the Company to its employees, as well as agrant of 13,250,000 shares of restricted common stock and 1,500,000 shares ofrestricted Series B preferred stock. The agreement contains a covenant not tocompete with the Company during the period of employment and for a period oftwo years following the termination or expiration of his employment. Theemployment agreement also contains a non-disclosure and non-use of proprietaryinformation clause and a non-interference clause covering the period ofemployment and for a period of five (5) years thereafter. Either party mayterminate Dr. Goldknopf’s employment under the contract, either with or withoutcause upon giving the other party at least thirty days notice. If the Companyterminates Dr. Goldknopf’s employment at any time during the initial termwithout cause, Dr. Goldknopf will be entitled to receive compensation providedunder the agreement for the remaining initial term of employment. In addition,in the event of a change in control as defined in the agreement, the Companymay waive, in whole or in part, any and all remaining restrictions on therestricted shares of common stock and Series B preferred stock granted to Dr.Goldknopf.

 

The Company entered into an employment agreement withMr. Burton. The employment agreement is effective as of September 1, 2005 andhas an initial term of three years, subject to each party’s termination rights.The agreement provides for a base salary of $100,000 per year and theopportunity to receive cash bonuses based on performance upon the discretion ofthe Company’s board of directors. The agreement also includes participation inemployee benefit plans offered by the Company to its employees, as well as agrant of 140,000 shares of restricted common stock. The agreement contains acovenant not to compete with the Company during the period of employment andfor a period of two (2) years following the termination or expiration of hisemployment. The employment agreement also contains a non-disclosure and non-useof proprietary information clause and a non-interference clause covering theperiod of employment and for a period of five (5) years thereafter. Eitherparty may terminate Mr. Burton’s employment under the contract, either with orwithout cause upon giving the other party at least thirty days notice. If theCompany terminates Mr. Burton’s employment at any time during the initial termwithout cause, Mr. Burton will be entitled to receive compensation providedunder the agreement for the remaining initial term of employment. In addition,in the event of a change in control as defined in the agreement, the Companywill waive, in whole or in part, any and all remaining restrictions on therestricted shares of common stock granted to Mr. Burton.

 

On June 3, 2005, Mr. Rosinski, then Chief FinancialOfficer of the Company, resigned and terminated his employment at the Companyas of that date. In accordance with his resignation, the employment agreementwith Mr. Rosinski terminated, on June 3, 2005, and the stock grant of 140,000shares of Restricted Stock to Mr. Rosinski is terminated. Mr. Rosinski hasreturned his stock shares in accordance with this forfeiture.

 

**Item12. Security Ownership of Certain Beneficial Owners and Management and RelatedStockholder’s Matters**

 

**SECURITYOWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT**

 

The following table sets forth information as ofDecember 31, 2005, the most recent practicable date, regarding beneficialownership of the Company’s common stock by the following persons:  (i) each person who is known to the Companyto beneficially own more than 5% of the outstanding shares of common stock;

 

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(ii) each of the Company’s directors; (iii) each of the Company’sexecutive officers named in the executive compensation table; and (iv) all of theCompany’s directors and executive officers as a group. There has been no changeto any of the amounts reported in the table below, as of the date of filingthis report.

 

Unless otherwise indicated below, to the Company’sknowledge, all persons listed below have sole voting and investment power withrespect to their shares of common stock, except to the extent authority isshared by spouses under applicable law. Beneficial ownership is determined inaccordance with the rules of the SEC based on factors including voting andinvestment power with respect to shares, subject to applicable communityproperty laws. Shares of common stock subject to options or warrantsexercisable within 60 days of December 31, 2005, are deemed outstanding for thepurpose of computing the percentage ownership of the person holding suchoptions or warrants, but are not deemed outstanding for computing thepercentage ownership of any other person.

 
| **Name of Beneficial Owner**                                                                                                     | ** ** | **Number of Shares of  Common Stock** | ** ** | **Percent of Class** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------|------------|--------------------------------|------------|
| Industrial  Enterprises of America, Inc.  (formerly known as Advanced Bio/Chem, Inc.)  770 South Post Oak Lane, Suite 330  Houston, Texas 77056 |       | 14,346,549                                                |       | 21.68                          | %          |
| Steven B.  Rash  3400 Research Forest Dr., Suite B2-3  The Woodlands, Texas 77381                                                               |       | 9,039,647                                                 |       | 13.66                          | %          |
| Trinity  Financing Investments  300 East 55th St Apt 14D  New York, NY 10022                                                                    |       | 5,000,000                                                 |       | 7.56                           | %          |
| Ira L.  Goldknopf  3400 Research Forest Dr., Suite B2-3  The Woodlands, Texas 77381                                                             |       | 4,946,549                                                 |       | 7.48                           | %          |
| John P.  Burton  3400 Research Forest Dr., Suite B2-3  The Woodlands, Texas 77381                                                               |       | 140,000                                                   |       | *                              |       |
| All current  directors and executive officers as a group (3 persons)                                                                            |       | 14,126,196                                                |       | 21.34                          | %          |

 

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*Indicates less than one percent.

 

**Changes of Control**

 

In addition to the shares of the Company’s commonstock beneficially owned by Mr. Rash and Dr. Goldknopf described above, theCompany has entered into amended and restated employment agreements with Mr.Rash and Dr. Goldknopf which require the Company to issue 1,500,000 shares ofrestricted Series B preferred stock to each of Mr. Rash and Dr. Goldknopf. TheCompany has not filed the certificate of amendment designating the Series Bpreferred stock and its powers, designations and relative rights and has notissued the shares of the Series B preferred stock. As a result of certainrestrictions agreed upon with the investors in connection with the Company’srecent financing, the Company may not issue the Series B preferred stock until90 days after the effective date of the registration statement filed by theCompany on behalf of the investors. After such restrictions lapse, the Companyintends to file the certificate of amendment and issue the Series B preferredstock.

 

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The terms of the Series B preferred stock agreed uponby the Company provide that while the shares of Series B preferred stock areheld by Mr. Rash and Dr. Goldknopf, they will have the right to vote thatnumber of votes equal to the number of outstanding shares of the Company’scommon stock plus one additional vote such that they will hold a majority ofthe voting rights of the Company. In the event of the death or termination ofemployment of either Mr. Rash or Dr. Goldknopf, the remaining holder of theSeries B preferred stock will continue to hold such voting rights. The issuanceof such shares of Series B preferred stock will result in a change of controlof the Company.

 

**Employee Stock OptionPlans**

 

**SecuritiesAuthorized for Issuance Under Equity Compensation Plans**

 
| ** **                                                                                                                                                                         | ** ** | **Number of securities  to be issued upon  exercise of outstanding  options, warrants and  rights** | ** ** | **Weighted-average  exercise price of  outstanding options,  warrants and rights** | ** ** | **Number of securities  remaining available  for future issuance  under equity  compensation plans  (excluding securities  reflected in column  (a))** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| ** **                                                                                                                                                                         | ** ** | **(a)**                                                                                                                                          | ** ** | **(b)**                                                                                                     | ** ** | **(c)**                                                                                                                                                                                                  | ** ** |
|                                                                                                                                                                               |       |                                                                                                                                             |       |                                                                                                        |       |                                                                                                                                                                                                     |       |
| Equity compensation plans approved by  security holders                                                                                                                            |       | 0                                                                                                                                                |       | 0                                                                                                           |       | 0                                                                                                                                                                                                        |       |
|                                                                                                                                                                               |       |                                                                                                                                             |       |                                                                                                        |       |                                                                                                                                                                                                     |       |
| Equity compensation plans enacted by  management and approved by the Board of Directors, but not submitted for a  vote or approved by all holders of the Company’s securities |       | 580,000                                                                                                                                          |       | $                                                                                                           | 1.44       |                                                                                                                                                                                                     | 9,929,268  |   |
|                                                                                                                                                                               |       |                                                                                                                                             |       |                                                                                                        |       |                                                                                                                                                                                                     |       |
| Total                                                                                                                                                                              |       | 580,000                                                                                                                                          |       | $                                                                                                           | 1.44       |                                                                                                                                                                                                     | 9,929,268  |   |

 

The 9,929,268 securities that remain available forfuture issuance under equity compensation plans arise from the Company’s 2004 Directors,Officers and Consultants Stock Option, Stock Warrant, and Stock Award Plan (“2004Plan”). The Company has issued 38,926,466 shares of common stock under the 2004Plan. The 2004 Plan initially authorized the issuance of 10,000,000 shares ofthe Company’s common stock pursuant to the Plan; however, the number of sharesavailable under the 2004 Plan shall increase so that immediately following anygrant of securities under the 2004 Plan, the total number of shares issuableunder the 2004 Plan and reserved for issuance upon exercise of options,warrants, or conversion of shares of preferred stock will equal 15% of thetotal number of the Company’s issued and outstanding shares of common stock.

 

In March 2003, the Company’s board of directorsapproved a 2003 Stock Compensation Plan, which provided for the granting ofcommon stock, options and/or warrants to officers, directors and employees aswell as consultants and attorneys who provide services to the Company. Later,on September 25, 2003, the Company issued a Post-Effective Amendment No. 1 toits Form S-8 Registration Statement previously filed on April 18,

 

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2003 and previously issued for this 2003 Stock Compensation Plan. Thisamendment deregistered the 2003 Stock Compensation Plan, the 8,000,000 sharesof Power3’s common stock previously registered under this Plan and any sharesof stock or warrants contemplated to be issued within this Plan.

 

**CertainRelationships and Related Transactions**

 

On May 18, 2004, the Company acquired a set of assetsfrom Advanced Bio/Chem and assumed certain of its liabilities in exchange forthe issuance of 15,000,000 shares of the Company’s common stock to AdvancedBio/Chem. At the time of the acquisition, Mr. Rash owned approximately 3.92% ofthe common stock of Advanced Bio/Chem, thus resulting in indirect beneficialownership at the time of the transaction of approximately 588,000 shares of theCompany’s common stock through Advanced Bio/Chem. Additionally, Dr. Goldknopfheld approximately 8.23% of the common stock of Advanced Bio/Chem at the timeof the transactions, thus resulting in his indirect beneficial ownership at thetime of the transaction of approximately 1,234,500 shares of the Company’scommon stock through Advanced Bio/Chem.

 

In October 2004, Mr. Rosinski loaned the Company$75,000. The loan was repaid to Mr. Rosinski, without interest, in November2004 with proceeds from the Company’s financing on October 28, 2004.

 

In March, 2005, Mr. Rosinski loaned the Company $35,000. The loan, due to be repaid on or before April 30, 2005, is to be repaidwith proceeds from later issue of permanent financing and is payable, withinterest at rate of 6% per annum,  Theloan remains outstanding and is carried on the Balance Sheet of the Company inNotes Payable.

 

OnMay 31, 2005, the Company received an Officer Advance in the amount of $55,000.This advance is in the form of a short-term Note Payable, to the Officer, andis payable on June 30, 2005, and bears interest at a rate of 6 % per annumuntil paid.

 

OnJune 3, 2005, the Company received an Officer Advance in the amount of $50,000.This advance is in the form of a short-term Note Payable, to the Officer, andis payable on June 30, 2005, and bears interest at a rate of 6 % per annumuntil paid.

 

During the latter half of 2005, the Chief ScientificOfficer advanced the Company $159,231 as short-term Officer Advances in orderto enable the Company to meet certain payment obligations. These advances werein the form of 180 day notes and bear interest at a rate of 6% per annum untilthe outstanding balance is paid in full. None of these short-term OfficerAdvances were due as of December 31, 2005.

 

**On December 14, 2005, the Companyreceived an Officer Advance in the amount of $50,000 from the Chief ScientificOfficer. This Note is due on June 15, 2006, and bears interest at a rate of 6%per annum until paid.**

** **

**Item13. Exhibits**

 

(a)   Exhibits

 
| **Exhibit  No.** | ** ** | **INDEX**                                                                                                                                                                                                                                                                                         |
|------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 2.1              |       | Asset Purchase Agreement dated as of May 11, 2004  by and among Power 3 Medical Products, Inc., Advanced Bio/Chem, Inc. d/b/a  ProteEx, Steven B. Rash and Ira Goldknopf (incorporated  by reference to Exhibit 2.1 to the Company’s Registration State on Form SB-2  (File No. 333-122227). |
| 3.1              |       | Certificate of Incorporation (incorporated by  reference to Exhibit 2.5 to the Company’s Form 10-SB                                                                                                                                                                                          |

 

86

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| **Exhibit  No.** | ** ** | **INDEX**                                                                                                                                                                                                                                                                |
|------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|             |       | filed on September 28, 1998).                                                                                                                                                                                                                                            |
| 3.2              |       | Certificate of Merger (incorporated by reference  to Exhibit 2.7 to the Company’s Form 10-SB filed on September 28, 1998).                                                                                                                                          |
| 3.3              |       | Certificate of Amendment of the Certificate of  Incorporation (incorporated by reference to Exhibit 2.9 to the Company’s Form  10-SB filed on September 28, 1998).                                                                                                  |
| 3.4              |       | Certificate of Amendment of the Certificate of  Incorporation (incorporated by reference to Exhibit 3.(I).10 to the Company’s  Form S-3 filed on March 2, 2000).                                                                                                    |
| 3.5              |       | Certificate of Amendment to the Certificate of  Incorporation (incorporated by reference to Exhibit 3.1 to the Company’s Form  8-K filed on November 5, 2004).                                                                                                      |
| 3.6              |       | Bylaws (incorporated by reference to Exhibit 2.10  to the Company’s Form 10-SB filed on September 28, 1998).                                                                                                                                                        |
| 4.1              |       | Form of Convertible Debenture Due October 28, 2007  (incorporated by reference to Exhibit 4.1 to the Company’s Form 8-K filed on  November 3, 2004).                                                                                                                |
| 4.2              |       | Form of Common Stock Purchase Warrant  (incorporated by reference to Exhibit 4.2 to the Company’s Form 8-K filed on  November 3, 2004).                                                                                                                             |
| 4.3              |       | Form of Additional Investment Right (incorporated  by reference to Exhibit 4.3 to the Company’s Form 8-K filed on November 3,  2004).                                                                                                                               |
| 10.1             |       | Form 10-QSB for quarter ended June 30, 2005 as  filed on August 22, 2005 (incorporated by reference to Exhibit 10.1 to the  Company’s Form 10QSB filed November 11, 2005).                                                                                          |
| 10.2             |       | Form 8-K/A, as filed on August 29, 2005  (incorporated by reference to Exhibit 10.2 to the Company’s Form 10QSB filed  November 11, 2005).                                                                                                                          |
| 10.3             |       | Form 10-QSB/A for quarter ended June 30, 2004  as filed on September 9, 2005 (incorporated by reference to Exhibit 10.3 to  the Company’s Form 10QSB filed November 11, 2005).                                                                                      |
| 10.4             |       | Form 10-QSB/A for quarter ended September 30,  2004 as filed on September 9, 2005 (incorporated by reference to Exhibit 10.4  to the Company’s Form 10QSB filed November 11, 2005).                                                                                 |
| 10.5             |       | Form 10-QSB/A for quarter ended March 31,  2004 as filed on September 9, 2005 (incorporated by reference to Exhibit 10.1  to the Company’s Form 10QSB filed November 11, 2005).                                                                                     |
| 10.6             |       | Form 10-KSB for year ended December 31, 2004  as filed on September 9, 2005 (incorporated by reference to Exhibit 10.1 to the Company’s Form  10QSB filed November 11, 2005).                                                                                       |
| 10.7             |       | Amendment #1 to Sb-2 filed October 6, 2005 as  filed on October 6, 2005 (incorporated by reference to Exhibit 10.7 to the Company’s Form  10QSB filed November 11, 2005).                                                                                           |
| 10.8(3)          |       | Amended and Restated Employment Agreement** **for Steven B. Rash (incorporated by  reference to Exhibit 10.1 to the Company’s Form 8-K filed January 5, 2005).                                                                                                 |
| 10.9(3)          |       | Amended and Restated Employment Agreement for Ira  L. Goldknopf, Ph.D. (incorporated by reference to Exhibit 10.2 to the  Company’s Form 8-K filed January 5, 2005).                                                                                                |
| 10.10(3)         |       | Amended and Restated Employment Agreement** **for Michael J. Rosinski (incorporated by  reference to Exhibit 10.3 to the Company’s Form 8-K filed January 5, 2005).                                                                                            |
| 10.11(3)         |       | Employment Agreement for John P. Burton  (incorporated by reference to Exhibit 10.1 to the Company’s Form 8-K filed  September 21, 2005).                                                                                                                           |
| 10.12(4)         |       | Exclusive License Agreement dated effective as of  June 28, 2004 by and between Baylor College of Medicine and Power3 Medical  Products, Inc. (incorporated by reference to Exhibit 10.1 to the Company’s  Form 10-QSB/A for the quarter ended September 30, 2004). |
| 10.13(1),(4)     |       | Research Agreement signed August 17, 2004 by and  between Baylor College of Medicine and Power3 Medical Products, Inc.                                                                                                                                                   |
| 10.14(4)         |       | Patent and Technology License Agreement dated  August 1, 2004 by and between The Board of Regents of The University of Texas  System, on behalf of The University of Texas M.D. Anderson                                                                                 |

 

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| **Exhibit  No.** | ** ** | **INDEX**                                                                                                                                                                                                                                                                                                                                                                           |
|------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|             |       | Cancer Center, and Power3 Medical Products, Inc.  (incorporated by reference to Exhibit 10.2 to the Company’s Form 10-QSB/A for  the quarter ended September 30, 2004).                                                                                                                                                                                                        |
| 10.15(4)         |       | Patent and Technology License Agreement dated  September 1, 2003 by and between The Board of Regents of The University of  Texas System, on behalf of The University of Texas M.D. Anderson Cancer  Center, and Advanced Bio/Chem, Inc. (d/b/a ProteEx) (incorporated by  reference to Exhibit 10.3 to the Company’s Form 10-QSB/A for the quarter  ended September 30, 2004). |
| 10.16            |       | Securities Purchase Agreement dated as of October  28, 2004, among the Company and each purchaser identified therein  (incorporated by reference to Exhibit 10.1 to the Company’s Form 8-K filed on  November 3, 2004).                                                                                                                                                        |
| 10.17            |       | Amendment to Securities Purchase Agreement dated  January 19, 2005 among the Company and each purchaser identified therein  (incorporated by reference to Exhibit 10.8 of the Company’s Registration  Statement on Form SB2 (File No.333-122227)).                                                                                                                             |
| 10.18            |       | Registration Rights Agreement dated as of October  28, 2004, among the Company and each purchaser identified therein  (incorporated by reference to Exhibit 10.2 to the Company’s Form 8-K filed on  November 3, 2004).                                                                                                                                                        |
| 10.19            |       | Power3’s Registration Statement (incorporated by  reference to the SB-2 (File No. 122227) as filed on January 21, 2005.                                                                                                                                                                                                                                                        |
| 10.20(3)         |       | 2003 Stock Compensation Plan (incorporated by  reference to Exhibit 4.1 of the Company’s Registration Statement on Form S-8  filed April 18, 2003).                                                                                                                                                                                                                            |
| 10.21  (3)  |       | 2004 Directors, Officers and Consultants Stock  Option, Stock Warrant and Stock Award Plan (incorporated by reference to  Exhibit 4.1 of the Company’s Registration Statement on Form S-8 filed January  20, 2004).                                                                                                                                                            |
| 10.22(3)         |       | Collaborative Research Agreement, dated March 21,  2005, by and between New Horizons Diagnostics and Power3 (incorporated by  reference to Exhibit 16.1 of the Company’s Registration Statement on Form  10KSB filed September 9, 2005).                                                                                                                                       |
| 10.23(3)         |       | Collaborative Research and Licensing Agreement,  dated May 17, 2005, by and between BioSite Incorporated and Power3 for  collaborative research and worldwide licensing to BioSite Incorporated.  (incorporated by reference to Exhibit 16.1 of the Company’s Registration Statement  on Form 10KSB filed September 9, 2005).                                                  |
| 10.24            |       | Research Agreement, dated October 13, 2005,  between Power3 and Pfizer, Inc. (incorporated by reference to Exhibit 10.1 to  the Company’s Form 8K filed October 19, 2005).                                                                                                                                                                                                     |
| 10.25            |       | Promissory Note executed by Power3 and Cordillera  Fund LP in the amount of $251,000, dated April 5, 2005 (incorporated by  reference to Exhibit 10.1 to the Company’s Form 10QSB filed August 22, 2005).                                                                                                                                                                      |
| 10.26(1)         |       | Promissory Note executed by Power3 and Michael J.  Rosinski in the amount of $35,000                                                                                                                                                                                                                                                                                                |
| 10.27            |       | Promissory Note, dated May 31, 2005, executed by  Power3 and Steven B. Rash in the amount of $55,000 (incorporated by reference  to Exhibit 26.4 to the Company’s Form SB2/A filed on October 6, 2005).                                                                                                                                                                        |
| 10.28            |       | Promissory Note, dated June 3, 2005, executed by  Power3 and Dr. Ira Goldknopf in the amount of $50,000 (incorporated by  reference to Exhibit 26.5 to the Company’s Form SB2/A filed on October 6,  2005).                                                                                                                                                                    |
| 10.29            |       | Promissory Note, dated June 13, 2005, executed  June 17, 2005 between Power3 and John Fife in the amount of $396,500  (incorporated by reference to Exhibit 10.1 to the Company’s Form 8K filed on  June 22, 2005).                                                                                                                                                            |
| 10.30            |       | Promissory Note (Amended version), dated August  29, 2005, executed by Power3 and John Fife in the amended amount of $446,500  (incorporated by reference to Exhibit 10.1 to the Company’s Form 8K filed on  September 9, 2005).                                                                                                                                               |

 

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| **Exhibit  No.** | ** ** | **INDEX**                                                                                                                                                                                                             |
|------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.31            |       | Promissory Note executed by Power3 and Cordillera  Fund LP in the amount of $200,000, dated September 5, 2005 (incorporated by  reference to Exhibit 10.3 to the Company’s Form 8K filed on September 9,  2005). |
| 10.32            |       | Promissory Note, dated October 17, 2005, between  Power3 and Dr. Ira Goldknopf in the amount of $39,231 (incorporated by  reference to Exhibit 10.2 to the Company’s Form 8K filed October 19, 2005).            |
| 10.33            |       | Promissory Note, dated September 6, 2005, between  Power3 and Dr. Ira Goldknopf in the amount of $80,000 (incorporated by  reference to Exhibit 10.2 to the Company’s Form 8K filed September 9, 2005).          |
| 10.34            |       | Promissory Noted dated November 3, 2005 between  Power3 and Trinity financing in the amount of $150,000 (incorporated by  reference to Exhibit 10.1 to the Company’s Form 8K filed on November 8,  2005).        |
| 10.35(1)         |       | Promissory Note, dated November 23, 2005, between  Power3 and Dr. Ira Goldknopf in the amount of $52,000.                                                                                                             |
| 10.36            |       | Promissory Note executed on December 12, 2005  between Power3 and Trinity Financing (incorporated by reference to Exhibit  10.1 to the Company’s Form 8K filed December 12, 2005)                                |
| 10.37(1)         |       | Promissory Note, dated December 14, 2005, between  Power3 and Dr. Ira Goldknopf in the amount of $50,000.                                                                                                             |
| 14.1             |       | Code of Ethics for Chief Executive Officer, Chief  Financial Officer and Principal Accounting Officer (incorporated by reference  to Exhibit 14.1 to the Company’s Form 10KSB filed September 9, 2005).          |
| 16.1             |       | Letter re: change in certifying accountant  (incorporated by reference to Exhibit 16.1 of the Company’s Registration  Statement on Form 10KSB filed September 9, 2005).                                          |
| 16.2             |       | Letter from Kingery & Crouse P.A. regarding  agreement with 8K statements (incorporated by reference to Exhibit 16.1 of  the Company’s Registration Statement on Form 18K filed August 2, 2005).             |
| 21.1             |       | List of subsidiaries (incorporated by reference to  Exhibit 21.1 to the Company’s Form 10KSB filed September 9, 2005).                                                                                           |
| 31.1(2)          |       | Certification of Power 3 Medical Products, Inc.  Chief Executive Officer, Steven B. Rash, pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002.                                                                 |
| 31.2(2)          |       | Certification of Power 3 Medical Products, Inc.  Chief Accounting Officer, John P. Burton, pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002.                                                                |
| 32.1(2)          |       | Certification of Power 3 Medical Products, Inc.  Chief Executive Officer, Steven B. Rash, pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002.                                                                 |
| 32.2(2)          |       | Certification of Power 3 Medical Products, Inc.  Chief Accounting Officer, John P. Burton, pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002.                                                                |
| 99.1             |       | Press Release dated April 18, 2005 (incorporated  by reference to Exhibit 99.1 to the Company’s Form 8K filed April 18, 2005).                                                                                   |
| 99.2             |       | Press Release dated April 27, 2005 (incorporated  by reference to Exhibit 99.1 to the Company’s Form 8K filed April 29, 2005).                                                                                   |

 

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(1)   Filed herewith

(2)   Furnished herewith

(3)   Management contract or compensatory plan orarrangement

(4)   Confidential treatment has been requestedwith respect to certain portions of this exhibit. Omitted portions have beenfiled separately with the Securities and Exchange Commission.

 

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**Item14. Principal Accountant Fees and Services**

 

The following table sets forth the aggregate amount offees billed by the Company’s independent accountants for the year endedDecember 31, 2005 and the year ended December 31, 2004:

 
| ** **          | ** ** | **2004** | ** ** | **2004** | ** ** |
|---------------------|------------|----------|------------|----------|------------|
| Audit Fees:         |       | $        | 101,743    |     | $          | 55,747 |   |
| Audit Related Fees: |       | $        | 46,163     |     | —     |   |
| Tax Fees:           |       | $        | 5,081      |     | —     |   |
| All Other Fees:     |       | $        | 3,925      |     | —     |   |
|                |       |     |       |     |       |
| Total Fees:         |       | $        | 156,912    |     | $          | 55,747 |   |

 

The Company does not have an Audit Committee of theBoard of Directors. All activities of the Company’s independent accountants arereviewed and approved prior to the engagement by the Board of Directors, whoconsider whether such activities could affect the independence of suchaccountants.

 

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**SIGNATURES**

** **

In accordance with Section 13 and 15(d) of theExchange Act, the Registrant caused this report to be signed on its behalf bythe undersigned, thereunto duly authorized.

 
| ** **           | **Power3 Medical Products, Inc.** |
|----------------------|-----------------------------------|
|                 | ** **                        |   |
|                 | ** **                        |   |
|                 | ** **                        | By: | /s/ Steven B. Rash |   |
|                 | ** **                        | Name: | Steven B. Rash |
|                 | ** **                        | Title: | Chairman and Chief Executive Officer |
|                 | ** **                        |   |   |
| Date: April 28, 2006 |                              | (Principal Executive Officer) |

 

Pursuant to the requirements of the Exchange Act, thisreport has been signed by the following persons in the capacities and on thedates indicated.

 
| **Signature**           | ** ** | **Title**                                     | ** ** | **Date**       |
|-------------------------|------------|-----------------------------------------------|------------|----------------|
|                    |       |                                          |       |           |
| /s/ Steven B. Rash      |       | Chairman and Chief  Executive Officer         |       | April 28, 2006 |
| Steven B. Rash          |       | (Principal Executive  Officer)                |       |           |
|                    |       |                                          |       |           |
| /s/ Ira L. Goldknopf    |       | Chief Scientific  Officer and Director        |       | April 28, 2006 |
| Ira L. Goldknopf, Ph.D. |       |                                          |       |           |
|                    |       |                                          |       |           |
| /s/ John P. Burton      |       | Chief Financial Officer                       |       | April 28, 2006 |
| John P. Burton          |       | (Principal Financial  and Accounting Officer) |       |           |

 

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