UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549





FORM
10-Q





(Mark
One)





[X]
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934





For the
quarterly period ended December 31, 2009





OR





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





For the
transition period from _____to_____





COMMISSION
FILE NUMBER 000-21846





AETHLON
MEDICAL, INC.





(Exact
name of registrant as specified in its charter)





NEVADA
            
            13-3632859(State
      or other jurisdiction of incorporation or organization)
            
            (I.R.S.
      Employer Identification No.)





8910
UNIVERSITY CENTER LANE, SUITE 255, SAN DIEGO, CA 92122


(Address
of principal executive offices) (Zip Code)





(858)
459-7800





(Registrant's
telephone number, including area code)





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





Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T (ss.232.405 of this
chapter) during the preceding 12 months (or for such shorter period that the
registrant was required to submit and post such files).   YES [_]
NO [_]





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





Large
      accelerated filer  [_]
            Accelerated
      filer   [_]Non-accelerated
      filer   [_]
              (Do
      not check if a smaller reporting company)
            Smaller
      reporting company  [X]





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





As of
February 12, 2010, the registrant had outstanding 60,166,423 shares of common
stock, $.001 par value.













PART
      I. FINANCIAL INFORMATIONITEM
      1.
            CONDENSED
      CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)CONDENSED
      CONSOLIDATED BALANCE SHEETS AT DECEMBER 31, 2009 (UNAUDITED) AND MARCH 31,
      2009
            3CONDENSED
      CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE THREE AND NINE MONTH PERIODS
      ENDED DECEMBER 31, 2009 AND 2008 AND FOR THE PERIOD JANUARY 31, 1984
      (INCEPTION) THROUGH DECEMBER 31, 2009 (UNAUDITED)
            4CONDENSED
      CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE NINE MONTHS ENDED DECEMBER
      31, 2009 AND 2008 AND FOR THE PERIOD JANUARY 31, 1984 (INCEPTION) THROUGH
      DECEMBER 31, 2009 (UNAUDITED)
            5NOTES
      TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
            7ITEM
      2.
            MANAGEMENT'S
      DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
      OPERATIONS
            24ITEM
      3.
            QUANTITATIVE
      AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
            28ITEM
      4T.
            CONTROLS
      AND PROCEDURES
            28PART
      II. OTHER INFORMATION
            29ITEM
      1.
            LEGAL
      PROCEEDINGS
            29ITEM
      1A.
            RISK
      FACTORS
            29ITEM
      2.
            UNREGISTERED
      SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
            29ITEM
      3.
            DEFAULTS
      UPON SENIOR SECURITIES
            29ITEM
      4.
            SUBMISSION
      OF MATTERS TO A VOTE OF SECURITY HOLDERS
            29ITEM
      5.
            OTHER
      INFORMATION
            30ITEM
      6.
            EXHIBITS
            30








2


PART I.
FINANCIAL INFORMATION





ITEM 1. CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS





AETHLON
MEDICAL, INC.


(A
Development Stage Company)


CONDENSED
CONSOLIDATED BALANCE SHEETS





December
      31,
            
            
            March
      31,2009
            
            
            2009(Unaudited)ASSETSCurrent
      assetsCash
            
            $
            48,600
            
            
            $
            6,157Deferred
      financing costs
            
            
            47,859
            
            
            
            --Prepaid
      expenses and other current assets
            
            
            11,109
            
            
            
            37,011Total
      current assets
            
            
            107,568
            
            
            
            43,168Property
      and equipment, net
            
            
            10,182
            
            
            
            2,603Patents
      and patents pending, net
            
            
            146,968
            
            
            
            138,417Deposits
            
            
            7,168
            
            
            
            13,200Total
      assets
            
            $
            271,886
            
            
            $
            197,388LIABILITIES
      AND STOCKHOLDERS' DEFICITCurrent
      LiabilitiesAccounts
      payable
            
            $
            304,337
            
            
            $
            460,074Due
      to related parties
            
            
            609,331
            
            
            
            634,896Notes
      payable
            
            
            290,000
            
            
            
            302,500Convertible
      notes payable, net of discounts
            
            
            1,445,583
            
            
            
            2,069,720Derivative
      liabilities
            
            
            587,627
            
            
            
            --Other
      current liabilities
            
            
            1,178,752
            
            
            
            679,498Total
      current liabilities
            
            
            4,415,630
            
            
            
            4,146,688Commitments
      and Contingencies (Note 9)Stockholders'
      DeficitCommon
      stock, par value $0.001 per share; 250,000,000 and 100,000,000 shares
      authorized as of December 31, 2009 and March 31, 2009; 59,355,101 and
      49,454,131 shares issued and outstanding as of December 31, 2009 and March
      31, 2009, respectively
            
            
            59,356
            
            
            
            49,455Additional
      paid-in capital
            
            
            37,374,195
            
            
            
            34,312,659Deficit
      accumulated during development stage
            
            
            (41,577,295
            )
            
            
            (38,311,414
            )(4,143,744
            )
            
            
            (3,949,300
            )Total
      liabilities and stockholders' deficit
            
            $
            271,886
            
            
            $
            197,388






The
accompanying notes are an integral part of these unaudited condensed
consolidated financial statements.


3




AETHLON
MEDICAL, INC.


(A
Development Stage Company)


CONDENSED
CONSOLIDATED STATEMENTS OF OPERATIONS


For the
Three Months and Nine Months Ended December 31, 2009 and 2008 and


For the
Period January 31, 1984 (Inception) Through December 31, 2009


(Unaudited)





January
      31, 1984Three
      Months
            
            
            Three
      Months
            
            
            Nine
      Months
            
            
            Nine
      Months
            
            
            (Inception)Ended
            
            
            Ended
            
            
            Ended
            
            
            Ended
            
            
            throughDecember
      31,
            
            
            December
      31,
            
            
            December
      31,
            
            
            December
      31,
            
            
            December
      31,2009
            
            
            2008
            
            
            2009
            
            
            2008
            
            
            2009REVENUESGrant
      income
            
            $
            --
            
            
            $
            --
            
            
            $
            --
            
            
            $
            --
            
            
            $
            1,424,012Subcontract
      income
            
            
            --
            
            
            
            --
            
            
            
            --
            
            
            
            --
            
            
            
            73,746Sale
      of research and development
            
            
            --
            
            
            
            --
            
            
            
            --
            
            
            
            --
            
            
            
            35,810--
            
            
            
            --
            
            
            
            --
            
            
            
            --
            
            
            
            1,533,568EXPENSESProfessional
      fees
            
            
            283,355
            
            
            
            151,022
            
            
            
            846,381
            
            
            
            593,622
            
            
            
            8,638,840Payroll
      and related
            
            
            286,468
            
            
            
            630,958
            
            
            
            959,593
            
            
            
            1,286,535
            
            
            
            12,085,319General
      and administrative
            
            
            146,154
            
            
            
            85,389
            
            
            
            384,204
            
            
            
            343,530
            
            
            
            6,282,286Impairment
            
            
            --
            
            
            
            --
            
            
            
            --
            
            
            
            --
            
            
            
            1,313,253715,977
            
            
            
            867,369
            
            
            
            2,190,178
            
            
            
            2,223,687
            
            
            
            28,319,698OPERATING
      LOSS
            
            
            (715,977
            )
            
            
            (867,369
            )
            
            
            (2,190,178
            )
            
            
            (2,223,687
            )
            
            
            (26,786,130
            )OTHER
      EXPENSE (INCOME)Loss
      on extinguishment of debt
            
            
            --
            
            
            
            1,063,344
            
            
            
            --
            
            
            
            1,063,344
            
            
            
            2,760,674Loss
      on settlement of accrued interest and damages
            
            
            --
            
            
            
            --
            
            
            
            --
            
            
            
            607,908
            
            
            
            607,908Loss
      (gain) on change in fair value of derivative liability
            
            
            77,426
            
            
            
            50,064
            
            
            
            (167,336
            )
            
            
            (213,903
            )
            
            
            1,454,282Interest
      and other debt expenses
            
            
            692,770
            
            
            
            363,964
            
            
            
            1,185,482
            
            
            
            1,477,854
            
            
            
            9,540,252Interest
      income
            
            
            (295
            )
            
            
            (187
            )
            
            
            (1,006
            )
            
            
            (2,701
            )
            
            
            (21,192
            )Other
            
            
            --
            
            
            
            --
            
            
            
            --
            
            
            
            --
            
            
            
            449,241769,901
            
            
            
            1,477,185
            
            
            
            1,017,140
            
            
            
            2,932,502
            
            
            
            14,791,165NET
      LOSS
            
            $
            (1,485,878
            )
            
            $
            (2,344,554
            )
            
            $
            (3,207,318
            )
            
            $
            (5,156,189
            )
            
            $
            (41,577,295
            )BASIC
      AND DILUTED LOSS PER COMMON SHARE
            
            $
            (0.03
            )
            
            $
            (0.05
            )
            
            $
            (0.06
            )
            
            $
            (0.12
            )WEIGHTED
      AVERAGE NUMBER OF COMMON SHARES OUTSTANDING
            
            
            58,230,294
            
            
            
            43,506,386
            
            
            
            55,369,652
            
            
            
            41,486,177








The
accompanying notes are an integral part of these unaudited condensed
consolidated financial statements.


4





AETHLON
MEDICAL, INC.


(A
DEVELOPMENT STAGE COMPANY)


CONDENSED
CONSOLIDATED STATEMENTS OF CASH FLOWS


FOR THE
NINE MONTHS ENDED DECEMBER 31, 2009 AND 2008 AND


FOR THE
PERIOD JANUARY 31, 1984 (INCEPTION) THROUGH DECEMBER 31, 2009


(Unaudited)





January
      31, 1984Nine
      Months
            
            
            Nine
      Months
            
            
            (Inception)Ended
            
            
            Ended
            
            
            ThroughDecember
      31,
            
            
            December
      31,
            
            
            December
      31,2009
            
            
            2008
            
            
            2009Cash
      flows from operating activities:Net
      loss
            
            $
            (3,207,318
            )
            
            $
            (5,156,189
            )
            
            $
            (41,518,732
            )Adjustments
      to reconcile net loss to net cash used in operating
      activities:Depreciation
      and amortization
            
            
            9,568
            
            
            
            12,534
            
            
            
            1,054,792Amortization
      of deferred consulting fees
            
            
            --
            
            
            
            --
            
            
            
            109,000Loss
      on settlement of accrued interest and damages
            
            
            --
            
            
            
            607,908
            
            
            
            607,264Gain
      on sale of property and equipment
            
            
            --
            
            
            
            --
            
            
            
            (13,065
            )Gain
      on settlement of debt
            
            
            --
            
            
            
            --
            
            
            
            (131,175
            )Loss
      on settlement of accrued legal liabilities
            
            
            --
            
            
            
            --
            
            
            
            142,245Stock
      based compensation
            
            
            401,840
            
            
            
            590,832
            
            
            
            2,084,616Fair
      value of warrants issued upon conversion
            
            
            31,549
            
            
            
            --
            
            
            
            31,549Fair
      market value of common shares donated to research
institute
            
            
            25,000
            
            
            
            --
            
            
            
            25,000Loss
      on debt extinguishment
            
            
            --
            
            
            
            1,063,344
            
            
            
            2,741,318Fair
      market value of warrants issued in connection with accounts payable and
      debt
            
            
            --
            
            
            
            --
            
            
            
            2,715,736Fair
      market value of common stock, warrants and options issued for
      services
            
            
            515,576
            
            
            
            249,186
            
            
            
            4,662,519Change
      in fair value of derivative liability
            
            
            (167,336
            )
            
            
            (213,903
            )
            
            
            1,454,282Amortization
      of debt discount and deferred financing costs
            
            
            557,293
            
            
            
            1,251,326
            
            
            
            4,556,075Impairment
      of patents and patents pending
            
            
            --
            
            
            
            --
            
            
            
            416,026Impairment
      of goodwill
            
            
            --
            
            
            
            --
            
            
            
            897,227Deferred
      compensation forgiven
            
            
            --
            
            
            
            --
            
            
            
            217,223Changes
      in operating assets and liabilities:Prepaid
      expenses
            
            
            25,902
            
            
            
            (14,315
            )
            
            
            180,387Deposits
            
            
            6,032
            
            
            
            --
            
            
            
            (7,168
            )Accounts
      payable and other current liabilities
            
            
            445,980
            
            
            
            136,799
            
            
            
            2,945,146Due
      to related parties
            
            
            (25,565
            )
            
            
            (28,000
            )
            
            
            1,260,142Net
      cash used in operating activities
            
            
            (1,381,479
            )
            
            
            (1,500,478
            )
            
            
            (15,549,593
            )Cash
      flows from investing activities:Purchases
      of property and equipment
            
            
            (10,274
            )
            
            
            --
            
            
            
            (283,124
            )Additions
      to patents and patents pending
            
            
            (15,424
            )
            
            
            (9,693
            )
            
            
            (402,767
            )Proceeds
      from the sale of property and equipment
            
            
            --
            
            
            
            --
            
            
            
            17,065Cash
      of acquired company
            
            
            --
            
            
            
            --
            
            
            
            10,728Net
      cash used in investing activities
            
            
            (25,698
            )
            
            
            (9,693
            )
            
            
            (658,098
            )Cash
      flows from financing activities:Proceeds
      from the issuance of notes payable
            
            
            --
            
            
            
            --
            
            
            
            2,350,000Principal
      repayments of notes payable
            
            
            (24,000
            )
            
            
            --
            
            
            
            (376,500
            )Net
      proceeds from the issuance of convertible notes payable
            
            
            1,358,420
            
            
            
            430,000
            
            
            
            3,926,420Proceeds
      from the issuance of common stock
            
            
            115,200
            
            
            
            917,500
            
            
            
            10,433,102Professional
      fees related to registration statement
            
            
            --
            
            
            
            --
            
            
            
            (76,731
            )Net
      cash provided by financing activities
            
            
            1,449,620
            
            
            
            1,347,500
            
            
            
            16,256,291Net
      (decrease) increase in cash
            
            
            42,443
            
            
            
            (162,671
            )
            
            
            48,600Cash
      at beginning of period
            
            
            6,157
            
            
            
            254,691
            
            
            
            --Cash
      at end of period
            
            $
            48,600
            
            
            $
            92,020
            
            
            $
            48,600





The
accompanying notes are an integral part of these unaudited condensed
consolidated financial statements.


5





AETHLON
MEDICAL, INC.


(A
DEVELOPMENT STAGE COMPANY)


CONDENSED
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)


FOR THE
NINE MONTHS ENDED DECEMBER 31, 2009 AND 2008 AND


FOR THE
PERIOD JANUARY 31, 1984 (INCEPTION) THROUGH DECEMBER 31, 2009


(Unaudited)





January
      31, 1984Nine
      Months
            
            
            Nine
      Months
            
            
            (Inception)Ended
            
            
            Ended
            
            
            ThroughDecember
      31,
            
            
            December
      31,
            
            
            December
      31,2009
            
            
            2008
            
            
            2009Supplemental
      disclosures of non-cash investing and financing
    information:Reclassification
      of accounts payable to notes payable
            
            $
            24,001
            
            
            $
            -- $
            
            
            
            24,001Reclassification
      of warrant derivative liability into equity
            
            
            --
            
            
            
            419,192
            
            
            
            419,192Additional
      convertible debt issued in debt restructuring
            
            
            --
            
            
            
            573,211
            
            
            
            573,211Debt
      and accrued interest converted to common stock
            
            
            1,279,037
            
            
            
            371,604
            
            
            
            5,130,508Stock
      option exercise by director for accrued expenses
            
            
            --
            
            
            
            --
            
            
            
            95,000Debt
      discount on convertible notes payable associated with conversion feature
      and warrants
            
            
            1,380,386
            
            
            
            150,095
            
            
            
            3,840,201Issuance
      of common stock, warrants and options in settlement of accrued expenses
      and due to related parties
            
            
            --
            
            
            
            --
            
            
            
            1,003,273Issuance
      of common stock in connection with acquisition of patent pending and with
      license agreements
            
            
            --
            
            
            
            --
            
            
            
            118,000Net
      assets of entities acquired in exchange for equity
    securities
            
            
            --
            
            
            
            --
            
            
            
            1,597,867Debt
      placement fees paid by issuance of warrants
            
            
            --
            
            
            
            13,307
            
            
            
            856,845Common
      stock issued for prepaid expenses
            
            
            --
            
            
            
            --
            
            
            
            161,537Derivative
      Liabilities recorded in connection with warrant reclassification and
      embedded conversion feature
            
            
            759,963
            
            
            
            --
            
            
            
            759,963





The
accompanying notes are an integral part of these unaudited condensed
consolidated financial statements.


6




AETHLON
MEDICAL, INC.


(A
Development Stage Company)


NOTES TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)


December
31, 2009





NOTE 1.
NATURE OF BUSINESS AND BASIS OF PRESENTATION





Aethlon
Medical, Inc. ("Aethlon", "We" or the "Company") is a development stage medical
device company focused on expanding the applications of our Hemopurifier (R)
platform technology, which is designed to rapidly reduce the presence of
infectious viruses and other toxins from human blood. In this regard, our core
focus is the development of therapeutic devices that treat acute viral
conditions, chronic viral diseases and pathogens targeted as potential
biological warfare agents. The Hemopurifier(R) combines the established
scientific principles of affinity chromatography and hemodialysis as a means to
mimic the immune system's response of clearing viruses and toxins from the blood
before cell and organ infection can occur. The Hemopurifier(R) cannot cure viral
conditions but can prevent viruses and toxins from infecting unaffected tissues and
cells. We have completed pre-clinical blood testing of the Hemopurifier(R) to
treat HIV and Hepatitis-C, and have completed human safety trials on Hepatitis-C
infected patients in India and are in the process of obtaining regulatory
approval from the U.S. Food and Drug Administration ("FDA") to initiate clinical
trials in the United States.





The
commercialization of the Hemopurifier(R) will require the completion of human
efficacy and safety-related clinical trials. The approval of any application of
the Hemopurifier(R) in the United States will necessitate the approval of the
FDA to initiate human studies. Such studies could take years to demonstrate
safety and effectiveness in humans and there is no assurance that the
Hemopurifier(R) will be cleared by the FDA as a device we can market to the
medical community. We also expect to face similar regulatory challenges from
foreign regulatory agencies should we attempt to commercialize and market the
Hemopurifier(R) outside of the United States. As a result, we have not generated
revenues from the sale of any Hemopurifier(R) application. Additionally, there
have been no independent validation studies of our Hemopurifiers(R) to treat
infectious disease. We manufacture our products on a small scale for testing
purposes but have yet to manufacture our products on a large scale for
commercial purposes. All of our pre-clinical human blood studies have been
conducted in our laboratories under the direction of Dr. Richard Tullis, our
Chief Science Officer.





We are
classified as a development stage enterprise under accounting principles
generally accepted in the United States of America ("GAAP"), and have not
generated revenues from our principal operations.





Our
common stock is quoted on the Over-the-Counter Bulletin Board administered by
the Financial Industry Regulatory Authority ("OTCBB") under the symbol
"AEMD.OB".





The
accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with GAAP for interim financial information and with the
instructions to Form 10-Q and Article 8-03 of Regulation S-X. Accordingly, they
do not include all of the information and footnotes required by GAAP for
complete financial statements. In the opinion of management, all adjustments
(consisting of normal recurring adjustments) necessary to make the financial
statements not misleading have been included. We have evaluated subsequent
events through February 12, 2010, the last business day before our condensed
consolidated financial statements were issued. The condensed consolidated
balance sheet as of March 31, 2009 was derived from our audited financial
statements. Operating results for the three and nine month periods ended
December 31, 2009 are not necessarily indicative of the results that may be
expected for the year ending March 31, 2010. For further information, refer to
our Annual Report on Form 10-K for the year ended March 31, 2009, which includes
audited financial statements and footnotes as of March 31, 2009 and for the
years ended March 31, 2009 and 2008 and the period January 31, 1984 (Inception)
through March 31, 2009.


7


NOTE 2.
GOING CONCERN AND LIQUIDITY CONSIDERATIONS





The
accompanying unaudited condensed consolidated financial statements have been
prepared on a going concern basis, which contemplates, among other things, the
realization of assets and the satisfaction of liabilities in the ordinary course of
business. We have experienced continuing losses from operations, are in default
on certain debt, have negative working capital of approximately ($4,308,000),
recurring losses from operations and a deficit accumulated during the
development stage of approximately ($41,577,000) at December 31, 2009, which
among other matters, raises significant doubt about our ability to continue as a
going concern. We have not generated significant revenue or any profit from
operations since inception. A significant amount of additional capital will be
necessary to advance the development of our products to the point at which they
may become commercially viable. Our current financial resources are insufficient
to fund our capital expenditures, working capital and other cash requirements
(consisting of accounts payable, accrued liabilities, amounts due to related
parties and amounts due under various notes payable) for the fiscal year ending
March 31, 2010 ("fiscal 2010"). Therefore we will be required to seek additional
funds through debt and/or equity financing arrangements to finance our current
and long-term operations.





We are
currently addressing our liquidity needs by exploring investment capital
opportunities through the private placement of common stock or issuance of
additional debt. We believe that our access to additional capital, together with
existing cash resources, will be sufficient to meet our liquidity needs for
fiscal 2010. However, no assurance can be given that we will receive any funds
in connection with our capital raising efforts.





The
unaudited consolidated financial statements do not include any adjustments
relating to the recoverability of assets that might be necessary should we be
unable to continue as a going concern.





NOTE 3.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES





The
summary of our significant accounting policies presented below is designed to
assist the reader in understanding our consolidated financial statements. Such
financial statements and related notes are the representations of our
management, who are responsible for their integrity and objectivity. These
accounting policies conform to GAAP in all material respects, and have been
consistently applied in preparing the accompanying consolidated financial
statements.





PRINCIPLES
OF CONSOLIDATION





The
accompanying condensed consolidated financial statements include the accounts of
Aethlon Medical, Inc. and its wholly-owned subsidiaries Aethlon, Inc., Hemex,
Inc., Syngen Research, Inc., Cell Activation, Inc. and Exosome Sciences, Inc.
(collectively hereinafter referred to as the "Company" or
"Aethlon").





Hemex,
Inc. is dormant and Aethlon, Inc., Syngen Research, Inc. and Cell Activation,
Inc. were dormant and were dissolved effective November 25, 2009. In December
2009, we formed Exosome Sciences, Inc. to conduct our future cancer-related
activities.  There exist no material intercompany transactions or
balances between Aethlon and any of our subsidiaries.





LOSS PER
COMMON SHARE





Basic
loss per share is computed by dividing net loss available to common stockholders
by the weighted average number of common shares assumed to be outstanding during
the period of computation. Diluted loss per share is computed similar to basic
loss per share except that the denominator is increased to include the number of
additional common shares that would have been outstanding if the potential
common shares had been issued, and if the additional common shares were
dilutive. As the Company had net losses for all periods presented, basic and
diluted loss per share are the same, since additional potential common shares
have been excluded as their effect would be antidilutive.





The
potentially dilutive common shares outstanding for the quarters ended December
31, 2009 and 2008, which include shares underlying outstanding stock options,
warrants and convertible debentures were 50,105,718 and 43,610,714,
respectively.





PATENTS





We
capitalize the cost of patents, some of which were acquired, and amortize such
costs over the estimated useful life, upon issuance of the
patent.


8


RESEARCH
AND DEVELOPMENT EXPENSES





We
incurred research and development expenses during the three and nine month
periods ended December 31, 2009 and 2008, which are included in various
operating expense line items in the accompanying consolidated statements of
operations. Our research and development expenses in those periods were as
follows:





December
      31,
            
            
            December
      31,2009
            
            
            2008Three
      months ended
            
            $
            155,059
            
            
            $
            143,150Nine
      months ended
            
            $
            389,758
            
            
            $
            522,993





FAIR
VALUE OF FINANCIAL INSTRUMENTS





The
carrying amount of the Company's cash, accounts payable and accrued liabilities
approximates their estimated fair values due to the short-term maturities of
those financial instruments. The fair value of certain convertible notes and
related warrants at December 31, 2009 approximates $587,627 based upon a third
party valuation report that we commissioned. Warrants classified as derivative
liabilities are reported at their estimated fair value, with changes in fair
value being reported in current period results of operations.





Management
has concluded that it is not practical to determine the estimated fair value of
amounts due to related parties because the transactions cannot be assumed to
have been consummated at arm's length, the terms are not deemed to be market
terms, there are no quoted values available for these instruments, and an
independent valuation would not be practicable due to the lack of data regarding
similar instruments, if any, and the associated potential costs.





EQUITY
INSTRUMENTS FOR SERVICES PROVIDED BY OTHER THAN EMPLOYEES





We
account for transactions involving goods and services provided by third parties
where we issue equity instruments as part of the total consideration using the
fair value of the consideration received (i.e., the value of the goods or
services) or the fair value of the equity instruments issued, whichever is more
reliably measurable.





In
transactions, when the value of the goods and/or services is not readily
determinable and (1) the fair value of the equity instruments is more reliably
measurable and (2) the counterparty receives equity instruments in full or
partial settlement of the transactions, we use the following
methodology:





(a)   For
transactions where goods have already been delivered or services rendered, the
equity instruments are issued on or about the date the performance is complete
(and valued on the date of issuance).


(b)   For
transactions where the instruments are issued on a fully vested, non-forfeitable
basis, the equity instruments are valued on or about the date of the
contract.


(c)   For
any transactions not meeting the criteria in (a) or (b) above, we re-measure the
consideration at each reporting date based on its then current stock
value.





IMPAIRMENT
OR DISPOSAL OF LONG-LIVED ASSETS





We review
our long-lived assets for impairment whenever events or changes in circumstances
indicate that their carrying amounts may not be recoverable. If the cost basis
of a long-lived asset is greater than the projected future undiscounted net cash
flows from such asset (excluding interest), an impairment loss is recognized.
Impairment losses are calculated as the difference between the cost basis of an
asset and its estimated fair value. We believe that no impairment occurred at or
during the three months ended December 31, 2009.





BENEFICIAL
CONVERSION FEATURE OF CONVERTIBLE NOTES PAYABLE





The
convertible feature of certain notes payable provides for a rate of conversion
that is below the market value of our common stock. Such feature is normally
characterized as a "Beneficial Conversion Feature" ("BCF"). We record the
estimated fair value of the BCF, when applicable, in the consolidated financial
statements as a discount from the face amount of the notes. Such discounts are
accreted to interest expense over the term of the notes using the effective
interest method.


9


DERIVATIVE
LIABILITIES AND CLASSIFICATION





We
evaluate free-standing derivative instruments (or embedded derivatives) to
properly classify such instruments within equity or as liabilities in our
financial statements. Our policy is to settle instruments indexed to our common
shares on a first-in-first-out basis.





The
classification of a derivative instrument is reassessed at each balance sheet
date. If the classification changes as a result of events during a reporting
period, the instrument is reclassified as of the date of the event that caused
the reclassification. There is no limit on the number of times a contract may be
reclassified.





On
April 1, 2009 we adopted new Financial Accounting Standards Board ("FASB")
guidance that requires us to apply a two-step model in determining whether a
financial instrument or an embedded feature is indexed to our own stock and thus
enables it to qualify for equity classification. We have identified several
convertible debt agreements in which the embedded conversion feature contains
certain provisions that may result in an adjustment of the conversion price,
which results in the failure of the embedded conversion feature to be considered
to be indexed to our stock. Accordingly, under this guidance, we are required to
record the estimated fair value of the embedded conversion feature as a
derivative liability. As a result of the adoption of this guidance, the
estimated fair value of the embedded conversion feature (See SIGNIFICANT RECENT
ACCOUNTING PRONOUNCEMENTS below) was recorded as a derivative liability (at the
date of issuance), and a cumulative effect adjustment was recorded to our
accumulated deficit. In addition, we have re-measured such derivative liability
at estimated fair value as of December 31, 2009 and have recorded the change in
the fair value for the three and nine months ended December 31, 2009 in other
expense (income) in the accompanying Condensed Consolidated Statement of
Operations.





REGISTRATION
PAYMENT ARRANGEMENTS





We
account for contingent obligations to make future payments or otherwise transfer
consideration under a registration payment arrangement separately from any
related financing transaction agreements, and any such contingent obligations
are recognized only when it is determined that it is probable that the Company
will become obligated for future payments and the amount, or range of amounts,
of such future payments can be reasonably estimated. On October 7, 2008, the SEC
declared effective a registration statement that covered all of the shares and
warrants that had previously been generating liquidated damages pursuant to
registration rights agreements and as a result, we ceased recording such
liquidated damages at that time.





However,
the above referenced registration statement ceased being effective in July
2009.  As a result, as of December 31, 2009, we have accrued potential
liquidated damages in the aggregate amount of $351,000, which represents amounts
owed through December 31, 2009, plus the additional estimated amounts that will
be owed through April 2010, at which time we currently expect to have an
effective registration statement back on file with the SEC. The actual amount of
liquidated damages owed for the period subsequent to December 31, 2009 through
the date that the registration statement is declared effective may be more or
less than the amount estimated as of December 31, 2009 in the event that the
actual length of time required for us to achieve an effective registration
statement differs from our current estimate. We also intend to negotiate the
amount of liquidated damages due and, as such, the ultimate amounts we may
actually pay may be less than the amount currently accrued.





STOCK
BASED COMPENSATION





Employee
stock options and rights to purchase shares under stock participation plans are
accounted for under the fair value method. Accordingly, share-based compensation
is measured when all granting activities have been completed, generally the
grant date, based on the fair value of the award. The exercise price of options
is generally equal to the market price of the Company's common stock (defined as
the closing price as quoted on the Over-the-Counter Bulletin Board) on the date
of grant. Compensation cost recognized by the Company includes (a) compensation
cost for all equity incentive awards granted prior to, but not yet vested as of
April 1, 2006, based on the grant-date fair value estimated in accordance with
the original provisions of the then current accounting standards, and (b)
compensation cost for all equity incentive awards granted subsequent to April 1,
2006, based on the grant-date fair value estimated in accordance with the
provisions of subsequent accounting standards. We use a Binomial Lattice option
pricing model for estimating fair value of options granted.





In June
2009, our Chief Executive Officer agreed to suspend the exercise of up to
9,588,243 of his stock options, which allowed us to utilize the shares
underlying those stock options in capital raising activities while we presented
our stockholders with a proposal to increase the number of authorized shares
from 100,000,000 to 250,000,000. That proposal was approved by our stockholders
at our Annual Meeting on September 16, 2009.  Following that approval
we extended the Chief Executive Officer's stock options by the 100 days that he
had unreserved his shares. We valued the change in fair value of
his stock options due to this extension, and based on the change in fair value,
recorded an increase to our stock based compensation expense in the quarter
ended September 30, 2009 of $64,678 for his vested options. For his unvested
options, we recorded an increase to fair value of $15,308 which will be expensed
over the remaining vesting period of those options.


10


The
following table summarizes share-based compensation expenses relating to shares
and options granted and the effect on basic and diluted loss per common share
during the three and nine months ended December 31, 2009 and 2008:





Three
      Months Ended
            
            
            Three
      Months Ended
            
            
            Nine
      Months Ended
            
            
            Nine
      Months EndedDecember
      31, 2009
            
            
            December
      31, 2008
            
            
            December
      31, 2009
            
            
            December
      31, 2008Payroll
      and related
            
            $
            103,093
            
            
            $
            456,640
            
            
            $
            401,840
            
            
            $
            590,832Total
      share-based compensation expense included in net loss
            
            $
            103,093
            
            
            $
            456,640
            
            
            $
            401,840
            
            
            $
            590,832Basic
      and diluted loss per common share
            
            $
            (0.00
            )
            
            $
            (0.01
            )
            
            $
            (0.01
            )
            
            $
            (0.01
            )





We review
share-based compensation on a quarterly basis for changes to the estimate of
expected award forfeitures based on actual forfeiture experience. The cumulative
effect of adjusting the forfeiture rate for all expense amortization is
recognized in the period the forfeiture estimate is changed. The effect of
forfeiture adjustments for the three and nine months ended December 31, 2009 was
insignificant.





The
expected volatility is based on the historic volatility. The expected life of
options granted is based on the "simplified method" as described in the SEC's
guidance due to changes in the vesting terms and contractual life of current
option grants compared to our historical grants.





We did
not issue any stock option grants in the nine months ended December 31,
2009.  In the nine months ended December 31, 2008, we issued 4,050,000
stock option grants.





Options
outstanding that have vested and are expected to vest as of December 31, 2009
are as follows:





WeightedWeighted
            
            
            AverageAverage
            
            
            RemainingNumber
      of
            
            
            Exercise
            
            
            ContractualShares
            
            
            Price
            
            
            Term
      in YearsVested
            
            
            12,789,060
            
            
            $
            0.37
            
            
            
            5.14Expected
      to vest
            
            
            1,700,000
            
            
            
            0.35
            
            
            
            8.67Total
            
            
            14,489,060





At
December 31, 2009, there was approximately $356,000 of unrecognized compensation
cost related to share-based payments which is expected to be recognized over a
weighted average period of 0.86 years.





On
December 31, 2009, our stock options had a negative intrinsic value since the
closing price on that date of $0.30 per share was below the weighted average
exercise price of our stock options.





INCOME
TAXES





Deferred
tax assets and liabilities are recognized for the future tax consequences
attributable to the difference between the consolidated financial statements and
their respective tax basis. Deferred income taxes reflect the net tax effects of
(a) temporary differences between the carrying amounts of assets and liabilities
for financial reporting purposes and the amounts reported for income tax
purposes, and (b) tax credit carryforwards. We record a valuation allowance for
deferred tax assets when, based on our best estimate of taxable income (if any)
in the foreseeable future, it is more likely than not that some portion of the
deferred tax assets may not be realized.


11


SIGNIFICANT
RECENT ACCOUNTING PRONOUNCEMENTS





In May
2009, the FASB issued a new accounting standard related to subsequent events,
which provides guidance on events that occur after the balance sheet date but
prior to the issuance of the financial statements. The new accounting standard
distinguishes events requiring recognition in the financial statements and those
that may require disclosure in the financial statements. Furthermore, the new
accounting standard requires disclosure of the date through which subsequent
events were evaluated. The new accounting standard is effective for interim and
annual periods after June 15, 2009. We adopted the new accounting standard for
the quarter ended June 30, 2009, and have evaluated subsequent events through
February 15, 2010.





In June
2009, the FASB issued a new accounting standard which provides guidance related
to the FASB Accounting Standards Codification and the Hierarchy of Generally
Accepted Accounting Principles - a replacement of a previously issued standard.
The new accounting standard stipulates the FASB Accounting Standards
Codification is the source of authoritative U.S. GAAP recognized by the FASB to
be applied by nongovernmental entities. The new accounting standard is effective
for financial statements issued for interim and annual periods ending after
September 15, 2009. The implementation of this standard during the quarter ended
September 30, 2009 did not have a material impact on our statements of
operations or financial position.





In May
2008, the FASB issued a new accounting standard which provides guidance relating
to accounting for convertible debt instruments that may be settled in cash upon
conversion (including partial cash settlement). This new standard requires
recognition of both the liability and equity components of convertible debt
instruments with cash settlement features. The debt component is required to be
recognized at the fair value of a similar instrument that does not have an
associated equity component. The equity component is recognized as the
difference between the proceeds from the issuance of the note and the fair value
of the liability. The standard also requires an accretion of the resulting debt
discount over the expected life of the debt. Retrospective application to all
periods presented is required and a cumulative-effect adjustment is recognized
as of the beginning of the first period presented. This standard was effective
for us in the first quarter of fiscal year 2010. The adoption of this standard
did not have a material impact on our financial statements.





In June
2008, the FASB issued a new accounting standard which provides guidance relating
to determining whether an instrument (or embedded feature) is indexed to an
entity's own stock and is effective for financial statements issued for fiscal
years beginning after December 15, 2008, and interim periods within those fiscal
years. This standard specifies that a contract that would otherwise meet the
definition of a derivative but is both (a) indexed to our own stock and (b)
classified in stockholders' equity in the statement of financial position would
not be considered a derivative financial instrument. The standard provides a new
two-step model to be applied in determining whether a financial instrument or an
embedded feature is indexed to an issuer's own stock and thus able to qualify
for the standard's scope exception.





We
adopted this new standard effective April 1, 2009. The adoption of the
standard's requirements can affect the accounting for warrants or convertible
debt that contain provisions that protect holders from a decline in the stock
price (or "down-round" protection). For example, warrants with such provisions
will no longer be recorded in equity. Down-round protection provisions reduce
the exercise price of a warrant or convertible instrument if a company either
issues equity shares for a price that is lower than the exercise price of those
instruments or issues new warrants or convertible instruments that have a lower
exercise price. We evaluated whether convertible debt or warrants to acquire
stock of the Company contain provisions that protect holders from declines in
the stock price or otherwise could result in modification of the exercise price
and/or shares to be issued under the respective warrant agreements based on a
variable that is not an input to the fair value of a "fixed-for-fixed" option.
We determined that we have several convertible debt agreements in which the
terms provide for a possible adjustment to the conversion price, and as such,
the embedded conversion feature fails to be indexed solely to our stock under
this pronouncement.





As a
result of the adoption of this standard, we classified the estimated fair value
of the embedded conversion feature of the convertible debt agreement described
above, which was determined to be $279,201, as a derivative liability on April
1, 2009 and recorded a cumulative effect adjustment to retained earnings
(deficit) based on the difference between amounts recognized at the date of
issuance and April 1, 2009.





In April
2009, the FASB issued an amendment to an existing standard which provides
guidance relating to interim disclosures about fair value of financial
instruments. This new standard requires the disclosure of the carrying amount
and the fair value of all financial instruments for interim reporting periods
and annual financial statements of publicly traded companies (even if the
financial instrument is not recognized in the balance sheet), including the
methods and significant assumptions used to estimate the fair values and any
changes in such methods and assumptions. This new standard is effective for
interim reporting periods ending after June 15, 2009. We adopted this
pronouncement during the quarter ended June 30, 2009 without material impact to
our financial statements.


12


The
Sarbanes-Oxley Act of 2002 ("the Act") introduced new requirements regarding
corporate governance and financial reporting. Among the many requirements of the
Act is for management to annually assess and report on the effectiveness of its
internal control over financial reporting under Section 404(a) and for its
registered public accountant to attest to this report under Section 404(b). The
SEC has modified the effective date and adoption requirements of Section 404(a)
and Section 404(b) implementation for non-accelerated filers multiple times,
such that we were required to issue our management report on internal control
over financial reporting in our annual report on Form 10-K for the fiscal year
ended March 31, 2009. Based on current SEC requirements, we will be required to
have our independent registered public accounting firm attest to the
effectiveness of internal controls over financial reporting for our fiscal year
ending March 31, 2011.





Other
recent accounting pronouncements issued by the FASB (including its Emerging
Issues Task Force), the American Institute of Certified Public Accountants, and
the Securities and Exchange Commission did not or are not believed by management
to have a material impact on the Company's present or future consolidated
financial statements.





NOTE 4.
NOTES PAYABLE





Notes
payable consist of the following at December 31, 2009:





Principal12%
      Notes payable, all past due
            
            $
            285,00010%
      Note payable, past due
            
            
            5,000Total
      Notes Payable
            
            $
            290,000





Notes
payable consisted of the following at March 31, 2009:





Principal12%
      Notes payable, all past due
            
            $
            297,50010%
      Note payable, past due
            
            
            5,000Total
      Notes Payable
            
            $
            302,500





12%
NOTES





From
August 1999 through May 2005, we entered into various borrowing arrangements for
the issuance of notes payable from private placement offerings (the "12%
Notes"). On November 4, 2009, a holder of $12,500 of the 12% Notes converted his
principal balance and $15,625 of accrued interest to common stock at the then
current market price of $0.43 per share. At December 31, 2009, 12% Notes with a
principal balance of $285,000 are outstanding, all of which are past due, in
default, and bearing interest at the default rate of 15%. At December 31, 2009,
interest payable on the 12% Notes totaled $303,125.





10%
NOTES





From time
to time, we issued notes payable ("10% Notes") to various investors, bearing
interest at 10% per annum, with principal and interest due six months from the
date of issuance. The 10% Notes required no payment of principal or interest
during the term. The total amount of the original notes issued was $275,000. One
10% Note in the amount of $5,000, which is past due and in default, remains
outstanding at December 31, 2009. At December 31, 2009, interest payable on this
note totaled $4,250.





Management's
plans to satisfy the remaining outstanding balance on these 12% and 10% Notes
include converting the notes to common stock at market value or repayment with
available funds. During the fiscal year ended March 31, 2009, we restructured
our 8% and 9% Notes and for accounting purposes, we recorded an extinguishment
loss of approximately $977,000.


13


NOTE 5.
CONVERTIBLE NOTES PAYABLE





Convertible
Notes Payable consist of the following at December 31, 2009:





NetPrincipal
            
            
            Discount
            
            
            AmountAmended
      Series A 10% Convertible Notes, past due
            
            $
            900,000
            
            
            $
            --
            
            
            $
            900,0002008
      10% Convertible Notes
            
            
            45,000
            
            
            
            (3,507
            )
            
            
            41,493December
      2006 10% Convertible Notes, past due
            
            
            17,000
            
            
            
            --
            
            
            
            17,000May
      & June 2009 10% Convertible Notes
            
            
            300,000
            
            
            
            (152,039
            )
            
            
            147,961July
      & August 2009 10% Convertible Notes
            
            
            668,250
            
            
            
            (329,124
            )
            
            
            339,126October
      & November 2009 10% Convertible Notes
            
            
            380,250
            
            
            
            (380,247
            )
            
            
            3Total
      - Convertible Notes
            
            $
            2,310,500
            
            
            $
            (864,917
            )
            
            $
            1,445,583





Convertible
Notes Payable consisted of the following at March 31, 2009:





Principal
            
            
            Discount
            
            
            AmountAmended
      Series A 10% Convertible Notes, past due
            
            $
            900,000
            
            
            $
            --
            
            
            $
            900,0002008
      10% Convertible Notes
            
            
            45,000
            
            
            
            (8,683
            )
            
            
            36,317December
      2006 10% Convertible Notes, past due
            
            
            17,000
            
            
            
            --
            
            
            
            17,000Restructured
      December 2008 10% ConvertibleNotes
      and Related Convertible Notes
            
            
            1,116,403
            
            
            
            --
            
            
            
            1,116,403Total
      - Convertible Notes
            
            $
            2,078,403
            
            
            $
            (8,683
            )
            
            $
            2,069,720





AMENDED
SERIES A 10% CONVERTIBLE NOTES





At
December 31, 2009, $900,000 of the Amended Series A 10% Convertible Notes
remained outstanding and in default. These notes are convertible into our common
stock at $0.20 per share. At December 31, 2009, interest payable on those notes
totaled $135,000.





2008 10%
CONVERTIBLE NOTES





2008 10%
Convertible Notes in the aggregate amount of $45,000 remain outstanding at
December 31, 2009. These notes are convertible into our common stock at $0.50
per share. At December 31, 2009, interest payable on those notes totaled $6,353.
The notes mature in January and February 2010.


14


DECEMBER
2006 10% CONVERTIBLE NOTES





At
December 31, 2009, $17,000 of the December 2006 10% Notes remained outstanding
and in default. These notes are convertible into our common stock at $0.17 per
share. At December 31, 2009, interest payable on those notes totaled
$7,508.





RESTRUCTURED
DECEMBER 2008 10% CONVERTIBLE NOTES AND RELATED CONVERTIBLE NOTES





None of
the Restructured December 2008 10% Convertible Notes and Related
Convertible  Notes remained outstanding at December 31, 2009. All of
the remaining principal and  accrued interest was converted into
2,511,264 common shares at an average conversion  price of $0.19 per
share during the three months ended December 31, 2009.





MAY &
JUNE 2009 10% CONVERTIBLE NOTES





In May
and June 2009, we raised an aggregate amount of $350,000 from the sale to
accredited investors of 10% convertible notes ("May & June 2009 10%
Convertible Notes"). The May & June 2009 10% Convertible Notes mature at
various dates between November 2010 through December 2010 and are convertible
into our common stock at a fixed conversion price of $0.20 per share prior to
maturity. If the investors opt to convert their convertible debt to our common
stock, then they will receive a matching three year warrant to purchase
unregistered shares of our common stock at a price of $0.20 per share. We have
measured the warrants but have not recorded them given their contingent
terms.





After
consideration of the warrants, we recorded a discount associated with the
beneficial conversion feature of $233,735 related to the May & June 2009 10%
Convertible Notes and we are amortizing that discount over the terms of the May
& June 2009 10% Convertible Notes using the effective interest
method.





During
the three months ended December 31, 2009, the holders of two of the May &
June 2009 10% Convertible Notes converted a total of $50,000 in notes to 250,000
shares of our common stock under the conversion feature of the
notes.  Due to these conversions, we accelerated the remaining
discount of $15,928 associated with those two converted notes and recorded that
amount as interest expense in the three months ended December 31,
2009.  We also issued 250,000 warrants as a result of those
conversions, the fair value of which had been measured on the issuance dates of
the relevant convertible notes using the Binomial lattice method at
$31,550.  We recorded that $31,550 amount as interest expense in the
three months ended December 31, 2009.





At
December 31, 2009, interest payable on those notes totaled $14,194.





JULY
& AUGUST 2009 10% CONVERTIBLE NOTES





In July
and August 2009, we raised an aggregate amount of $668,250 from the sale to
three investment funds of 10% convertible notes ("July & August 2009 10%
Convertible Notes"). Each note carries a one-year term and is convertible into
our common stock at 80% of market with a floor of $0.15 cents and a ceiling of
$0.25 cents per share. As additional consideration, the investors also received
1,336,500 three year warrants to purchase our common stock at $0.50 per share,
although that exercise price is subject to change based on certain conditions.
The conversion feature may additionally be adjusted in the event of future
financing by the Company. Because the conversion feature and warrant exercise
price each can be reset based on future events, they are considered
derivatives.





We
commissioned a valuation study on this transaction from a third party valuation
firm and based on the results of that study, we recorded a discount associated
with the derivative liability of $475,762 associated with the conversion
feature.  We commissioned a valuation of the derivative liability to
measure the fair value of the derivative liability at December 31, 2009 and
based on the results of that study, we recorded a fair value at December 31,
2009 of $597,627.  As a result of this fair value change we recorded a
gain of $122,626 in the three months ended December 31, 2009.





We are
amortizing the discount associated with the July & August 2009 10%
Convertible Notes and associated warrants using the effective interest method.
Deferred financing costs incurred in connection with this financing totaled
$60,750, which were capitalized and are being amortized using the effective
interest method.





At
December 31, 2009, interest payable on those notes totaled
$27,418.


15


OCTOBER
& NOVEMBER 2009 10% CONVERTIBLE NOTES





In
October and November 2009, we raised $430,000 from the sale to accredited
investors of 10% convertible notes ("October & November 2009 10% Convertible
Notes"). The October & November 2009 10% Convertible Notes mature at various
dates between April 2011 and May 2011 and are convertible into our common stock
at a fixed  conversion price of $0.25 per share prior to maturity. The
investors also received matching three year warrants to purchase unregistered
shares of our common stock at a price of $0.25 per share.





We
measured the fair value of the warrants and the beneficial conversion feature of
the notes and recorded a 100% discount against the principal of the
notes.  We are amortizing the discount associated with the October
& November 2009 10% Convertible Notes and associated warrants using the
effective interest method.





Three of
the investors immediately converted their convertible notes totaling $70,000
into 280,000 shares of our common stock under the conversion
formula.  As a result, we accelerated the discount of $70,000
associated with their notes and recorded that amount as interest expense in the
three months ended December 31, 2009.





Deferred
financing costs of $20,250 incurred in connection with this financing were
issued in the form of a convertible note with warrants on the same terms as
those received by the investors.  We capitalized the $20,250 of
deferred financing costs and are amortizing them over the term of the notes
using the effective interest method.





At
December 31, 2009, interest payable on these notes totaled $9,506.





NOTE 6.
EQUITY TRANSACTIONS





In April
2009, we issued 71,519 shares of common stock pursuant to our S-8 registration
statement covering our 2003 Consultant Stock Plan at $0.17 per share in payment
for financial consulting services and research services valued at $12,158 based
on the value of the services.





In April
2009, we issued 1,688,211 shares of common stock as a result of conversions of
$263,478 of convertible notes payable and related accrued interest. The shares
were issued to accredited investors.





In April
2009, an accredited investor exercised a warrant to purchase 555,556 shares of
our common stock at the agreed strike price of $0.18 per share for cash proceeds
of $100,000. We issued that investor a five year warrant to purchase 555,556
shares at $0.18 per share and a conditional warrant to purchase a like number of
shares at the same strike price if that warrant is exercised.





In April
2009, we issued 490,000 shares of restricted common stock valued at the closing
price in payment for investor relations services.





In April
2009, we issued 25,000 shares of common stock pursuant to our S-8 registration
statement covering our 2003 Consultant Stock Plan at $0.22 per share in payment
for business development consulting services valued at $5,500 based on the value
of the services provided.





In April
2009, we issued 32,935 shares of common stock pursuant to our S-8 registration
statement covering our 2003 Consultant Stock Plan at $0.23 per share in payment
for internal controls consulting services valued at $7,575 based on the value of
the services provided.





In April
2009, we issued 12,372 shares of common stock pursuant to our S-8 registration
statement covering our 2003 Consultant Stock Plan at $0.22 per share in payment
for regulatory affairs consulting services valued at $2,660 based on the value
of the services provided.





In April
2009, we issued 80,000 shares of restricted common stock and warrants to
purchase 80,000 shares of common stock in exchange for $15,200. The shares were
issued to an accredited investor.


16


In April
2009, we issued 43,021 shares of common stock pursuant to our S-8 registration
statement covering our 2003 Consultant Stock Plan at $0.17 per share in payment
for financial consulting services valued at $7,744 based on the value of the
services provided.





In April
2009, we issued 70,870 shares of common stock pursuant to our S-8 registration
statement covering our 2003 Consultant Stock Plan at $0.20 per share in payment
for legal services valued at $14,500 based on the value of the services
provided.





In April
2009, we issued 22,817 shares of common stock pursuant to our S-8 registration
statement covering our 2003 Consultant Stock Plan at $0.24 per share in payment
for business development consulting services valued at $5,500 based on the value
of the services provided.





In May
2009, holders of certain convertible notes converted $139,256 of principal and
accrued interest into 878,059 shares of our common stock pursuant to the terms
of the notes at an average conversion rate of approximately $0.16 per
share.





In May
2009, we issued 13,043 shares of common stock pursuant to our S-8 registration
statement covering our 2003 Consultant Stock Plan at $0.23 per share in payment
for regulatory affairs consulting services valued at $3,000 based on the value
of the services provided.





In May
2009, we issued 10,714 shares of common stock pursuant to our S-8 registration
statement covering our 2003 Consultant Stock Plan at $0.28 per share in payment
for regulatory affairs consulting services valued at $3,000 based on the value
of the services provided.





In May
2009, we issued 51,118 shares of common stock pursuant to our S-8 registration
statement covering our 2003 Consultant Stock Plan at $0.19 per share in payment
for financial consulting services valued at $9,713 based on the value of the
services provided.





In May
2009, we issued 22,000 shares of common stock pursuant to our S-8 registration
statement covering our 2003 Consultant Stock Plan at $0.25 per share in payment
for business development consulting services valued at $5,500 based on the value
of the services provided.





In May
2009, we issued 34,602 shares of common stock pursuant to our S-8 registration
statement covering our 2003 Consultant Stock Plan at $0.22 per share in payment
for financial consulting services valued at $7,613 based on the value of the
services provided.





In May
2009, we issued 40,104 shares of restricted common stock at $0.24 in payment for
financial advisory services valued at $9,625 based on the value of the services
provided.





In May
2009, we issued 22,917 shares of common stock pursuant to our S-8 registration
statement covering our 2003 Consultant Stock Plan at $0.24 per share in payment
for business development consulting services valued at $5,500 based on the value
of the services provided.





In June
2009, we issued 20,500 shares of common stock pursuant to our S-8 registration
statement covering our 2003 Consultant Stock Plan at $0.24 per share in payment
for regulatory affairs consulting services valued at $4,920 based on the value
of the services provided.





In June
2009, we issued 57,055 shares of common stock pursuant to our S-8 registration
statement covering our 2003 Consultant Stock Plan at $0.22 per share in payment
for scientific and financial consulting services valued at $12,552 based on the
value of the services provided.





In June
2009, we issued 22,917 shares of common stock pursuant to our S-8 registration
statement covering our 2003 Consultant Stock Plan at $0.24 per share in payment
for business development consulting services valued at $5,500 based on the value
of the services provided.


17


In June
2009, we issued 23,000 shares of common stock pursuant to our S-8 registration
statement covering our 2003 Consultant Stock Plan at $0.23 per share in payment
for regulatory affairs consulting services valued at $5,290 based on the value
of the services provided.





In June
2009, we issued 48,106 shares of common stock pursuant to our S-8 registration
statement covering our 2003 Consultant Stock Plan at $0.22 per share in payment
for scientific and financial consulting services valued at $10,583 based on the
value of the services provided.





In June
2009, we issued 779,956 shares of common stock as a result of conversions of
$143,512 of convertible notes payable and related accrued interest. The shares
were issued to accredited investors.





In June
2009, we issued 16,176 shares of common stock pursuant to our S-8 registration
statement covering our 2003 Consultant Stock Plan at $0.34 per share in payment
for business development consulting services valued at $5,500 based on the value
of the services provided.





On June
29, 2009, Mr. Joyce, our Chief Executive Officer entered into an Option
Suspension Agreement, whereby Mr. Joyce agreed to not exercise his stock options
pending the filing of amended articles of incorporation of the Company
increasing the Company's authorized capital. Accordingly of Mr. Joyce's total
options, 2,857,143 could not be exercised until the amended articles of
incorporation were filed, and 6,731,090 could not be exercised until the later
of June 9, 2010 or the filing of the amended articles of incorporation. We filed
the amendment to our articles of incorporation on September 21, 2009. The
Agreement also provided Mr. Joyce certain protections in the event the Company
shall undergo a change of control transaction while his options are suspended.
Such protections include the right to receive, in the form of cash payments, the
positive value of his options (which remain subject to suspension) at the time
of such transaction.





In
addition, we committed to issue 4,000,000 shares of restricted common stock, to
Mr. Joyce at a price per share of $0.24, which shall vest in equal installments
over a thirty six month period commencing June 9, 2010.





In July
2009, we registered 1,000,000 additional shares under our 2003 Consultant Stock
Plan through the filing of a Form S-8 Registration Statement.





In July
2009, we issued 518,649 shares of common stock as a result of conversions of
$100,566 of convertible notes payable and related accrued interest. The shares
were issued to accredited investors.





In July
2009, we issued 18,333 shares of common stock pursuant to our S-8 registration
statement covering our 2003 Consultant Stock Plan at $0.30 per share in payment
for business development consulting services valued at $5,500 based on the value
of the services provided.





In July
2009, we issued 51,971 shares of common stock pursuant to our S-8registration
statement covering our 2003 Consultant Stock Plan at $0.28 per share in payment
for legal services valued at $14,500 based on the value of the services
provided.





In July
2009, we issued 11,647 shares of common stock pursuant to our S-8 registration
statement covering our 2003 Consultant Stock Plan at $0.34 per share in payment
for regulatory affairs consulting services valued at $3,960 based on the value
of the services provided.





In July
2009, we issued 19,643 shares of common stock pursuant to our S-8 registration
statement covering our 2003 Consultant Stock Plan at $0.28 per share in payment
for business development consulting services valued at $5,500 based on the value
of the services provided.





In July
2009, we issued a convertible promissory note in the principal amount of
$330,000 to an accredited investor. The note is convertible into shares of our
common stock at a price per share that is equal to the lesser of (i) $0.25, or
(ii) the average of the closing bid prices of the common stock for the three
days immediately preceding the conversion date, subject in any case to a floor
of $0.15 per share. The investor also received warrants to purchase 660,000
shares of our common stock at an exercise price of $0.50 per share. See JULY
& AUGUST 2009 10% CONVERTIBLE NOTES in note 5.


18


In August
2009, we issued two convertible promissory note in the principal amount of
$338,250 to two accredited investors. These notes are convertible into shares of
our common stock at a price per share that is equal to the lesser of (i) $0.25,
or (ii) the average of the closing bid prices of the common stock for the three
days immediately preceding the conversion date, subject in any case to a floor
of $0.15 per share. The investors also received warrants to purchase 676,500
shares of our common stock at an exercise price of $0.50 per share. See JULY
& AUGUST 2009 10% CONVERTIBLE NOTES in note 5.





In August
2009, we issued 21,154 shares of common stock pursuant to our S-8 registration
statement covering our 2003 Consultant Stock Plan at $0.26 per share in payment
for business development consulting services valued at $5,500 based on the value
of the services provided.





In August
2009, we issued 14,143 shares of common stock pursuant to our S-8 registration
statement covering our 2003 Consultant Stock Plan at $0.28 per share in payment
for regulatory affairs consulting services valued at $3,960 based on the value
of the services provided.





In August
2009, we issued 22,917 shares of common stock pursuant to our S-8 registration
statement covering our 2003 Consultant Stock Plan at $0.24 per share in payment
for business development consulting services valued at $5,500 based on the value
of the services provided.





In
September 2009, we issued 36,094 shares of common stock pursuant to our S-8
registration statement covering our 2003 Consultant Stock Plan at $0.22 per
share in payment for financial consulting services valued at $7,941 based on the
value of the services provided.





In
September 2009, we issued 20,370 shares of common stock pursuant to our S-8
registration statement covering our 2003 Consultant Stock Plan at $0.27 per
share in payment for business development consulting services valued at $5,500
based on the value of the services provided.





In
September 2009, we issued 16,000 shares of common stock pursuant to our S-8
registration statement covering our 2003 Consultant Stock Plan at $0.24 per
share in payment for regulatory affairs consulting services valued at $3,840
based on the value of the services provided.





In
September 2009, we issued 19,784 shares of common stock pursuant to our S-8
registration statement covering our 2003 Consultant Stock Plan at $0.28 per
share in payment for business development consulting services valued at $5,500
based on the value of the services provided.





In
September 2009, we issued 12,000 shares of common stock pursuant to our S-8
registration statement covering our 2003 Consultant Stock Plan at $0.25 per
share in payment for regulatory affairs consulting services valued at $3,000
based on the value of the services provided.





In
October 2009, we issued 100,000 shares of restricted common stock as a donation
to a scientific research foundation valued at $25,000 based on the closing price
of $0.25.





In
October 2009, we issued 319,033 shares of common stock pursuant to our S-8
registration statement covering our 2003 Consultant Stock Plan at $0.22 per
share in payment for financial consulting services valued at $70,187 based on
the value of the services provided.





In
October 2009, we issued 22,088 shares of common stock pursuant to our S-8
registration statement covering our 2003 Consultant Stock Plan at $0.25 per
share in payment for business development consulting services valued at $5,500
based on the value of the services provided.





In
October 2009, we issued 37,585 shares of common stock pursuant to our S-8
registration statement covering our 2003 Consultant Stock Plan at $0.22 per
share in payment for financial consulting services valued at $8,269 based on the
value of the services provided.


19


In
October 2009, we issued 2,511,264 shares of common stock as a result of
conversions of $481,297 of convertible notes payable and related accrued
interest. The shares were issued to accredited investors.





In
October 2009, we issued 15,231 shares of common stock pursuant to our S-8
registration statement covering our 2003 Consultant Stock Plan at $0.26 per
share in payment for regulatory affairs consulting services valued at $3,960
based on the value of the services provided.





In
October 2009, we issued 11,702 shares of common stock pursuant to our S-8
registration statement covering our 2003 Consultant Stock Plan at $0.47 per
share in payment for business development consulting services valued at $5,500
based on the value of the services provided.





In
October and November 2009, we raised $430,000 through the issuance of 10%
convertible notes to accredited investors. The notes are convertible into our
common stock at a fixed conversion price of $0.25 per share. The investors also
received 1,720,000 three year warrants to purchase shares of our common stock at
$0.25 per share.  We also issued to a finder as deferred offering
costs a convertible note for $20,250 on the same terms as those received by the
investors.  Three of the investors in this financing immediately
converted their notes totaling $70,000 to 280,000 shares of our common stock per
the conversion formula in the notes (see Note 5).





In
November 2009, we issued 117,759 shares of common stock as a result of
conversions of $38,595 of notes payable ($15,200 in a 12% Note Payable, see Note
4, and $10,000 in a May & June 2009 10% Convertible Note, see Note 5) and
related accrued interest. The shares were issued to accredited
investors.





In
November 2009, we issued 14,103 shares of common stock pursuant to our S-8
registration statement covering our 2003 Consultant Stock Plan at $0.39 per
share in payment for business development consulting services valued at $5,500
based on the value of the services provided.





In
November 2009, we issued 89,397 shares of common stock pursuant to our S-8
registration statement covering our 2003 Consultant Stock Plan at $0.36 per
share in payment for legal services valued at $32,451 based on the value of the
services provided.





In
November 2009, we issued 19,688 shares of common stock pursuant to our S-8
registration statement covering our 2003 Consultant Stock Plan at $0.35 per
share in payment for financial consulting services valued at $6,891 based on the
value of the services provided.





In
November 2009, we issued 15,068 shares of common stock pursuant to our S-8
registration statement covering our 2003 Consultant Stock Plan at $0.37 per
share in payment for business development consulting services valued at $5,500
based on the value of the services provided.





In
December 2009, we issued 9,900 shares of common stock pursuant to our S-8
registration statement covering our 2003 Consultant Stock Plan at $0.40 per
share in payment for regulatory affairs consulting services valued at $3,960
based on the value of the services provided.





In
December 2009, we issued 50,313 shares of common stock pursuant to our S-8
registration statement covering our 2003 Consultant Stock Plan at $0.30 per
share in payment for financial consulting services valued at $15,094 based on
the value of the services provided.





In
December 2009, we issued 114,066 shares of common stock pursuant to our S-8
registration statement covering our 2003 Consultant Stock Plan at $0.30 per
share in payment for financial consulting services valued at $34,220 based on
the value of the services provided.


20


In
December 2009, we issued 17,188 shares of common stock pursuant to our S-8
registration statement covering our 2003 Consultant Stock Plan at $0.32 per
share in payment for business development consulting services valued at $5,500
based on the value of the services provided.





In
December 2009, we issued 11,314 shares of common stock pursuant to our S-8
registration statement covering our 2003 Consultant Stock Plan at $0.35 per
share in payment for regulatory affairs consulting services valued at $3,960
based on the value of the services provided.





In
December 2009, we issued 18,333 shares of common stock pursuant to our S-8
registration statement covering our 2003 Consultant Stock Plan at $0.30 per
share in payment for business development consulting services valued at $5,500
based on the value of the services provided.





In
December 2009, we issued 211,665 shares of common stock as a result of the
conversion of a $40,000 convertible note payable (see Note 5) and related
accrued interest.  The shares were issued to an accredited
investor.





NOTE 7.
OTHER CURRENT LIABILITIES





At
December 31, 2009 and March 31, 2009, our other current liabilities were
comprised of the following items:





December
      30,
            
            
            March
      31,2009
            
            
            2009Accrued
      interest
            
            $
            528,100
            
            
            $
            352,204Accrued
      legal fees
            
            
            211,865
            
            
            
            211,865Deferred
      rent
            
            
            921
            
            
            
            --Accrued
      liquidated damages
            
            
            351,000
            
            
            
            --Other
            
            
            85,945
            
            
            
            115,429Total
      other current liabilities
            
            $
            1,177,831
            
            
            $
            679,498





As of the
date of this report, various promissory and convertible notes payable in the
aggregate principal amount of $1,207,000 (as identified in Notes 4 and 5 above)
have reached maturity and are past due. We are continually reviewing other
financing arrangements to retire all past due notes. At December 31, 2009, we
had accrued interest in the amount of $415,496 associated with these defaulted
notes in accrued liabilities payable (see Notes 4 and 5).


21





NOTE 8.
FAIR VALUE MEASUREMENTS





On April
1, 2008, we adopted guidance issued by the FASB that defines fair value, and
establishes a three-level valuation hierarchy for disclosures of fair value
measurement that enhances disclosure requirements for fair value
measures.  Financial instruments measured at fair value on a recurring
basis as of December 31, 2009 are classified based on the valuation technique
level noted in the table below:




Active
      Markets for
              
              
              Significant
              
              
              UnobservableIdentical
              
              
              Observable
              
              
              UnobservableInstruments
              
              
              Inputs
              
              
              InputsTotal
              
              
              Level
      1
              
              
              Level
      2
              
              
              Level
      3Assets:None
              
              $
              --
              
              
              $
              --
              
              
              $
              --
              
              
              $
              --Liabilities:Derivative
      liability
              
              $
              587,627
              
              
              $
              --
              
              
              $
              --
              
              
              $
              587,627





Based on
estimated fair value of the derivative liability at December 31, 2009, we have
recorded a loss of $77,426 and a gain of $167,336 for the three and nine months
ended December 31, 2009, respectively, in other expense (income) in the
accompanying Condensed Consolidated Statements of Operations, based on the
change in fair value in those periods.





The table
below sets forth a summary of changes in the fair value of our Level
3


derivative
liability for the nine months ended December 31, 2009:




RecordedInitial
      FairValue onApril 1,
              
              
              Recorded
      FairValue ofDerivativeLiabilitiesin July
      &
              
              
              Change
      inEstimated FairValue Recognizedin Results of
              
              
              Fair
      ValueatDecember 31,2009
              
              
              August,
      2009
              
              
              Operations
              
              
              2009Derivative
      Liability
              
              $
              279,201
              
              
              $
              475,762
              
              
              $
              (167,336
              )
              
              $
              587,627




NOTE 9.
COMMITMENTS AND CONTINGENCIES





LEGAL
MATTERS





From time
to time, claims are made against us in the ordinary course of business, which
could result in litigation. Claims and associated litigation are subject to
inherent uncertainties and unfavorable outcomes could occur, such as monetary
damages, fines, penalties or injunctions prohibiting us from selling one or more
products or engaging in other activities. In connection with our termination of
our lease at our former headquarters, our former landlord, BMR 3030 Bunker Hill
Street LLC, commenced an action in the Superior Court of California, County of
San Diego, against us on September 14, 2009 seeking damages of approximately
$25,000 for alleged unpaid rent and for surrender of the premises. All amounts
were timely paid and the premises were timely surrendered. This action was
dismissed in November 2009.





The
occurrence of an unfavorable outcome in any specific period could have a
material adverse effect on our results of operations for that period or future
periods. Other than as mentioned here, we are not presently a party to any
pending or threatened legal proceedings.


22


LEASES





In
September 2009, we gave notice that we were terminating the month-to-month
rental arrangement for our offices and laboratory effective October 3, 2009 and
we entered into two new leases for office and laboratory space. The terms of the
new leases are three years and two years, respectively, and the initial base
lease payments are $4,746 per month and $1,667 per month, respectively. We
expect that the cost of our new facilities will be less than the cost of our old
facilities, which was $10,075 per month for rent and common area maintenance
charges.





NOTE 9.
SUBSEQUENT EVENTS





In
January 2010, we issued 36,683 shares of restricted common stock as a patent
license payment valued at $11,500.





In
January 2010, we issued 14,474 shares of common stock pursuant to our S-8
registration statement covering our Amended and Restated 2003 Consultant Stock
Plan at $0.38 per share in payment for business development consulting services
valued at $5,500 based on the value of the services provided.





In
January 2010, we issued 731,251 shares of restricted common stock and 731,251
warrants to purchase our common stock at $0.20 per share to repay $146,250 of
interest on certain convertible debentures accrued through January 31, 2010 (see
Note 5).





In
January 2010, we issued 13,200 shares of common stock pursuant to our S-8
registration statement covering our Amended and Restated 2003 Consultant Stock
Plan at $0.30 per share in payment for regulatory affairs consulting services
valued at $3,960 based on the value of the services provided.





In
January 2010, we issued 15,714 shares of common stock pursuant to our S-8
registration statement covering our Amended and Restated 2003 Consultant Stock
Plan at $0.35 per share in payment for business development consulting services
valued at $5,500 based on the value of the services provided.





In
January 2010, we raised $250,000 from the sale to an accredited investor of 10%
convertible notes.  The convertible notes mature in July 2011 and are
convertible into our common stock at a fixed conversion price of $0.25 per share
prior to maturity. The investor also received matching three year warrants to
purchase unregistered shares of our common stock at a price of $0.25 per
share.  This investment concluded our 10% convertible debt round that
began in October 2009.  In aggregate, we issued $700,250 in 10%
convertible notes in that financing round.





In
February 2010, we entered into an amendment to our lease for our administrative
offices to move into a slightly larger space in the same building.  We
agreed to extend our lease for an additional year and otherwise the terms of the
lease were unchanged.





On
February 12, 2010, we raised $300,000 in cash and received a secured promissory
note in the amount of $300,000 in exchange for the issuance by the Company of a
$660,000 principal amount 10% convertible promissory note (the "Note") to one
accredited investor. The conversion price per share is equal to eighty percent
(80%) of the average of the three lowest closing bid prices of our common stock
as reported by Bloomberg L.P. on the Principal Market for the ten (10) trading
days preceding the conversion date, subject to a maximum price per share of
$0.30 and a minimum price per share of $0.20. The Note is convertible into a
maximum of 3,300,000 shares of our common stock at the minimum price per share
of $0.20. The investor also received 660,000 three-year warrants to purchase
shares of our common stock at $0.50 per share. The Note was issued in a private
placement.


23


ITEM 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS.





The
following discussion of our financial condition and results of operations should
be read in conjunction with, and is qualified in its entirety by, the condensed
consolidated financial statements and notes thereto included in Item 1 in this
Quarterly Report on Form 10-Q. This item contains forward-looking statements
that involve risks and uncertainties. Actual results may differ materially from
those indicated in such forward-looking statements.





FORWARD
LOOKING STATEMENTS





All
statements, other than statements of historical fact, included in this Form 10-Q
are, or may be deemed to be, "forward-looking statements" within the meaning of
Section 27A of the Securities Act of 1933, as amended ("the Securities Act"),
and Section 21E of the Exchange Act. Such forward-looking statements involve
assumptions, known and unknown risks, uncertainties and other factors which may
cause the actual results, performance, or achievements of Aethlon Medical, Inc.
("we", "us" or "the Company") to be materially different from any future
results, performance, or achievements expressed or implied by such
forward-looking statements contained in this Form 10-Q. Such potential risks and
uncertainties include, without limitation, completion of our capital-raising
activities, FDA approval of our products, other regulations, patent protection
of our proprietary technology, product liability exposure, uncertainty of market
acceptance, competition, technological change, and other risk factors detailed
herein and in other of our filings with the Securities and Exchange Commission.
The forward-looking statements are made as of the date of this Form 10-Q, and we
assume no obligation to update the forward-looking statements, or to update the
reasons actual results could differ from those projected in such forward-looking
statements.





THE
COMPANY





We are a
developmental stage medical device company focused on expanding the applications
of our Hemopurifier(R) platform technology which is designed to rapidly reduce
the presence of infectious viruses and other toxins from human blood. As such,
we focus on developing therapeutic devices to treat acute viral conditions
brought on by pathogens targeted as potential biological warfare agents and
chronic viral conditions including HIV/AIDS and Hepatitis-C. The Hemopurifier(R)
combines the established scientific technologies of hemodialysis and affinity
chromatography as a means to mimic the immune system's response of clearing
viruses and toxins from the blood before cell and organ infection can occur. The
Hemopurifier(R) cannot cure these afflictions but can lower viral loads and
allow compromised immune systems to overcome otherwise serious or fatal medical
conditions.





WHERE YOU
CAN FIND MORE INFORMATION





We are
subject to the informational requirements of the Securities Exchange Act and
must file reports, proxy statements and other information with the SEC. The
reports, information statements and other information we file with the
Commission can be inspected and copied at the Commission Public Reference Room,
450 Fifth Street, N.W. Washington, D.C. 20549. You may obtain information on the
operation of the Public Reference Room by calling the SEC at (800) SEC-0330. The
Commission also maintains a Web site (http://www.sec.gov) that contains reports,
proxy and information statements and other information regarding registrants,
like us, which file electronically with the Commission. Our headquarters are
located at 8910 University Center Lane, Suite 255, San Diego, CA 92122. Our
phone number at that address is (858) 459-7800. Our Web site is
http://www.aethlonmedical.com.





RESULTS
OF OPERATIONS





THREE
MONTHS ENDED DECEMBER 31, 2009 COMPARED TO THE THREE MONTHS ENDED DECEMBER
31, 2008





Operating
Expenses





Consolidated
operating expenses for the three months ended December 31, 2009 were $715,977 in
comparison with $867,369 for the comparable quarter a year ago. This decrease of
$151,392, or 18%, was primarily due to a decrease in payroll
and  related expenses of $344,490, which was partially offset by
increases in professional fees of $132,333 and in general and administrative
expenses of $60,765.


24


The
$344,490 decrease in payroll and related expenses was primarily due to a
$314,071  decrease in stock based compensation and to a $26,250
decrease in our research and development related payroll due to staff
reductions.





The
$132,333 increase in our professional fees was primarily due to a $71,319
increase  in our accounting and financial consulting fees. We also had
a $33,000 increase in  fees related to business development work and a
$13,840 increase in our legal fees.   We also had a $11,176
increase in scientific consulting fees, largely related to
the  development of our new manufacturing practices. $211,992, or 75%,
of our professional fees for  the three months ended December 31, 2009
were paid for through issuances of our common stock.





The
$60,765 increase in general and administrative expenses was due primarily to a
$25,000 stock-based contribution to a scientific research institute and to a
$24,079  increase in lab supplies. Those increases were partially
offset by a decrease in our  rent expense of $19,823 as a result of
our move to less expensive facilities.





Other
Expenses (Income)





Other
expenses (income) consist primarily of the change in the fair value of our
derivative liability and interest expense. Other expenses for the three months
ended December 31, 2009 were $769,901 in comparison with $1,477,185 for the
comparable quarter a year ago.





Both
periods include changes in the fair value of derivative liability. For the three
months ended December 31, 2009, the change in the estimated fair value of
derivative liability was a charge of $77,426 and for the three months ended
December 31, 2008, the change in estimated fair value was a charge of
$50,064.





Interest
expense was $692,770 for the three months ended December 31, 2009 compared to
$363,964 in the corresponding prior period, an increase of $328,806. The various
components of our interest expense are shown in the following
table:





Quarter
      Ended
            
            
            Quarter
      Ended12/31/09
            
            
            12/31/08
            
            
            ChangeInterest
      Expense
            
            $
            81,832
            
            
            $
            91,948
            
            
            $
            (10,116
            )Amortization
      of Deferred Financing Costs
            
            
            19,921
            
            
            
            10,930
            
            
            
            8,991Liquidated
      damages
            
            
            351,000
            
            
            
            --
            
            
            
            351,000Amortization
      of Note Discounts
            
            
            240,017
            
            
            
            261,086
            
            
            
            (21,069
            )Total
      Interest Expense
            
            $
            692,770
            
            
            $
            363,964
            
            
            $
            328,806




As noted
in the above table, the most significant factor in the $328,806 increase in
interest expense was the $351,000 in accrued damages that we accrued due to a
lapse in the effectiveness of a registration  statement we had filed
with the SEC. A lesser factor was the $31,550 charge for amortization of
debt discounts related to warrants that  were issued as certain
noteholders converted their notes to our common stock  Those increases
were partially offset by a $52,619 reduction in amortization of note
discounts.





Net
Loss





As a
result of the increased expenses noted above, we recorded a consolidated net
loss of approximately $1,486,000 and $2,345,000 for the quarters ended December
31, 2009 and 2008, respectively.





Basic and
diluted loss per common share were ($0.03) for the three month period ended
December 31, 2009 compared to ($0.05) for the period ended December 31,
2008.


25


NINE
MONTHS ENDED DECEMBER 31, 2009 COMPARED TO THE NINE MONTHS ENDED DECEMBER 31,
2008





Operating
Expenses





Consolidated
operating expenses for the nine months ended December 31, 2009 were $2,190,178
in comparison with $2,223,687 for the comparable period a year ago. This
decrease of $33,509, or 2%, was due to decreases in payroll and
related  expenses of $326,942 which was partially offset by increases
in professional fees  of $252,759 and in general and administrative
expenses of $40,674.





The
$326,942 decrease in payroll and related expenses was primarily due to a
$149,516  decrease in stock based compensation and to a $127,136
decrease in our research and  development-related payroll and a
$49,415 decrease in administrative-related payroll  due to staff
reductions.





The
$40,674 increase in general and administrative expenses arose from a number of
factors,  including a $25,000 stock-based contribution to a scientific
research institute, a $20,695 increase in investor relations and travel expense
which were partially offset by a $14,986 reduction in our insurance expense and
a $38,525 reduction in lab supplies.





The
$252,759 increase in our professional fees arose from a number of
factors,  including a $64,769 charge by a contract manufacturer for
establishing the systems to manufacture our product under the FDA's good
manufacturing practices and also to produce both a trial product manufacturing
run and to produce our first commercial  batch of
products.  Other factors included a $32,635 increase in our accounting
and  financial consulting fees, a $73,454 increase in fees related to
business development work and a $104,656 increase in our investor
relations-related expenses. The above-noted increases were partially offset by a
$32,342 reduction in our scientific consulting fees. $525,201, or approximately
62%, of our professional fees for the nine months ended December 31, 2009 were
paid for through issuances of our common stock.





Other
Expenses (Income)





Other
expenses (income) consist primarily of the change in the fair value of our
derivative liability and interest expense. Other expenses for the nine months
ended December 31, 2009 were $1,017,140 in comparison with $2,932,502 for the
comparable period a year ago.





The nine
month period ended December 31, 2008 included a $1,063,344 loss on
extinguishment of debt and a $607,908 charge for a loss on the issuance of
common stock and warrants in payment of accrued interest and penalties to
certain convertible noteholders. There were no comparable charges in the nine
month period ended December 31, 2009.





Both
periods include changes in the fair value of derivative liability. For the nine
months ended December 31, 2009, the change in the estimated fair value of
derivative liability was a gain of $167,336 and for the nine months ended
December 31, 2008, the change in estimated fair value was a gain of
$213,903.





Interest
expense was $1,185,482 for the nine months ended December 31, 2009 compared to
$1,477,854 in the corresponding prior period, a decrease of $292,372. The
various components of our interest expense are shown in the following
table:





Nine
      Months
            
            
            Nine
      MonthsEnded
            
            
            Ended12/31/09
            
            
            12/31/08
            
            
            ChangeInterest
      Expense
            
            $
            245,639
            
            
            $
            226,386
            
            
            $
            19,253Amortization
      of Deferred Financing Costs
            
            
            33,141
            
            
            
            92,253
            
            
            
            (59,112
            )Liquidated
      damages
            
            
            351,000
            
            
            
            --
            
            
            
            351,000Amortization
      of Note Discounts
            
            
            555,702
            
            
            
            1,159,215
            
            
            
            (603,703
            )Total
      Interest Expense
            
            $
            1,185,482
            
            
            $
            1,477,854
            
            
            $
            (292,372
            )





As noted
in the above table, the primary factor in the $643,372 reduction in interest
expense was the $635,063 reduction in amortization of note discounts. This
occurred because a significant portion of our note discounts were fully
amortized as of December 31, 2009. Amortization of deferred offering costs also
decreased by $59,112.  Partially offsetting the reductions in
amortization of note discounts and of deferred offering costs was the $351,000
in accrued damages that we accrued due to a lapse in the effectiveness of a
registration statement we had filed with the SEC and the $31,550 charge for
the amortization of debt discounts related to warrants that
were issued as certain noteholders converted their notes to our common
stock.


26


Net
Loss





As a
result of the increased expenses noted above, we recorded a consolidated net
loss of approximately $3,207,000 and $5,156,000 for the nine month periods ended
December 31, 2009 and 2008, respectively.





Basic and
diluted loss per common share were ($0.06) for the nine month period ended
December 31, 2009 compared to ($0.12) for the period ended December 31,
2008.





LIQUIDITY
AND CAPITAL RESOURCES





To date,
we have funded our capital requirements for the current operations from net
funds received from the public and private sale of debt and equity securities,
as well as from the issuance of common stock in exchange for services. Our cash
position at December 31, 2009 was approximately $49,000 compared to
approximately $6,000, at March 31, 2009, representing an increase of
approximately $43,000. During the nine months ended December 31, 2009, operating
activities used net cash of approximately $1,381,000, while we received
approximately $1,450,000 from financing activities from the issuance of common
stock and convertible notes. In addition, during this period we used $26,000 in
investing activities related to expenditures related to additions to patents and
patents pending and to fixed asset acquisitions.





During
the nine month period ended December 31, 2009, net cash used in operating
activities resulted primarily from the approximate net loss of $3,207,000 and
the non-cash gain of approximately $167,000 relating to the change in the
estimated fair value of derivative liability offset by the amortization of note
discounts of approximately $557,000, fair market value of common stock of
approximately $516,000 issued in payment for services, approximately $402,000 in
stock-based compensation and the accrual for damages of $351,000.





A
decrease in working capital during the nine months ended December 31, 2009 in
the amount of approximately $204,000 changed our negative working capital
position to approximately ($4,308,000) at December 31, 2009 from a negative
working capital of approximately ($4,104,000) at March 31, 2009.





Our
current deficit in working capital requires us to obtain funds in the short-term
to be able to continue in business, and in the longer term to fund research and
development on products not yet ready for market. Subsequent to December 31,
2009, we raised an additional $250,000 through the sale to accredited investors
of convertible notes and common stock purchase warrants, however, we continue to
seek additional financing.





We are a
development stage medical device company that has not yet engaged in significant
commercial activities. The primary focus of our resources is the advancement of
our proprietary Hemopurifier(R) platform treatment technology, which is designed
to rapidly reduce the presence of infectious viruses and toxins in human blood.
Our focus is to prepare our Hemopurifier(R) to treat chronic viral conditions,
acute viral conditions and viral-based bioterror threats in human clinical
trials.





We plan
to continue research and development activities related to our Hemopurifier(R)
platform technology, with particular emphasis on the advancement of our
treatment for "Category A" pathogens as defined by the Federal Government under
Project Bioshield and the All Hazards Preparedness Act of 2006. The Company has
filed an Investigational Device Exemption ("IDE") with the FDA in order to
proceed with human safety studies of the Hemopurifier(R). Such studies,
complemented by planned IN VIVO and appropriate animal IN VITRO studies, should
allow us to proceed to the Premarket Approval ("PMA") process. The PMA process
is the last major FDA hurdle in determining the safety and effectiveness of
Class III medical devices (of which the Hemopurifier(R) is one).





Subject
to the availability of working capital, we anticipate continuing to increase
spending on research and development over the next 12 months. Additionally,
associated with our anticipated increase in research and development
expenditures, we anticipate purchasing additional amounts of equipment during
this period to support our laboratory and testing operations. Operations to date
have consumed substantial capital without generating revenues, and will continue
to require substantial and increasing capital funds to conduct necessary
research and development and pre-clinical and clinical testing of our
Hemopurifier(R) products, as well as market any of those products that receive
regulatory approval. We do not expect to generate revenue from operations for
the foreseeable future, and our ability to meet our cash obligations as they
become due and payable is dependent for at least the next several years on our
ability to sell securities, borrow funds or a combination thereof. Future
capital requirements will depend upon many factors, including progress with
pre-clinical testing and clinical trials, the number and breadth of our clinical
programs, the time and costs involved in preparing, filing, prosecuting,
maintaining and enforcing patent claims and other proprietary rights, the time
and costs involved in obtaining regulatory approvals, competing technological
and market developments, as well as our ability to establish collaborative
arrangements, effective commercialization, marketing activities and other
arrangements. We expect to continue to incur increasing negative cash flows and
net losses for the foreseeable future, and presently require a minimum of
$150,000 per month to sustain operations.


27


We do not
believe that inflation has had or is likely to have any material impact on our
limited operations.





At the
date of this filing, we plan to invest significantly into purchases of our raw
materials and into our contract manufacturing arrangement subject to
successfully raising additional capital.





In
September 2009, we terminated our month-to-month rental arrangement for our
offices and laboratory and we entered into two new leases for office and
laboratory space. The terms of the new leases are three years and two years,
respectively, and the initial base lease payments are $4,746.15 per month and
$1,667.00 per month, respectively. We expect that the cost of our new facilities
will be less than the cost of our old facilities.





CRITICAL
ACCOUNTING POLICIES





The
preparation of condensed consolidated financial statements in conformity with
accounting principles generally accepted in the United States of America
requires the Company to make a number of estimates and assumptions that affect
the reported amounts of assets and liabilities and disclosure of contingent
assets and liabilities at the date of the financial statements. Such estimates
and assumptions affect the reported amounts of expenses during the reporting
period. On an ongoing basis, we evaluate estimates and assumptions based upon
historical experience and various other factors and circumstances. We believe
our estimates and assumptions are reasonable in the circumstances; however,
actual results may differ from these estimates under different future
conditions.





We
believe that the estimates and assumptions that are most important to the
portrayal of our financial condition and results of operations, in that they
require the most difficult, subjective or complex judgments, form the basis for
the accounting policies deemed to be most critical to us. These critical
accounting policies relate to measurement of stock purchase warrants issued with
notes payable, beneficial conversion feature of convertible notes payable,
impairment of intangible assets and long lived assets, stock compensation, and
the classification of warrant obligations, and evaluation of contingencies. We
believe estimates and assumptions related to these critical accounting policies
are appropriate under the circumstances; however, should future events or
occurrences result in unanticipated consequences, there could be a material
impact on our future financial condition or results of operations.





There
have been no changes to our critical accounting policies as disclosed in our
Form 10-K for the year ended March 31, 2009.





OFF-BALANCE
SHEET ARRANGEMENTS





We have
no obligations required to be disclosed herein as off-balance sheet
arrangements.





ITEM 3.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.





As a
Smaller Reporting Company as defined by rule 12b-2 of the Exchange Act and in
Item 10(f)(1) of Regulation S-K, we are electing scaled disclosure reporting
obligations and therefore are not required to provide the information requested
by this item.





ITEM 4T.
CONTROLS AND PROCEDURES.





DISCLOSURE
CONTROLS AND PROCEDURES





Under the
supervision and with the participation of our management, including our Chief
Executive Officer, who is also our acting Chief Financial Officer, we evaluated
the effectiveness of the design and operation of our disclosure controls and
procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act) as
of the end of the period covered by this Quarterly Report.





Based on
such evaluation, our Chief Executive Officer and Chief Financial Officer
concluded that, as of the end of such period, our disclosure controls and
procedures are effective in recording, processing, summarizing and reporting, on
a timely basis, information required to be disclosed by us in the reports that
we file or submit under the Exchange Act and are effective in ensuring that
information required to be disclosed by us in the reports that we file or submit
under the Exchange Act is accumulated and communicated to our management,
including our Chief Executive Officer and Chief Financial Officer, as
appropriate to allow timely decisions regarding required
disclosure.





CHANGES
IN INTERNAL CONTROL OVER FINANCIAL REPORTING





There
have been no changes in our internal control over financial reporting during the
last fiscal quarter that have materially affected, or are reasonably likely to
materially affect, our internal control over financial
reporting.


28


PART II.
OTHER INFORMATION





ITEM 1.
LEGAL PROCEEDINGS.





From time
to time, claims are made against us in the ordinary course of business, which
could result in litigation. Claims and associated litigation are subject to
inherent uncertainties and unfavorable outcomes could occur, such as monetary
damages, fines, penalties or injunctions prohibiting us from selling one or more
products or engaging in other activities. In connection with our termination of
our lease at our former headquarters, our former landlord, BMR 3030 Bunker Hill
Street LLC, commenced an action in the Superior Court of California, County of
San Diego, against us on September 14, 2009 seeking damages of approximately
$25,000 for alleged unpaid rent and for surrender of the premises. All amounts
were timely paid and the premises were timely surrendered. This action was
dismissed in November 2009.





The
occurrence of an unfavorable outcome in any specific period could have a
material adverse effect on our results of operations for that period or future
periods. Other than as set forth here, we are not presently a party to any
pending or threatened legal proceedings.





ITEM 1A.
RISK FACTORS.





As a
Smaller Reporting Company as defined by rule 12b-2 of the Exchange Act and in
Item 10(f)(1) of Regulation S-K, we are electing scaled disclosure reporting
obligations and therefore are not required to provide the information requested
by this item.





ITEM 2.
UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.





During
the quarter ended December 31, 2009, we issued the following securities which
were not registered under the Securities Act of 1933, as amended, and have not
been included previously in a Current Report on Form 8-K. We did not employ any
form of general solicitation or advertising in connection with the offer and
sale of the securities described below. In addition, we believe the purchasers
of the securities are "ACCREDITED INVESTORS" for the purpose of Rule 501 of the
Securities Act. For these reasons, among others, the offer and sale of the
following securities were made in reliance on the exemption from registration
provided by Section 4(2) of the Securities Act or Regulation D promulgated by
the SEC under the Securities Act:





In
October 2009, we issued 2,511,264 shares of common stock as a result of
conversions of $481,297 of convertible notes payable and related accrued
interest. The shares were issued to accredited investors.





In
October and November 2009, we raised $430,000 through the issuance of 10%
convertible notes to accredited investors. The notes are convertible into our
common stock at a fixed conversion price of $0.25 per share. The investors also
received 1,720,000 three year warrants to purchase shares of our common stock at
$0.25 per share.  We also issued to a finder as deferred offering
costs a convertible note for $20,250 on the same terms as those received by the
investors.  Three of the investors in this financing immediately
converted their notes totaling $70,000 to 280,000 shares of our common stock per
the conversion formula in the notes.





In
November 2009, we issued 117,759 shares of common stock as a result of
conversions of $38,595 of notes payable ($15,200 in a 12% Note Payable and
$10,000 in a May & June 2009 10% Convertible Note) and related accrued
interest. The shares were issued to accredited investors.




In
December 2009, we issued 211,665 shares of common stock as a result of the
conversion of a $40,000 convertible note payable and related accrued
interest.  The shares were issued to an accredited
investor.





ITEM 3.
DEFAULTS UPON SENIOR SECURITIES.





As of the
date of this report, various promissory and convertible notes payable in the
aggregate principal amount of $1,207,000 have reached maturity and are past due.
We are continually reviewing other financing arrangements to retire all past due
notes. Additionally, on July 30, 2008, the holders of the Amended Series A
Convertible Notes notified us that we were in default on the notes due to our
failure to register the warrants by March 31, 2008 and for failing to make
required interest payments. At December 31, 2009, we had accrued interest in the
amount of $415,496 associated with these notes and accrued liabilities
payable.





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





We did
not submit any matters to a vote of security holders during the quarter ended
December 31, 2009.


29


ITEM 5.
OTHER INFORMATION.





Beginning
in October and to date through February 2010, we have raised $680,000 through
the issuance in a private placement of 10% convertible notes to accredited
investors. The notes are convertible into 2,720,000 shares of our common stock
at a fixed conversion price of $0.25 per share. The investors also received
2,720,000 three year warrants to purchase shares of our common stock at $0.25
per share. We also issued to a finder as deferred offering costs a convertible
note for $20,250 on the same terms as these received by the
investors.





In
February 2010, we entered into an amendment to our lease for our administrative
offices to move into a slightly larger space in the same building.  We
agreed to extend our lease for an additional year and otherwise the terms of the
lease were unchanged.





On
February 12, 2010, we raised $300,000 in cash and received a secured promissory
note in the amount of $300,000 in exchange for the issuance of a $660,000
principal amount 10% convertible promissory note (the "Note") to one accredited
investor. The conversion price per share is equal to eighty percent (80%) of the
average of the three lowest closing bid prices of our common stock as reported
by Bloomberg L.P. on the Principal Market for the ten (10) trading days
preceding the conversion date, subject to a maximum price per share of $0.30 and
a minimum price per share of $0.20. The Note is convertible into a maximum of
3,300,000 shares of our common stock at the minimum price per share of $0.20.
The investor also received 660,000 three-year warrants to purchase shares of our
common stock at $0.50 per share. The Note was issued in a private
placement.








ITEM
6.  EXHIBITS.





(a)
Exhibits. The following documents are filed as part of this report:





3.1
            Articles
      of Incorporation of Aethlon Medical, Inc., as amended
  (1)3.2
            Bylaws
      of Aethlon Medical, Inc. (1)10.1
            10%
      Convertible Note*10.2
            Class
      C Common Stock Purchase Warrant*10.3
            First
      Amendment to Lease, dated as of February 1, 2010, between Glenborough
      Aventine, LLC and Aethlon Medical, Inc.*10.4
            Securities
      Purchase Agreement, dated as of February 12, 2010*10.5
            Convertible
      Promissory Note, dated February 12, 2010*10.6
            Warrant
      to Purchase Common Stock, dated February 12, 2010*10.7
            Secured
      Promissory Note, dated February 12, 2010*31.1
            Certification
      of Principal Executive Officer and Principal Financial Officer pursuant to
      Securities Exchange Act rules 13a- 15 and 15d-15(c) as adopted pursuant to
      section 302 of the Sarbanes-Oxley Act of 2002.*32.1
            Certification
      of James A. Joyce, Principal Executive Officer and Principal Financial
      Officer pursuant to 18 U.S.C. section 1350, as adopted pursuant to section
      906 of the Sarbanes-Oxley Act of
2002.*





* Filed
herewith.





(1)
Incorporated by reference to the exhibit of the same number to the Company's
Quarterly Report on Form 10-Q for the period ended September 30,
2009.


30








SIGNATURES





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







AETHLON
      MEDICAL, INC.Date:
      FEBRUARY 16, 2010
              By:
              /s/ JAMES
      A. JOYCEJAMES
      A. JOYCECHAIRMAN,
      PRESIDENT, CHIEFACCOUNTING
      OFFICER ANDCHIEF
      EXECUTIVE OFFICER





31