U.S. Securities and Exchange Commission

Washington, D.C. 20549

Form 10-QSB

(Mark One)

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

For the quarterly period ended March 31, 2006

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

For the transition period from to

Commission file no. 0-24921

Power3 Medical Products, Inc.

(Exact name of small business issuer as specified in its charter)

New York		65-0565144
(State or other jurisdiction of		(I.R.S. Employer
incorporation or organization)		Identification No.)

3400 Research Forest Drive, Suite B2-3

Woodlands, Texas 77381

(Address of principal executive offices)

(281) 466-1600

(Issuer’s telephone number)

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

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

As of March 31, 2006, there were 69,600,348 shares of voting common stock of the registrant issued and outstanding.

Transitional Small Business Disclosure Format (check one): Yes o No ý

I. FINANCIAL INFORMATION

Item 1. Financial Statements

POWER3 MEDICAL PRODUCTS, INC.

(A Development Stage Enterprise)

CONDENSED BALANCE SHEET AS OF March 31, 2006

(unaudited)

ASSETS
CURRENT ASSETS
Cash and cash equivalents	$	163,191
All Other Current Assets	36,149
Total Current Assets	199,340
FIXED ASSETS
Furniture, Fixtures and Equipment (Net of accumulated depreciation of $72,004)	63,930
Intellectual Property	179,786
Total Fixed Assets	243,716
OTHER ASSETS
Goodwill	13,371,776
Deferred Finance Costs	284,715
Deposits	25,900
Total Other Assets	13,682,391

TOTAL ASSETS	$	14,125,447

LIABILITIES AND STOCKHOLDER’S EQUITY
CURRENT LIABILITIES
Accounts Payable	$	998,007
Notes Payable-in default	2,089,131
Convertible Debentures-in default	107,280
Other Current Liabilities	945,663
Derivative Liabilities	1,975,089

TOTAL LIABILITIES	$	6,115,170

STOCKHOLDER’S EQUITY
Common Stock-$0.001 par value:150,000,000 shares authorized; 69,600,348 shares issued and outstanding	69,900
Additional Paid-In Capital	58,375,402
Deferred Compensation Expense	(1,717,766		)
Deficit accumulated before entering development stage	(11,681,500		)
Deficit accumulated during development stage	(37,035,759		)
Total Stockholder’s Equity	8,010,277
TOTAL LIABILITIES AND STOCKHOLDERS EQUITY	$	14,125,447

See notes to the condensed financial statements.

POWER3 MEDICAL PRODUCTS, INC.

(A Development Stage Enterprise)

BALANCE SHEETS

AS OF DECEMBER 31, 2005

	2005
ASSETS

CURRENT ASSETS
Cash and cash equivalents	$	1,399
Accounts receivable
Prepaid expenses and other current assets	21,092
Total current assets	22,491

OTHER ASSETS
Goodwill	13,371,776
Deferred finance costs, net	290,027
Intangible assets, net	179,786
Furniture, fixtures and equipment, net	70,751
Deposits	25,900

TOTAL ASSETS	$	13,960,730

LIABILITIES AND STOCKHOLDER’S EQUITY
CURRENT LIABILITIES
Accounts payable and accrued liabilities	$	1,003,331
Notes payable—in default	1,285,739
Convertible debentures—in default	75,279
Other current liabilities	916,857
Derivative liabilities	1,454,936
Total current liabilities	4,736,142

STOCKHOLDERS’ EQUITY
Common Stock-$0.001 par value:150,000,000 shares authorized; 65,215,121 shares issued and outstanding	65,215
Additional paid-in capital	57,773,506
Deferred compensation	(4,802,621		)
Loss accumulated before entering development stage	(11,681,500		)
Loss accumulated during the development stage	(32,130,011		)
Total stockholders’ equity	9,224,588

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY	$	13,960,730

POWER3 MEDICAL PRODUCTS, INC.

(A Development Stage Enterprise)

STATEMENTS OF OPERATIONS

(unaudited)

	For the three month period ended March 31, 2006			For the three month period ended March 31, 2005			Development Stage from May 18, 2004 to March 31, 2006
				(as restated)
REVENUES:
Sales	$
Other revenue							4,000
Total revenue	$						4,000

COST OF GOODS SOLD:
Production costs
Total cost of goods sold	$

GROSS PROFIT							4,000

OPERATING EXPENSES:
Stock based compensation	$	3,084,855		3,356,775			22,959,712
Employee compensation and benefits	451,788			309,959			2,536,160
Professional and consulting fees	187,924			182,766			8,267,767
Occupancy and equipment	39,345			56,744			342,324
Travel and entertainment	15,391			22,006			171,016
Other selling, general and administrative expenses	28,684			142,194			634,290
Total operating expenses	(3,807,987		)	(4,070,444		)	(34,911,269		)

LOSS FROM OPERATIONS	$	(3,807,987	)	(4,070,444		)	(34,907,269		)

OTHER INCOME AND (EXPENSE):
Derivative income (expense)	$	(520,154	)	718,846			3,070,078
Interest income				225			1,474
Other income (expense)							(715,077		)
Interest expense	(577,607		)	(19,506		)	(1,103,991		)
Total other income(expense)	$	(1,097,761	)	699,565			1,252,484

NET LOSS	$	(4,905,748	)	$	(3,370,879	)	(33,654,785		)

NET LOSS PER SHARE	$	(0.07	)	$	(0.05	)	$	(0.52	)

Weighted average number of shares outstanding	67,759,930			65,345,121			64,827,754

POWER 3 MEDICAL PRODUCTS, INC

(A Development Stage Enterprise)

CONDENSED STATEMENTS OF CASH FLOWS

(unaudited)

					Development
	For the Three		For the Three		Stage Results
	Months Ended		Months Ended		May 18, 2004 -
	March 31 2006		March 31 2005		March 31, 2006
	(as restated)
Operating Activities:
Net Loss	(4,905,748	)	(3,370,879	)	(33,654,785	)
Adjustment to reconcile net loss to net cash used in operating activities:
Stock based services and compensation	3,442,507		3,356,775		30,786,612
Stock issued to retire preferred stock and debt					4,236
Derivative (income) expense	520,154		(718,846	)	(3,070,078	)
Depreciation and amortization	6,820		15,564		72,002
Amortization of debt discount and finance costs	212,440		14,199		334,614
Other					(34,935	)
Decrease(increase) in deposits					(25,900	)
Decrease(increase) in prepaids	(15,057	)			(36,149	)
Increase (decrease) in Deferred finance costs			(300	)	290,027
Increase(decrease) in accounts payable and accrued liabilities and other	23,482		249,884		1,707,810

Net cash used in Operating Activities	(715,402	)	(453,603	)	(3,626,546	)

INVESTING ACTIVITIES
Capital expenditures, net			(2,822	)	(135,933	)
Increase (decrease) in other assets			(1,980	)	(179,786	)
Net cash used in Investing Activities			(4,802	)	(315,719	)

FINANCING ACTIVITIES
Proceeds from CD, warrants and investment rights			338,000		1,197,041
Adjustment related to derivatives	198,865				198,865
Proceeds from borrowings under notes payable (net)	429,400				1,810,208
Proceeds from sale of common stock, net	248,929				896,746

Net cash provided by financing activities	877,194		338,000		4,102,860

Net increase (decrease) in cash and cash equivalents	161,792		(120,405	)	160,595

Cash and cash equivalents, beginning of period	1,399		158,301		2,596

Cash and cash equivalents, end of period	163,191		37,896		163,191

	For the Three months ended March 31, 2006	For the Three months ended March 31, 2005	Cumulative during Development Stage May 18, 2004 to March 31, 2006

Cash paid for:
Interest	0	0	0
Income taxes	0	0	0

Non-cash transactions:
Conversion of convertible notes payable and accrued interest to common stock
Conversion of accrued payroll to preferred stock
Conversion of stockholder advances to notes payable			—
Conversion of notes payable to equity	—
Conversion of preferred stock to common stock
Conversion of other liabilities to stockholder advances
Issuance of warrants in connection with services	90,000
Issuance of warrants in connection with convertible debentures	—

See notes to the condensed financial statements.

POWER 3 MEDICAL PRODUCTS, INC

(A Development Stage Enterprise)

NOTES TO CONDENSED FINANCIAL STATEMENTS

(unaudited)

Note 1. ORGANIZATION, PRINCIPAL ACTIVITIES AND BASIS OF PRESENTATION

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

Prior to May 17, 2004, the Company had one direct subsidiary, Tenthgate, Inc. (“Tenthgate”), a Nevada corporation formerly known as Power3 Medical, Inc. Prior to this date, Tenthgate was accounted for, by Power3, as a wholly-owned subsidiary, operating as a “development stage company”, under the cost method. As part of the transaction which involved the acquisition of substantially all the assets and certain liabilities from Advanced BioChem, now known as Industrial Enterprises of America, it was agreed that Power3 would distribute the shares of its subsidiary, Tenthgate, to its then existing shareholders. To fulfill this obligation, the shares of Tenthgate were transferred to a trustee for distribution to the shareholders of Power3 as of May 17, 2004. Tenthgate was spun off because the management of Power3, in place prior to May 17, 2004, desired to continue to own and eventually operate this subsidiary. At the time of the spinoff, Tenthgate was granted the rights to market a product line that had previously been marketed by Power3, but which the company had decided to abandon. Tenthgate had not been an operating company, and their management has apparently abandoned any plans to market the product as evidenced by their SEC filings, specifically their amended 10-QSB filed for the quarterly period ending January 31, 2005, wherein they specifically state that they are a “development stage company.” The prior operations of the company which are reflected in the financial statements as occurring prior to reentering the development stage were the operations the Company had decided to abandon and which were transferred to the prior shareholders under the control of prior management. Any activities since May 17, 2004, are not consolidated from Power3 because Power3 does not now own or control the operations or activities of Tenthgate, nor are their activities associated with Power3 in any manner whatsoever.

In 2003, the Company was an operating company, marketing devices to aid surgical procedures. Prior to May 18, 2004, the products had received only minor market acceptance and sales had slowed to the point that Power3 was searching for other products and markets to increase its presence in the healthcare industry. In early 2004, Power3 became aware of a biotech company that appeared to have a set of assets and intellectual properties that it required to more effectively pursue its business model. That company, named Advanced BioChem, doing business as ProteEx, now known as Industrial Enterprises of America, provided contract-for-fee lab services analyzing protein biomarkers. At the conclusion of negotiations with Advanced BioChem, Power3 entered into an Asset Purchase Agreement dated May 18, 2004, whereby it purchased substantially all the assets and intellectual properties of Advanced BioChem, and assumed certain liabilities, as scheduled in the agreement, from Advanced BioChem. After the transaction, certain employees from Advanced BioChem became employees of Power3 and were later issued employment agreements by Power3. As consideration in the Asset Purchase Agreement, Power3 issued 15,000,000 shares of common stock to Advanced BioChem.

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

Note 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

The Company’s financial statements provide for (i) the classification of warrants as liabilities, at fair value, (ii) the classification of embedded conversion and other features embedded in the convertible debentures and investment rights as liabilities at fair value and (iii) the amortization of discounts that resulted in the host instruments using the effective interest method. This revised accounting is required because, under current accounting standards, financial instruments, such as warrants and embedded conversion features that are indexed to a Company’s common stock, are classified as liabilities when either (a) the holder possesses rights to net-cash settlement or (b) physical or net-share settlement is not within the control of the Company. In such instances, net-cash settlement is assumed for financial accounting and reporting, even when the terms of the underlying contracts do not provide for net-cash settlement. Such financial instruments are initially recorded at fair value and subsequently adjusted to fair value at the close of each reporting period. This accounting will be utilized in the accounting for these instruments until the Company reaquires the ability to share settle the instruments or physically settles the instruments through other means. Also see Note 8.

Financial Instruments and Concentrations of Credit Risk

The Company’s financial instruments consist of cash and cash equivalents, accounts receivable, accounts payable, accrued expenses, notes payable, derivative financial instruments, other current liabilities, and convertible debentures. Management believes the carrying values of cash and cash equivalents, accounts payable, accounts payable and accrued expenses, notes payable, and other current liabilities approximate their fair values due to their short-term nature. The convertible debentures have a face value and carrying value of $107,280 and $1,400,000, respectively and the Trinity notes payable have a face value and carrying value of $302,750 and $311,000, respectively

The Company generally does not use derivative financial instruments to hedge exposures to cash-flow risks or market-risks that may affect the fair values of its financial instruments. However, certain other financial instruments, such as warrants and embedded conversion features that are indexed to the Company’s common stock, are classified as liabilities when either (a) the holder possesses rights to net-cash settlement or (b) physical or net-share settlement is not within the control of the Company. In such instances, net-cash settlement is assumed for financial accounting and reporting, even when the terms of the underlying contracts do not provide for net-cash settlement. Such financial instruments are initially recorded at fair value and subsequently adjusted to fair value at the close of each reporting period.

The caption Derivative Financial Instruments consists of (i) the fair values associated with derivative features embedded in the Convertible Debentures and (ii) the fair values of the detachable warrants and additional investment rights that were issued in connection with the debenture financing arrangements. (See Note 8. Financing Arrangements)

Financial instruments that potentially subject the Company to significant concentrations of credit risk consist primarily of cash and cash equivalents. The Company occasionally maintains cash and cash equivalents balances in excess of federally insured limits. The Company has not experienced any losses in such accounts.

Principles of Consolidation and Investments

During 2003, the Company accounted for its investment in its subsidiary, Tenthgate, Inc. under the cost method. As described in Note 1, the Company’s former subsidiary, known as Tenthgate, Inc., is not consolidated for periods after May 17, 2004, because the Company, in May of 2004, distributed its common stock ownership in Tenthgate to a trustee for distribution to the shareholders of record as of May 17, 2004. Power3 does not now own or control Tenthgate, Inc.’s activities or operations in any manner whatsoever. Since Tenthgate, Inc. was spun off in May, 2004, as described in Item I, it is not consolidated for periods subsequent to that transaction..

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make certain 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. The reported amounts of revenues and expenses during the reporting period may be affected by the estimates and assumptions management is required to make. Estimates that are critical to the accompanying financial statements include assessing the impact of contingencies and the amortization periods for the debt issuance costs and debt discount on the convertible debentures (see Note 7) as well as estimating depreciation and amortization periods of tangible and intangible assets, and long-lived impairments, among others. The markets for the Company’s products are characterized by intense competition, evolving standards and price competition, all of which could impact the future realizability of the Company’s assets. Estimates and assumptions are reviewed periodically and the effects of revisions are reflected in the financial statements in the period they are determined to be necessary.

Furniture, Fixtures and Lab Equipment

Furniture, fixtures and lab equipment are stated at cost. Major additions are capitalized, while minor additions and maintenance and repairs, which do not extend the useful life of an asset, are expensed as incurred. Depreciation and amortization are provided using the straight-line method over the assets’ estimated useful lives. At March 31, 2006, certain lab equipment having a net book value of approximately $37,500 serves as security for certain liabilities.

Debt Discounts and Deferred Finance Costs

Debt discounts and deferred finance costs are being amortized through periodic charges to interest expense over the maximum term of the convertible debentures of three years using the effective interest method. Amortization of debt discounts amounted to $207,128 for the quarter ended March 31, 2006.

Long-Lived Assets

Statement of Financial Accounting Standards (SFAS) 142 “Accounting for Intangible Assets” provides that goodwill is not subject to periodic amortization, but is evaluated at least annually for impairments. The goodwill acquired by the Company at the time of the May 18, 2004 transaction was evaluated at March 31, 2006, and for the years ended December 31, 2005 and 2004. Goodwill was determined to not be impaired because the fair value of the reporting unit, based on the market capitalization of the Company, exceeded the carrying value of the reporting unit, based on assets minus liabilities, at year end in 2004 and 2005 and at March 31, 2006.

Net Loss Per Share

Net loss per share is computed in accordance with SFAS No. 128 “Earnings per Share” (“SFAS No. 128”) and SEC Staff Accounting Bulletin No. 98 (“SAB 98”). Under the provisions of SFAS No. 128 and SAB 98, basic net loss per share is computed by dividing the net loss available to common stockholders for the period by the weighted average number of common shares outstanding during the period. Diluted net loss per share is computed by dividing the net loss, adjusted for using the “if-converted method” for

convertible securities, for the period by the weighted average number of common and common equivalent shares (using the “treasury-stock” method) outstanding during the period. In periods in which common stock equivalents would be anti-dilutive, such shares are ignored in the loss per share calculations because they would have an anti-dilutive effect.

Reclassification of Liabilities

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

In addition, since the Event of Default occurred on April 25, 2005, Power3 now recognizes the Mandatory Prepayment Amount, as a Current Liability, as described in the debenture agreements as due in case an Event of Default occurs.

Stock – Based Compensation

The Company accounts for equity instruments awarded to employees for services based on the fair value of common stock issued and the intrinsic value of stock options and warrants. The accompany accounts for all equity instruments issued to those other than employees based on the fair value of the consideration received or the fair value of the equity instruments, whichever is more reliably measurable. Fair value is measured based on the closing market price of the common stock on the effective date of the agreement or Board resolution, using the Black Scholes valuation model.

During the 1^st quarter of 2006, the Company amortized $3,025,493 to stock-based compensation for employees who had been issued stock in May, 2004; $59,362 for warrants issued in 2004 and 2005; and $179,635 for stock issued to consultants and others for services.

Income Taxes

The Company computes income taxes using the asset and liability method in accordance with Financial Accounting Standards Statement No. 109 “Accounting for Income Taxes” (“SFAS 109”). Under SFAS 109, deferred taxes are recognized for the tax consequences of temporary differences by applying enacted statutory rates applicable to future years to differences between the financial statement carrying amounts and the tax basis of existing assets and liabilities. Also, the effect on deferred taxes of a change in tax rates is recognized in income in the period that included the enactment date. There were no significant temporary differences at March 31, 2006.

Research and Development

Research and development costs, which approximated $14,907 for the quarter ended March 31, 2006, were expensed as incurred.

Cash Equivalents

For purposes of the statements of cash flows, the Company considers all highly liquid debt instruments purchased with a maturity of three months or less to be cash equivalents.

Revenue Recognition

In 2004, the Company shipped its product directly from the outsource manufacturer to the customer without taking ownership or possession of its products. All shipments were FOB destination with freight allowed and payment terms were net 30 days after shipment. Accordingly, revenue was recognized upon delivery.

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

Advertising Costs

Advertising costs are expenses as incurred. Advertising expenses were $-0- for each of the years ended December 31, 2005 and December 31, 2004. No advertising expenses were incurred during the quarter ended March 31, 2006.

Note 3. GOING CONCERN

The Company’s financial statements are presented on a going concern basis, which contemplates the realization of assets and satisfaction of liabilities in the normal course of business. The Company is in the development stage and has primarily been involved in research and development and capital raising activities; as such the Company has incurred significant losses from operations during 2004 and 2005.

As a result, the Company has an immediate need for capital to continue its operations, and it will need to raise significant additional funds to implement its business plan. This cash will have to come from equity sales and/or borrowings as management has projected that the Company will need significant additional capital for development and other ongoing operational activities before it will have any anticipated revenue generating products. The actual amount of funds that the Company will need will be determined by many factors, some of which are beyond the Company’s control. These factors include:

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

• The progress and results of research and product development;

• The costs and timing of obtaining new patent rights;

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

• Regulatory changes and competition and technological developments in the market.

A current possibility available to the Company is to raise the remaining funds of $1,600,000 potentially available to them pursuant to the Securities Purchase Agreement dated October 28, 2004 (the “Agreement”). These funds will be immediately reduced by the payment of certain delinquent payables of approximately $1,597,500 of certain bridge financing received in 2005 and 2006. The Company is in immediate need for capital to continue its operations and as such its ability to continue as a going concern is subject to its ability to generate a profit or obtain necessary funding from outside sources. Management believes that even though the Company currently has limited cash resources and liquidity, assuming exercise of the warrants and additional investment rights specified in the Agreement, that the net funds available from the final closing under such Agreement will allow the Company to continue operations through June, 2006. In the event the final closing and sale of $1,600,000 in aggregate principal amount of debentures occurs, but the warrants and additional investment rights are not exercised, the Company anticipates that it will need to raise additional capital prior to June, 2006 to meet its operating costs. However, the Company is currently in default under the conditions set forth in the Agreement as well as the debentures and registration rights agreement and consequently, there is no assurance that the Company will be successful in completing the sale and issuance of the remaining $1,600,000 aggregate principal amount of debentures and/or the additional investments rights pursuant to the Agreement. If the Company is unsuccessful in the closing of the sale and issuance of the $1,600,000

aggregate principal amount of debentures at the final closing, the Company will be required to obtain alternative financing, sell or license some of its technology, and/or curtail or cease its operations. Any such funding may significantly further dilute existing shareholders or may limit the Company’s rights to its technology. Moreover, the increase in the number of shares available in the public marketplace may reduce the market price for the Company’s common stock, and consequently, the price investors may receive at the time of sale. The financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the possible inability of the Company to continue as a going concern.

Note 4. LOSS PER SHARE

At December 31, 2005, common stock options were excluded from the fully diluted loss per share calculations because the effects would be anti-dilutive:

• 2,500,000 warrants, and additional investment rights having a value of $2,500,000, which were issued to certain accredited investors on October 28, 2004 under the Agreement. In addition, pursuant to the Agreement, the investors purchased certain convertible debentures that if exercised, will result in the issuance of an indeterminate number of shares of common stock.

• 333,333 warrants which were issued to certain accredited investors on January 26, 2005 under the Amended Agreement. In addition, pursuant to the Agreement, the investors purchased certain convertible debentures that if exercised, will result in the issuance of an indeterminate number of shares of common stock

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

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

In addition, at December 31, 2005, loss per share excludes 34,222,222 shares that are indexed to convertible debentures and investment rights. These instruments would also have an anti-dilutive effect on loss per share.

Note 5. INCOME TAXES

The Company recognized losses for both financial and tax reporting purposes during each of the periods in the accompanying statements of operations. Accordingly, no provisions for income taxes and/or deferred income taxes payable have been provided for in the accompanying financial statements.

Based on the Company’s 2004 tax return, the Company has net operating loss carryforwards for income tax purposes of approximately $12,957,858 arising primarily from stock based expenses that are considered to be permanent differences. These net operating loss carryforwards expire at various times through the period ended December 31, 2022 however because the Company has experienced changes in control and has incurred significant operating losses, utilization of the income tax loss carryforwards are

not assured. As a result, the non-current deferred income tax asset arising from these net operating loss carryforwards is not recorded in the accompanying balance sheet because the Company established a valuation allowance to fully reserve such assets as their realization did not meet the required asset recognition standard established by SFAS 109. The tax return for 2005 has not been finalized at the time of this report, however it is expected that additional net operating loss carryforwards will result from the Company’s 2005 operations.

Note 6. RELATED PARTY TRANSACTIONS

On January 20, 2006, the Company received an Officer Advance in the amount of $40,000 from Steven B. Rash, Chief Executive Officer of the Company. This advance is in the form of a short-term Note Payable to the Officer, is payable on July 20, 2006 and bears interest at a rate of 6% per annum until paid.

During February, 2006, the Chief Scientific Officer advanced the Company $89,400 as short-term Officer Advances in order to enable the Company to meet certain payment obligations. These advances were in the amounts of $5,000, $5,000, $20,000, $20,000, $20,000 and $19,400. On February 28, 2006, the Company executed a 180-day Note Payable in the amount of $39,400 with the Officer, payable on August 27, 2006, with interest at 6% per annum until paid. In addition, on March 1, 2006, the Company executed a 180-day Note Payable in the amount of $50,000 with the Officer, payable on or before September 1, 2006.

Note 7. OTHER COMMITMENTS AND CONTINGENCIES

Operating Lease for Office and Laboratory Space

In August 2004, the Company entered into a new lease which expires on August 31, 2009, has an initial term of sixty-three months, and requires base monthly minimum lease payments ranging from approximately $6,000 to $9,600 (plus utilities and operating expenses) over the lease term. The lease contains a provision which allows the Company to extend the lease for two additional terms of sixty months. Rent expense (for the office lease) was $20,016 for the quarter ended March 31, 2006.

Other Leases

In June, 2004, the Company entered into a new lease for a telephone system which expires in June, 2009, has an initial term of 60 months and requires base monthly minimum lease payments in the amount of $184.51 per month over the lease term. The Company paid $554 on this lease during the quarter ended March 31, 2006.

In October, 2004, the Company entered into a new lease for computers which expires in September, 2006, has an initial term of 24 months and requires base monthly minimum lease payments in the amount of $344 per month over the lease term. The Company paid $1,032 on this lease during the quarter ended March 31, 2006.

Future lease commitments are as follows:

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

Employment Agreements

The Company is obligated under amended and restated employment agreements with its Chief Executive Officer, Chief Scientific Officer and Chief Financial Officer. The significant terms of the agreements are as follows:

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

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

Chief Financial Officer – The employment agreement is effective as of September 1, 2005 and has an initial term of three years, subject to each party’s termination rights. The agreement provides for a base salary of $100,000 per year and the opportunity to receive cash bonuses based on performance upon the discretion of our board of directors. The agreement also includes participation in employee benefit plans offered by us to our employees, as well as a grant of 140,000 shares of restricted common stock. Either party may terminate the Chief Financial Officer’s employment under the contract, either with or without cause upon giving the other party at least thirty days notice. If the Company terminates the chief financial officer’s employment at any time during the initial term without cause, he will be entitled to receive compensation provided under the agreement for the remaining initial term of employment. In addition, in the event of a change in control as defined in the agreement, the Company may waive, in whole or in part, any and all remaining restrictions on the restricted shares of common stock granted to him.

Other Common Stock Grants

In addition to the above common stock grants, during 2004, the Company granted 1,445,000 shares of its common stock to various other employees. Because all of the shares were granted at no cost to the employees, and because the shares generally vest over a period of two years, the total value of the grants, to all employees, was recorded as $25,451,500 of deferred compensation expense upon the date of the grant (which amount was determined based on the total number of shares granted times the trading values of the shares on the dates the stock grants were made). This amount is being amortized to stock based compensation expense over the vesting period.

As mentioned above, the Company has agreed to issue a total of 3,000,000 shares of Series B Preferred Stock to two of its officers. However, for various reasons, including certain restrictions required by the indebtedness (which preclude the shares from being issued for at least 90 days after the effective date of the registration statement that has been filed to cover the resale of the shares of common stock that will be issued upon the conversion or exercise of the securities issued by the Company for such indebtedness), the shares have not yet been issued. The Company intends to issue such shares of the Series B Preferred Stock at such time as it is permitted.

Future required payments for base compensation under all of the employment agreements discussed above are approximately as follows:

Periods Ending December 31,	Amounts

2006	470,000
2007	410,000
2008	350,000
2009	131,250

Total	$	1,361,250

Other Contingencies

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

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

In June, 2005, Charles Caudle et al filed a lawsuit in Harris County, TX against Advanced BioChem, Power3 and the officers and directors of both companies. Power3 has filed an answer denying all claims in the lawsuit. The Company believes that the Plaintiff’s claims are without merit, however the Company cannot be assured it will prevail or if the outcome of the action will adversely affect the Company’s financial position or operations. Settlement negotiations between the parties are ongoing, however no resolution has been achieved thus far.

In May, 2005, Quinn Capital Consulting, Inc. filed suit against Power3 and it’s Chief Executive Officer, claiming breach of contract regarding payment for services claimed to have been provided to Power3, with payment to have been made by issue of 500,000 shares of Power3’s common stock to Quinn Capital. Power3 believes that it is not liable for the issuance of such shares to Quinn Capital for the services

performed, however we cannot be assured we will prevail or if the outcome of this action will affect our financial position or operations.

In September, 2005, Focus Partners LLC filed suit against David Zazoff and Power3 alledging that Power3 breached its agreement with Focus Partners in that it failed to issue stock to the Plaintiff according to the terms of their agreement, that the stock in question was issued to Zazoff and that Zazoff later sold the stock in question for $480,000. Negotiations between the parties are ongoing, however no resolution has been achieved so far.

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

Subpoena from the SEC, Division of Enforcement

On June 27, 2005, the Company received a subpoena for documents regarding the SEC’s Division of Enforcement investigation In The Matter of Maui General Store, Inc. It is the Company’s understanding that the Maui General Store matter relates to a promotional scheme by certain individuals to promote the stock and stock price of certain entities during 2004. The Company provided all documents in its possession pursuant to the subpoena and complied fully with the subpoena on July 11, 2005. In February, 2006, Steven B. Rash and Dr. Ira Goldknopf appeared before a Grand Jury in Washington, D.C., as witnesses, for the SEC Division of Enforcement. The Company has received no further correspondence from the Enforcement Division of the SEC. The Company has not been notified that it is a subject of this investigation.

Note 8. FINANCING ARRANGEMENTS:

Securities Purchase Agreement—Convertible Debentures

The Company entered into a Securities Purchase Agreement, dated October 28, 2004 (the “Agreement”) with certain accredited investors (the “Purchasers”). Pursuant to the Agreement, the Purchasers agreed to purchase convertible debentures due three (3) years from the date of issuance in the aggregate principal amount of $3,000,000. The Agreement also provides for the issuance to the Purchasers, at no additional cost to the purchasers, warrants to purchase shares of the Company’s common stock and additional investment rights to purchase additional convertible debentures. In connection with the Agreement, the Company also entered into a Registration Rights Agreement with the Purchasers that requires the Company to (i) file a registration statement with the SEC registering the resale of the shares of common stock issuable upon conversion of the debentures and the exercise of the warrants, (ii) achieve effectiveness within a stated period and (iii) maintain effectiveness of the registration statement. Failure to meet these requirements will require the Company to incur liquidating damages amounting to 2.0% for each month.

On October 28, 2004, the Company issued the Purchasers the first $1,000,000 in aggregate principal amount of such debentures at the initial closing under the Agreement. Effective January 26, 2005, the Company issued and sold, to a sub-group of the original investors, a second tranche of $400,000 aggregate principal amount of debentures. Subject to the conditions set forth in the Agreement, all purchasers are required to purchase the remaining $1,600,000 in aggregate principal amount of such debentures at the final closing, which is to occur on or before the fifth trading day after the effective date of the registration statement. The Company is currently in default under the Agreement and the previously issued debentures and related registration rights agreement, and therefore the conditions of the Agreement will not be satisfied or otherwise met on a timely basis. Consequently, there are no assurances that the Purchasers will purchase all or any portion of the remaining $1,600,000 aggregate principal amount of debentures. The $1,000,000 aggregate principal amount of debentures issued in the initial closing and the

$400,000 aggregate principal amount of debentures issued on January 19, 2005 are due and payable in accordance with their original terms in full three years after the date of issuance and do not bear interest. The debentures which may be issued at the final closing will be due and payable in full three (3) years after the date of their issuance, and will also not bear interest. At any time from the closing date until the maturity date of the debentures, the Purchasers have the right to convert the debentures, in whole or in part, into common stock of the Company at the then effective conversion price, which varies relative to the Company’s trading stock price, as follows: $0.90 per share, provided however if the lesser of (i) 75% of the average of the 5 consecutive Closing Prices immediately prior to the Effective Date, as defined in the Securities Purchase Agreement, and (ii) the Closing Price on the Effective Date (the lesser of (i) and (ii) being referred to as the “Effective Date Price”) is less than the Conversion Price, the Conversion Price shall be reduced to equal the Effective Date Price.

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

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

The additional investment rights are exercisable at a price equal to the principal amount of the debentures to be purchased, for (1) a period of nine months following the effective date of the registration statement to be filed pursuant to the Registration Rights Agreement, or (2) a period of 18 months from the date of issuance of the additional investment rights, whichever is shorter. The rights debentures will have the same terms as the debentures described above, except that the conversion price will be equal to $1.08.

The debentures contain covenants that limit the Company’s ability to, among other things: incur or guarantee additional indebtedness; incur or create liens; amend the Company’s certificate of incorporation, bylaws or other charter documents so as to adversely affect any rights of the holders of the debentures; and repay or repurchase more than a de minimus number of shares of common stock other than as permitted in the debentures and other documents executed with the purchasers.

The convertible debentures contain consequences in case of default. Events of default which could subject the Company to penalties and liabilities as specified in the Agreement include:

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

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

• Any case or action of bankruptcy or insolvency commenced by the Company, against the Company or adjudicated by a court against the Company for the benefit of creditors;

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

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

• Any Change in Control or sale or disposal of 33% or more of the assets of the Company;

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

• Any failure to deliver certificates within the specified time; and

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

Upon the occurrence of an event of default, each debenture may become immediately due and payable, either automatically or by declaration of the holder of such debenture. The aggregate amount payable upon an acceleration by reason of an event of default shall be equal to the greater of 130% of the principal amount of the debentures to be prepaid or the principal amount of the debentures to be prepaid, divided by the conversion price on the date specified in the debenture, multiplied by the closing price on the date set forth in the debenture.

Other provisions included in the Securities Purchase Agreement include the following:

• The debenture may be exchanged for an equal aggregate principal amount of debentures in different authorized denominations;

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

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

• The Company has one business day after receipt of conversion notice to object to any such request to convert;

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

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

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

• The Company will reserve and keep available authorized and unissued registered shares available to be issued upon conversion;

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

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

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

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

• During the term of the debentures, the Company is not permitted to do certain things unless approved by the holders of 2/3 majority of the debentures such as create any indebtedness senior to the Company’s debenture obligations, amend its certificate of incorporation or buy back any amount of its common stock;

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

• If the Company offers, sells or grants securities that have a price less than the otherwise calculated Conversion Price, then the current exercise price of the warrants is thereby adjusted to be the lower of the offered or sold price or the otherwise calculated Conversion Price;

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

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

As mentioned above, the Company is in default under the provisions of the Agreement, Registration Rights Agreement and previously issued debentures. The events of default principally relate to the Company’s inability to have its registration statement declared effective within the time period required by the agreements. Although the Company intends to seek waivers or forbearance agreements from the holders of its debentures, there is no assurance that the Company will receive such concessions. As such, the indebtedness has been classified as a current liability in the accompanying balance sheet. If the Company is unable to obtain such concessions, the aggregate amount payable under the outstanding debentures due to the acceleration thereof by reason of the default is equal to the “Mandatory Prepayment Amount” as specified in the debentures. The Mandatory Prepayment Amount equals the sum of (i) the greater of: (a) 130% of the principal amount of the debentures to be prepaid, or (b) the principal amount of the debentures to be prepaid, divided by the conversion price on (x) the date the payment is demanded or otherwise due, or (y) the date the payment is paid in full, whichever is less, multiplied by the closing price of the Company’s common stock on (x) the date the payment is demanded or otherwise due, or (y) the date the payment is paid in full, whichever is greater, and (ii) all other amounts, costs, expenses and liquidated damages due in respect of the debentures.

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

The Company has received notice from one of the Purchasers informing the Company that it is in default under the debentures and demanding payment of the Mandatory Prepayment Amount, together with the liquidated damages, to which it is entitled pursuant to the agreement. The Company has filed an SB-2 to

register the shares of stock associated with the convertible debenture agreements and is endeavoring to have it declared effective as soon as practicable. The Company is in discussion with its debenture holders regarding a resolution of this matter.

In connection with such financing, the Company issued, a warrant to purchase 100,000 shares of common stock at an exercise price of $3.00 to its placement agent, Westor Online and Kogan and Associates. If any investor exercises their additional investment rights and purchases additional debentures, the placement agent will be entitled to receive additional warrants to purchase up to a number of shares of common stock equal to ten percent (10%) of the exercise price paid upon exercise of the additional investment rights divided by ninety percent (90%) of the market price as of the initial closing. The Company accounted for the warrants as deferred financing costs and is amortizing the fair values thereof through periodic charges to interest expense using the effective method.

Convertible Debentures, Warrants and Additional Investment Rights:

The carrying values of the Company’s convertible debentures amounted to $14,251 and $75,279, at December 31, 2004 and 2005, respectively. As of March 31, 2006, the carrying values were increased to $107,280. Convertible debentures consist of face value $1,000,000 and $1,400,000, as of December 31, 2004 and 2005, respectively, non-interest bearing convertible debentures due in two traunches: $1,000,000 on October 28, 2007 and $400,000 due on January 26, 2008. The convertible debentures arose from the aforementioned financing, where the proceeds were allocated among the components of the financing arrangement, as follows:

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

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

(2) The Company issued additional warrants to purchase 333,333 share of common stock in connection with Traunch 2, which was not contemplated in the initial financing agreement. Current accounting standards require that these warrants be allocated between the debt (and recorded as deferred financing costs) and the derivative instruments (and allocated directly to derivative expense). Since the initial allocation of proceeds did not result in any initial value allocated to the debt, the fair value of these warrants was charged to derivative expense, as reflected in the table.

(3) Direct financing costs associated with the offerings amounted to $140,959 and $62,000 for Traunch 1 and Traunch 2, respectively. Deferred financing costs are being amortized through periodic charges to interest expense using the effective method. Amortization of the deferred financing costs amounted to $5,312 for the quarter ended March 31, 2006.

Derivative financial instruments arising from the financing are initially recorded and continuously carried at fair values. The following tabular presentation reflects the components of derivative financial instruments on the Company’s balance sheet at December 31, 2004 and 2005:

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

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

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

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

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

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

Derivative income (expense) for the years ended December 31, 2004 and 2005 associated with adjustments recorded to reflect the aforementioned derivatives at fair value (in addition to the initial allocation, above) amounted to $5,130,521 and $2,246,890, respectively.

Fair value considerations for derivative financial instruments:

Freestanding derivative financial instruments, consisting of warrants that arose from the debenture financing, are valued using the Black-Scholes-Merton valuation methodology because that model embodies all of the relevant assumptions that address the features underlying these instruments. Significant assumptions included in this model are as follows:

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

Embedded derivative financial instruments, arising from the debentures and the additional investment rights, consist of multiple individual features that were embedded in the convertible debentures. The Company evaluated all significant features of the hybrid instruments and, where required under current accounting standards, bifurcated features for separate report classification. These features were, as attributable to each convertible debenture and additional investment right, aggregated into one compound derivative financial instrument for financial reporting purposes. The compound embedded derivative instruments are valued using the Flexible Monte Carlo methodology because that model embodies certain relevant assumptions (including, but not limited to, interest rate risk, credit risk, and conversion/redemption privileges) that are necessary to value these complex derivatives.

Assumptions included exercise estimates/behaviors and the following other significant estimates:

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

Equivalent amounts reflect the net results of multiple modeling simulations that the Monte Carlo Simulation methodology applies to underlying assumptions.

Other derivative financial instruments consist of warrants and Series A Preferred stock that were issued prior to and subsequent to the debenture financing and were reclassified from stockholders’ equity or initially accounted as liabilities, at fair values, since share-settlement was not within the Company’s control after the debenture financing. The other warrants are valued using the Black-Scholes-Merton valuation methodology because that model embodies all of the relevant assumptions that address the features underlying those instruments. The preferred stock was determined by management to contain simple, non-complex conversion features and was, therefore, also valued using Black-Scholes-Merton methodology. Significant assumptions included in this model are as follows:

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

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

Trinity Notes Payable

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

The proceeds from the Trinity financing were allocated first to the warrants, based upon their fair values, with the balance of $103,100 allocated to the notes. The allocation of proceeds to the fair value to the warrants was performed because, as discussed in the previous section, share settlement is not within management’s control. Such amount was initially classified as a derivative liability. The resulting note discount is being amortized through periodic charges to interest expense using the effective method. Amortization of note discount amounted to $207,900 during the period from issuance of the notes to December 31, 2005.

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

Note 9. OTHER SIGNIFICANT EQUITY TRANSACTIONS

On January 3, 2006, Power3 executed an agreement with Stonemill Consulting Company (“Stonemill”) wherein the Company engaged Stonemill to find and bring in investor capital from third party investors. The Company agreed to provide Stonemill with 121,428 shares of common stock of Power3 as commission for locating investors to purchase common stock of Power3. The Company issued 50,000 shares of common stock to Stonemill as S-8 stock issued under its 2004 Stock Compensation Plan. In February, 2006, the Company issued an additional 71,428 shares to Stonemill for services.

On January, 5, 2006, Power3 executed an agreement with Glocap Advisors LLC (“Glocap”) wherein the Company engaged Glocap to act as financial advisors and provide the Company with financial advice and strategic consulting services. The Company agreed to provide Glocap with a retainer equal to $30,000 in free-trading common stock of the Company upon the signing of the engagement letter. In confirmation of this agreement, Power3 issued 226,415 shares of common stock to Glocap, as S-8 shares issued under its 2004 Stock Compensation Plan.

On February 9, 2006, Power3 executed an agreement with The Kaminer Group wherein the Company engaged The Kaminer Group to create and implement programs designed to generate interest from strategic partners and investors. As compensation for these services, the Company agreed to a monthly retainer fee of $3,000 in cash and the Kaminer Group will receive the equivalent of $2,000 in options per month to purchase Power3 common shares at the average daily closing market price for shares during the previous month.

Stock Option Plans

The Company has various stock option and warrant plans outstanding. Options granted under the 1998 stock option plans are exercisable only after the respective vesting period, which is determined by the Company’s stock option committee. Options expire seven years from the date of grant. Under the 1999 stock option plan, options granted to employees vested ratably over three years as determined by the Company’s stock option committee for options granted to officers, directors, and consultants. Options expire ten years from the date of grant. A total of 6,360 options remained in effect for warrants granted in 2000. The fair value of these warrants was estimated at the date of grant using a Black-Scholes option pricing model with the following assumptions for warrants granted in 2000: risk-free interest rate of 6.03%;dividend yield of 0%; volatility factor of the expected market price of the Company’s common stock of $.34; and a weighted-average expected life of the options of 2.7 years.

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

In January 2004, the Company’s Board of Directors approved the 2004 Directors, Officers and Consultants Stock Option, Stock Warrant, and Stock Award Plan (the 2004 Plan). Pursuant to the 2004 Plan, initially 10,000,000 shares of common stock, warrants, options, preferred stock or any combination thereof may be optioned. After the grant of any option, warrant or share of preferred stock, the number of shares that may be optioned under the 2004 Plan will be increased. The number of shares of such increase shall be an amount such that immediately following such increase, the total number of shares issuable under this plan and reserved for issuance upon exercise of options, warrants, or conversion of shares of preferred stock will equal 15% of the total number of issued and outstanding shares of the Company’s common stock. The Company has issued 38,926,466 shares of common stock and 580,000 warrants under the 2004 Plan. Based upon the automatic increase provisions above, the number of shares available for issue under the Plan is 9,929,269, based upon 15% of the outstanding shares as of December 31, 2005.

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

All of the Company’s warrants were recorded at their fair values; accordingly stock based compensation actually recorded and stock based compensation that would be recorded using a fair value based method are identical. For purposes of pro forma disclosures, the estimated fair value of the options is charged to expense over the options’ vesting period.

A summary of the Company’s warrant activity and related information for the years ended December 31, 2005 and 2004 is as follows:

	2005		2004
		Weighted		Weighted
		Average		Average
		Exercise		Exercise
	Warrants	Price	Warrants	Price

Outstanding at beginning of year	3,086,360	1.46	6,360	12.50

Cancelled	—	—	—	—

Granted	2,333,333	.32	3,080,000	1.44

Exercised	—	—	—	—

Outstanding at end of year	5,419,693	.97	3,086,360	1.46

Exercisable at the end of the year	5,419,693	.97	3,086,360	1.46

The following table summarizes information about the Company’s Warrants outstanding at December 31, 2005...

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

		5,419,693		$	.97

In February, 2006, Power3 executed an agreement to issue warrants allowing the holder, The Kaminer Group, to purchase the equivalent of $2,000 per month in common stock, based upon the average daily closing market price for the stock during the previous month.

Note 10. RECENT PRONOUNCEMENTS

FIN 46 – Consolidation of Variable Interest Entities

In January 2003, the FASB issued FIN 46, (revised in December 2003 as FIN46R) “Consolidation of Variable Interest Entities,” which clarifies the application of Accounting Research Bulletin (“ARB”) 51, Consolidated Financial Statements, to certain entities (called variable interest entities) in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. The disclosure requirements of this Interpretation are effective for all financial statements issued after January 31, 2003. The consolidation requirements apply to all variable interest entities created after January 31, 2003. In addition, public companies must apply the consolidation requirements to variable interest entities that existed prior to February 1, 2003 and remain in existence as of the beginning of annual or interim periods beginning after June 15, 2003. The adoption of FIN 46R had no impact on the financial statements of the Company as the Company has no variable interests in variable interest entities.

SFAS 150 - Accounting for Certain ‘Financial Instruments with Characteristics of Both Liabilities and Equity

In May 2003, SFAS No. 150 “Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity,” was issued to establish new standards for how an entity classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that an entity classify a financial instrument that is within its scope as a liability (or an asset in some circumstances). Many of these instruments were previously classified as equity. This statement was effective when issued for financial instruments entered into or modified after May 31, 2003, and otherwise is effective for calendar year public companies for the third quarter of 2003. The adoption of SFAS 150 had no impact on the financial statements of the Company.

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

In December 2003, FASB Statement No. 132 (revised) was issued which prescribes the required employers’ disclosures about pension plans and other postretirement benefit plans; but it does not change the measurement or recognition of those plans. The Statement retains and revises the disclosure requirements contained in the original Statement 132. It also requires additional disclosures about the assets, obligations, cash flows, and net periodic benefit cost of defined benefit pension plans and other postretirement benefit plans. The Statement generally is effective for fiscal years ending after December 15, 2003. Since the Company does not have any types of pension plans or other postretirement benefits, the adoption of this Statement did not have an effect on the Company’s financial statements.

SFAS 123(R) ‘Share-Based Payments’

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

SFAS 153 - Exchanges of Non-monetary Assets an Amendment of APB Opinion No. 29

In December 2004, FASB Statement No. 153 was issued amending APB Opinion No. 29 to eliminate the exception allowing non-monetary exchanges of similar productive assets to be measured based on the carrying value of the assets exchanged as opposed to at their fair values. This exception was replaced

with a general exception for exchanges of non-monetary assets that do not have commercial substance. A non-monetary exchange has commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. The provisions of this statement are effective for non-monetary asset exchanges occurring in fiscal periods beginning after the June 15, 2005. The adoption of this statement did not have a material impact on the Company’s financial statements.

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

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

FASB 154 Accounting Changes and Error Corrections.

SFAS No. 154 replaces APB Opinion No. 20, Accounting Changes and SFAS No. 3, Reporting Accounting Changes in Internal Financial Statements, and changes the requirements for the accounting for and reporting of a change in accounting principle.
SFAS No. 154 requires retrospective application of changes in accounting principle to prior periods’ financial statements unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. SFAS No. 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. We adopted SFAS No. 154 on January 1, 2006. Any impact on our results of operations and earnings per share have been recognized where appropriate.

Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION

Forward Looking Statements

This report contains certain forward-looking statements of the intentions, hopes, beliefs, expectations, strategies, and predictions of the Company or its management with respect to future activities or other future events or conditions within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. These statements are usually identified by the use of words such as “believes,” “will,” “anticipates,” “estimates,” “expects,” “projects,” “plans,” “intends,” “should,” “could,” or similar expressions. These statements are based on certain assumptions and analyses made by the Company in light of its experience and its perception of historical trends, current conditions, expected future developments and other factors it believes are appropriate. Investors are cautioned that all forward-looking statements involve risks and uncertainties, including, without limitation:

• The Company’s history of operating losses;

• The Company’s need and ability to raise significant capital and obtain adequate financing for its development efforts;

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

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

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

• Development by competitors of new or competitive products or services;

• The Company’s ability to retain management, implement its business strategy, assimilate and integrate any acquisitions;

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

• The increasing emphasis on controlling healthcare costs and potential legislation or regulation of healthcare pricing.

Although the Company believes that the assumptions underlying the forward-looking statements contained in this report are reasonable, any of the assumptions could be inaccurate, and, therefore, there can be no assurance that the forward-looking statements included in this report will prove to be accurate. In light of the significant uncertainties inherent in the forward-looking statements included in this report, the inclusion of such information should not be regarded as a representation by the Company or any other person that the objectives and plans of the Company will be achieved. Except for its ongoing obligation to disclose material information as required by the federal securities laws, the Company undertakes no obligation to release publicly any revisions to any forward-looking statements to reflect events or circumstances after the date of this report or to reflect the occurrence of unanticipated events. Accordingly, the reader should not rely on forward-looking statements, because they are subject to known and unknown risks, uncertainties, and other factors that may cause our actual results to differ materially from those contemplated by the forward-looking statements.

Overview

The Company is an early stage development company engaged in the early detection, monitoring, and targeting of diseases through the analysis of proteins. The Company’s business objective is to commercialize its intellectual property by focusing on disease diagnosis, protein and biomarkers identification and drug resistance in the areas of cancers, neurodegenerative and neuromuscular diseases. The Company has established a scientific advisory board to assist in the research and development of its products. The members of the scientific advisory board are recognized leaders in their chosen fields, and the Company is working with them in the development of effective early diagnosis and drug targets for early treatment of cancers, neurodegenerative and neuromuscular diseases.

Prior to the Company’s acquisition of the assets of Advanced BioChem, Inc. on May 18, 2004, the Company was primarily engaged in the production and distribution of surgical safety devices through the operations of its subsidiary, Power3 Medical, Inc. On May 18, 2004, the Company completed its acquisition of the assets of Advanced BioChem. The Company acquired all assets and intellectual properties of Advanced BioChem and assumed certain liabilities in exchange for the issuance of 15,000,000 shares of the Company’s common stock. Subsequent to the Advanced BioChem transaction, the Company established the new business direction described above. After the acquisition of the assets and certain liabilities of Advanced BioChem, the Company transformed into an advanced proteomics company applying existing proprietary methodologies to commercialize the intellectual property it acquired in the Advanced BioChem transaction and subsequently developed new proprietary methodologies related to the discovery and identification of protein biomarkers associated with diseases. The Company currently has no products for sale nor does it provide any service for hire. The Company is focused on research and development activities and initiating the “proof of concept” of its technologies.

The Company is in the developmental stage. As such, it has not begun generating revenue from the sales of products or services, nor has it produced such for sale at this time. The Company is dependent on debt and equity capital for its activities. Our ongoing operations consist of research and development operations and activities directed toward commercializing the intellectual property of the Company at this time. The Company has been in its current developmental stage since its acquisition of its current set of intellectual properties on May 18, 2004.

The Company has incurred significant losses since inception. The Company anticipates that it will continue to incur substantial operating losses as it progresses in its research and development activities as well as the commercialization of its technologies. The Company does not expect to produce revenues from operations in the near term and expects that its revenues will be limited to research grants, collaboration agreements, and other strategic alliances which the Company is able to obtain. The Company has an immediate need for capital to continue its current operations

Scientific Developments

The members of the Company’s scientific team have developed a method for the differential diagnosis of neurodegenerative diseases utilizing blood serum, which was co-developed with neurologist, Dr. Stan Appel, Chair of Neurology and his team at The Methodist Hospital Neurological Research Institute in Houston. Under the trade name of NuroPro™, the Company is continuing development of a suite of four tests to differentiate individuals with no known neurological disorders from those with Alzheimer’s disease, Parkinson’s disease, ALS, and other disorders that have similar clinical symptoms as these diseases. The Company is also continuing to do research in the area of early breast cancer detection, based on the identification and study of protein biomarkers in blood serum.

Product Candidates

The Company plans to target the protein-based diagnostic and drug targeting markets utilizing the Company’s portfolio of proprietary biomarker disease footprints. In the area of neurodegenerative disease, the Company has completed clinical validation studies involving over 650 patient samples and is utilizing biostatistics to monitor appropriate biomarkers for diagnostic sensitivity, specificity, positive predictive value, and negative predictive value. By testing patient body fluids and tissues, such as serum, nipple aspirate fluid, and bone marrow, the Company has discovered unique snapshots of protein patterns in diseases including:

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

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

The Company’s discovery platform uses both proprietary methodologies owned by or licensed to the Company and accepted technologies to discover biomarkers in clinical samples. Following sample preparation, a 2D Gel system is used for the separation of protein. The gels are stained, imaged and analyzed with unprecedented sensitivity for differences in the diseased vs. normal samples. The significance of these differences is evaluated relative to the status of the health of the individual. The proteins of interest are removed from the gel matrix and analyzed on a mass spectrometer. This information is then cross-referenced on a worldwide database to identify the protein of origin. This process requires a great deal of proteomics experience and expertise to make the end-data interpretable. In addition, all of the procedures are scaleable. The Company’s biomarker discovery platform delivers significant discoveries that are capable of detecting up to 20 times as many proteins in nipple aspirate fluids as Mud Pit or SELDI TOF (competing technologies); exhibiting reproducible and reliable identification; and displaying broad dynamic range and linearity of disease protein footprints.

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

Power3 is transitioning from a company focused only on research and development to one that is demonstrating “proof of concept” of its technology as it enters the commercialization stage for its technology, products and services. The Company is engaged in the process of developing a portfolio of products including the biomarkers and blood serum tests (for early detection of breast cancer), NuroPro™ biomarkers and blood serum tests (for neurodegenerative diseases including Alzheimer’s, Parkinson’s and ALS diseases) and biomarkers, tests and drug targets for drug resistance to chemotherapeutics.

License and Sponsored Research

Advanced Bio/Chem entered into a license agreement with the Board of Regents of The University of Texas System, an agency of the State of Texas, on behalf of The University of Texas M.D. Anderson Cancer Center in September 2003, which the Company acquired in its transaction with Advanced Bio/Chem. The license agreement gives the Company an exclusive, worldwide, royalty-bearing license to certain patent rights and technology rights for proteomic methods of diagnosis and monitoring of breast cancer using nipple aspirate fluids. On February 17, 2006, Power3 received notice from UT M.D. Anderson Cancer Center confirming that the license agreements between Power3 and UT M.D. Anderson Cancer Center were terminated under Section 13.3 of the license agreement for breach of certain payment obligations as outlined in the License Agreement. The letter further described maintenance fees, license documentation fees and patent costs due to UT M.D. Anderson in the amounts of $46,945.62, prior to the termination date. In addition, the letter stated that Power3 was obligated to grant UT M.D. Anderson a non-exclusive royalty-bearing license to improvements made by Power3 and asked the Company to immediately disclose these improvements so that UT M.D. Anderson could consider whether it wished to license them.

Effective June 28, 2004, Power3 entered into an exclusive license agreement with the Baylor College of Medicine which grants to the Company an exclusive, worldwide, sublicensable license for serum proteomics methods under certain patent rights for all biomarkers for both diagnostic and therapeutic use in neurodegenerative disease. Under the terms of the agreement, Power3 paid Baylor an initial license fee and it has the obligation to pay future royalties and additional licensing fees upon the achievement of certain milestones. The Company is obligated under the license agreement to indemnify Baylor, its faculty members, scientists, researchers, employees, officers, trustees and agents against claims arising from the design, process, manufacture or use of any of the patent rights or licensed products that are developed through the use of the license from Baylor. Subject to customary termination provisions, the term of the agreement is established on a country-by-country basis and expires on the date of expiration of the last patent rights to expire in that country or the tenth anniversary of the first commercial sale of licensed products in countries where no patents exist in such country. After such expiration the Company will have a perpetual paid in full license in such country.

On August 1, 2004, Power3 entered into an exclusive license agreement with M.D. Anderson which grants the Company an exclusive, worldwide, sublicensable license to patents and technologies for early detection screening tests, identified protein biomarkers and drug targets for cancer patient’s resistance to drug therapy. The licensed technology was developed through joint collaboration between the Company’s scientific team and M.D. Anderson. Under the terms of the agreement, the Company paid M.D. Anderson an initial license fee and the Company has the obligation to pay further royalties and additional licensing fees upon the achievement of certain milestones. The license agreement imposes upon the Company an obligation to indemnify the Board of Regents, The University of Texas System, M.D. Anderson, the regents, officers, employees, students, and agents against claims arising on account of any injury or death or damage to property caused by the exercise of the rights granted under the license agreement to the Company, its officers and affiliates. The term of the license agreement is based on the date of expiration of the last patent rights to expire or, in the case of licensed technology rights, for a term of fifteen (15) years. However, in addition to customary termination provisions, M.D. Anderson has the right to terminate the license in any country if the Company fails, within ninety (90) days after receiving written notification from M.D. Anderson, to provide satisfactory evidence that it has commercialized or is attempting to commercialize the licensed invention in such country.

On August 31, 2004 the Company entered into a research agreement with Baylor College of Medicine for the purpose of discovering biomarkers in serum and plasma that are of particular utility in the diagnosis and drug targeting for metabolic syndrome and associated disorders including diabetes, cardiovascular disease, hypertension and stroke. Under the terms of the agreement, Baylor College of Medicine will provide the Company sample materials for use in diagnosis in drug targeting metabolic syndrome and associated diseases including diabetes, cardiovascular disease, hypertension and stroke. With respect to any inventions developed pursuant to the agreement, the party who develops such invention will retain sole and exclusive rights to such invention. The other party will have the right to an exclusive license for the invention, which has been developed. Inventions developed jointly by the parties will be jointly owned. Power3 does not have any obligations for the payment of fees or royalties pursuant to this agreement. The agreement has a term ending June 30, 2007 and may be renewed for successive one-year periods.

On March 21, 2005, the Company entered into a collaborative research agreement with New Horizons Diagnostic for the development of antibody based diagnostic tests for neurodegenerative disease utilizing the Company’s identified biomarkers. The research agreement is based on groups of biomarkers whose profiles are relatively sensitive and specific in distinguishing patients with ALS, Alzheimer’s disease and Parkinson’s disease from each other, as well as from normal patients and patients with other neuromuscular and neurological disorders. The purpose of the agreement is to tailor monoclonal and polyclonal antibodies to the biomarkers, which will be incorporated into immunoassays. Once the assays are available, they will be developed to validate diagnostic tests specifically designed to detect and discriminate among the neurodegenerative diseases. The research agreement provides that the parties will develop an agreed upon schedule and budget for the work contemplated thereunder within sixty (60) days of the effective date. The agreement provides that in the event the parties are able to achieve specified goals relating to the development of a diagnostic kit as contemplated by the research agreement, New Horizons would be compensated in any one of the following manners with respect to such diagnostic kit: (i) a contract to manufacture at least one key component of such diagnostic kit; (ii) royalties on the sale of such diagnostic kit; (iii) the opportunity to form a joint venture with the Company for the commercialization of such diagnostic kit; or (iv) a reasonable percentage of any cash consideration that the Company receives from a third party for such diagnostic kit. Although the form and amounts of any consideration to be paid have not been agreed upon, the parties have agreed to be reasonable in negotiating such consideration.

On May 24, 2005, the Company entered into a Collaboration Agreement with BioSite Incorporated. The Agreement provides that the Company and Biosite will engage in a collaborative research program in which Biosite will attempt to develop antibodies and diagnostic assays for selected target biomolecules proposed by the Company. The Company and Biosite will then assess the diagnostic and therapeutic potential of these antibodies and diagnostic assays for breast cancer and neurological diseases. If the antibodies and diagnostic assays are found to have diagnostic and/or therapeutic potential, Biosite will develop and commercialize Biosite Products for the detection and/or treatment of breast cancer and/or neurological diseases. Biosite will make milestone payments to the Company, as well as pay royalties on the sale of any Biosite Products containing antibodies to any selected target biomolecule claimed in a patent application or an issued patent.

More specifically, the Agreement provides that the Company shall propose target biomolecules for the collaborative research program; Biosite and the Company shall mutually select certain target biomolecules for immunization (“Program Target”); and Biosite shall use commercially reasonable efforts to develop monoclonal and omniclonal antibodies to the selected target biomolecules that meet the specification set out by the parties (“Program Antibodies”). Upon Biosite’s written request subsequent to the delivery of Program Antibodies to the Company, the Company will provide Biosite with blood-based clinical samples useful in the assessment of the Program Antibodies.

Biosite will use commercially reasonable efforts to generate an ELISA-based assay for each Program Target for which Biosite has generated Program Antibodies. If Biosite successfully develops an

ELISA-based assay for any such Program Target, Biosite shall analyze each of the clinical samples provided by Power3 with such assay and shall provide the resulting data to Power3.

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

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

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

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

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

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

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

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

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

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

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

Breast Cancer Screening Test

An important factor in surviving cancer is early detection and treatment. According to the American Cancer Society Surveillance Research, when breast cancer is confined to the breast, the five-year survival rate is close to 100%. Breast cancer is the second leading cause of cancer deaths in women, with over $7 billion spent on breast cancer diagnosis annually. Due to the limitations of the current diagnostic techniques of mammograms and self-examination, diagnosis of cancer is often missed or inconclusive. The Company’s proteomic discovery platform covered by pending patent applications and trade secrets for identifying proteins which signal pre-mammography stages of breast cancer has led to what the Company believes to be one of the first tests of its type that may detect breast cancer earlier than current technology allows. These discoveries establish the basis of a very sensitive, non-invasive, early detection breast cancer-screening test.

The Company has decided to focus development efforts for its early-detection tests for breast cancer on blood serum. The Company has successfully used blood serum as the platform for its NuroPro™ neurodegenerative tests and believes that blood serum as a single platform is the best medium for the development and commercialization of proteomics diagnostic tests.

The Company’s Breast Cancer NAFTest™ analyzes fluids from the breast called nipple aspirates fluid (NAF). Initial success yielded the identification of groups of breast cancer proteins in the aspirates. The procedure utilizes a breast pump to obtain a drop of fluid from the nipple. The aspirate is analyzed to identify specific breast cancer protein footprints.

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

Concurrently, Power3 conducted its own biomarker discovery program using blood serum samples collected from the same clinical validation sites, in collaboration with Dr. Alan Hollingsworth at the Mercy Woman’s Center.

The blood serum biomarkers and tests for early-detection of breast cancer discovered by comparing blood serum samples, distinguish between women with breast cancer, women with benign breast disease, and normal women with high sensitivity and specificity. The Company believes that there are many advantages to a simple blood test over other samples taken from patients, not the least of which is the ready acceptance by patients to having blood drawn. This, along with numerous complaints from patients about the discomfort of the procedure, as well as the low success rate in getting nipple aspirate samples (less than 50%) and the experience that even when samples were successfully drawn, they were often not representative enough for accurate testing, has led the Company to decide that nipple aspirate testing is not commercially viable.

Since the Company has elected to not pursue nipple aspirate testing for commercialization, the license agreement with MD Anderson has not been renewed by the Company. The blood serum biomarkers and tests, discovered directly using blood serum, are covered under intellectual property solely owned by the Company.

Neurodegenerative Screening Test

Early detection of neurodegenerative disease generally results in better patient outcomes. Three diseases of particular interest are Alzheimer’s disease, Parkinson’s disease and ALS. The Alzheimer’s Association reports that Alzheimer’s disease is the most common form of dementia affecting over 4 million Americans. People as young as 30 years old can contract the disease and one in ten people age 65 and over have Alzheimer’s disease. In addition, the American Parkinson’s Disease Association reports that more than 1.5 million people in the U.S. have Parkinson’s disease, affecting about 1 in 100 Americans over the age of 60. On a smaller scale, the ALS Association reports that an average of approximately 30,000 Americans are afflicted with ALS, with 5,000 new cases diagnosed annually.

The members of the Company’s scientific team have developed a method for the differential diagnosis of neurodegenerative diseases utilizing blood serum, which was co-developed with neurologist, Dr. Stan Appel, now Chair of Neurology and Co-Director of Methodist Neurological Institute in Houston. With this test, which involves monitoring the concentration of differentially expressed proteins, the Company has identified groups of unique markers that appear to distinguish normal patients from those with motor neuron, cognitive, and other neurological disorders.

The Company is continuing its ongoing clinical validation program in collaboration with the Methodist Neurological Institute. The initial phase was completed in July 2004 and the latest phase was completed in March, 2006. During this time period, the Company’s database has increased from 183 to over 650 unique samples classified either as normal or being clinically diagnosed with ALS, Alzheimer’s, Parkinson’s, and other related neurological disorders. During this time, the number of differentially expressed proteins used in the discriminant analysis has increased from 9 to 47. The ability to differentiate diseases from each other and from normal and disease controls has improved using the proprietary PD3™ process, including Polyiterative™ biostatistical analysis on the larger database and the expanded set of biomarkers. Currently, select panels of biomarkers are being employed in development of the NuroPro™ blood serum-based tests for four disease diagnostics including neurological diseases of motor control such as Parkinson’s disease, ALS and their like disorders; ALS specific tests for ALS vs. ALS-like disorders; Alzheimer’s disease specific tests; and a Parkinson’s disease-specific test. Pre-IDE applications for the first two have been filed with the U.S. Food and Drug Administration.

Drug Resistance to Chemotherapeutic Agents

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

Strategic Partners Initiative

In January of 2006, the Company retained GloCap Advisors, LLC, as exclusive advisor for strategic alternatives. As the Company continues to seek synergistic strategic partners to license and develop its growing portfolio of protein biomarkers and tests, it believes Glocap Advisors assistance, business introductions and advice will increase the Company’s exposure in target markets, provide important strategic relationships and identify appropriate strategic partners, instrumental and essential for overall successful execution of the Company’s business plan. The Company’s business plan includes the development of these strategic partnerships which it anticipates will assist in the Company’s evolution over the next several years including the commercialization of its proprietary technologies.

The Company recognizes that the licensing of its proprietary technologies to industry leaders is one of the most expedient approaches to develop the Company’s technology into important diagnostic

tools for the detection of diseases. The Company believes this focused positioning of its products and services will enable the Company to capture clinical and public awareness of its proprietary technologies, and apply a major portion of that technology to the early detection and screening markets.

Results of Operations

Three Months Ended March 31, 2006 as Compared to Three Months Ended March 31, 2005

Revenues for the three months ending March 31, 2006 were $-0- and $-0- for the same period in 2005. Due to the Company’s focus on disease diagnosis, protein and biomarkers identification, and research on drug resistance in the areas of cancer, neurodegenerative and neuromuscular diseases, it is unlikely that the Company will receive any revenues from commercial operations in the immediate future.

Total operating expenses were $3,807,987 during the three months ended March 31, 2006 as compared to $4,070,444 for the three months ended March 31, 2005, a decrease of $262,457. The decrease in operating expenses was primarily attributable to a decrease of $271,920 in stock based compensation expense and to the amortized costs of the warrants issued to consultants and to the convertible debenture holders. Other income and expenses, including gain or loss from derivatives, were ($1,097,761) in the first three months of 2006 as compared to $699,565 during the first three months of 2005.

Interest expense thus far in 2006 has amounted to $577,607 as compared to $19,506 during the same three month period of 2005. The increase in interest expense is primarily attributable to the recognition of the original issue discount on notes payable, the additional interest due on the notes payable the company has taken on and the amortization of the debt discounts and deferred finance costs.

The above matters result in our Net Loss being $1,534,869 greater in 2006 than during the first three months of 2005.

Liquidity and Capital Resources

The Company has financed its operations since the date of the Advanced BioChem transaction primarily through the net proceeds generated from the sale of common stock, the issuance of convertible debentures and the issuance of notes payable as bridge loans. From the date of the Advanced BioChem transaction through March 31, 2006, the Company has raised approximately $3,026,978 in debt capital. As described in “Recent Financing” below, the Company may sell an additional $1,600,000 in aggregate principal amount of convertible debentures following the effectiveness of the Registration Statement on Form SB-2 filed by the Company for the resale of certain shares of the Company’s stock by the purchasers of the Company’s convertible debentures. The Company is in default under the terms of the Securities Purchase Agreement, the previously issued debentures and related registration rights agreement and there can be no assurance that the existing investors will purchase all or any portion of the additional $1,600,000 aggregate principal amount of debentures. If additional debentures are issued and sold by the Company, the Company will use a portion of the proceeds from the sale and issuance of such debentures to pay the $451,000 principal balance owing under the promissory notes dated April and September, 2005, the $446,500 principal balance owing under the promissory note dated June 17, 2005, amended in September, 2005 and the Officer Advances.

The Company’s liquidity and capital needs relate primarily to working capital, development and other general corporate requirements. The Company has not received any cash from operations. The Company has an immediate need for capital to continue its current operations. In addition to seeking additional capital, the Company will seek revenues from research grants, collaboration agreements, and other strategic alliances.

In the event the sale and issuance of the $1,600,000 aggregate principal amount of debentures occurs and the investors exercise their warrants and additional investment rights, the Company anticipates it will have adequate cash to meet its funding requirements through the fourth quarter of 2006. The foregoing

projections are based upon the Company’s existing obligations. If the Company’s obligations are increased, the Company will require additional funding sooner than is currently anticipated.

Net cash used in operating activities approximated ($715,402) for the three months ended March 31, 2006, compared to ($445,963) for the three months ended March 31, 2005. The increase in net cash used in operating activities during 2006 was primarily due to a larger loss from operations, losses on derivatives and an increase in accounts payable, as compared to the first three months of 2005.

Net cash provided by financing activities approximated $877,194 for the first three months of 2006 as compared to $338,000 for the three months ended March 31, 2005, based primarily on new bridge loans taken out during the first quarter of 2006.

As of March 31, 2006, the Company’s principal source of liquidity was approximately $163,191 in cash.

Recent Financing

On January 20, 2006, Power3 executed a promissory note in the principal amount of $40,000 payable to Steven B. Rash, Chief Executive Officer, of the Company. Under the terms of the note, the principal amount of Forty thousand dollars ($40,000), (the “Principal”) shall be due and payable on or before July 19, 2006 (the “Maturity Date”.) Should the principal not be repaid as of July 19, 2006, interest of 6% per year on any unpaid principal amount will be earned by the note holder until such time as all of the principal amount is repaid. This note may be repaid at any time prior to July 19, 2006, without interest or penalty.

During February, 2006, Dr. Ira Goldknopf, the Chief Scientific Officer of the Company, advanced the Company a total of $39,400 in a series of five different infusions as Officer Advances. On March 2, 2006, the Company executed a promissory note in the principal amount of $89,400 payable to Dr. Goldknopf, the “note holder”. This note is due and payable on September 1, 2006 and may be repaid at any time prior to September 1, 2006, by the Company, without penalty. Should the principal not be repaid as of September 1, 2006, interest of 6% per year on any unpaid principal amount will be earned by the note holder, until such time as the entire principal amount has been repaid.

On March 1, 2006, Power3 executed a promissory note in the principal amount of $50,000 payable to Dr. Ira Goldknopf, the Chief Scientific Officer of the Company (the “payee”.) Under the terms of the note, the principal amount of $50,000 shall be due and payable on or before September 1, 2006 (the “maturity date”.) Should the principal not be repaid as of September 1, 2006, interest of 6% per year on any unpaid principal amount will be earned the payee until such time as all of the principal amount has been repaid. The note may be repaid at any time prior to September 1, 2006, without interest or penalty.

Previously, in March, 2006, the Company executed a promissory note in the principal amount of $80,000 payable to Steven B. Rash, Chief Executive Officer of Power3. This note was cancelled on March 31, 2006, by mutual consent of the Company and Mr. Rash and no monies were ever received by the Company from Mr. Rash for this note.

On March 29, 2006, the Company executed a promissory note with John Fife (the “note holder”) in the principal amount of $400,000 (the “Principal”.) The note is due and payable on the earlier of June 28, 2006 or the fifth day following the effective date of the Company’s registration statement on Form SB-2 becoming effective. In case of default, all amounts due on the note shall bear interest at the rate of 18% per annum from the date such interest is due through and including the date of payment. The note is secured by a stock pledge agreement from the Chief Executive Officer and the Chief Scientific Officer of Power3, as a pledge of their personal shares of common stock of Power3.

Plan of Operation and Cash Requirements

The Company currently does not have operating revenues from product sales or the performance of services and it continues to experience net operating losses. The Company is actively pursuing third party licensing agreements, collaboration agreements and similar business arrangements in order to establish a revenue base utilizing its capabilities in disease diagnosis based on protein and biomarker identification, and drug resistance in the areas of cancers, neurodegenerative and neuromuscular diseases. The Company has undertaken clinical validation studies to demonstrate the diagnostic capabilities of its technologies. However, there can be no assurances that revenue-generating agreements will be in place in the next twelve months.

Absent a source of revenues, the Company will require funding in order to carry out its business plan until such time as it is able to generate sustained revenues. The Company’s current cash requirements are approximately $300,000 per month and the Company anticipates that it will require approximately $3,600,000 for the twelve months ended March 31, 2007, to continue its development activities, undertake and perform clinical validation studies, continue its marketing efforts and maintain its administrative infrastructure, broken down as follows:

Estimated Expenditures Required
During Next Twelve Months

General and Administrative	$	2,750,000
Patent filings and intellectual property	$	200,000
Capital Expenditures and research agreements	$	650,000

Total	$	3,600,000

The foregoing is based upon the Company’s current estimated cash requirements. The resolution of the Company’s current dispute with Advanced BioChem regarding the liabilities assumed by the Company in the parties’ transaction may result in an increase in the Company’s liabilities and cash requirements. The Company has no significant capital expenditure requirements and does not plan to increase its monthly expenditure rate absent an increase in revenues or additional funding.

As noted previously, the Company entered into a securities purchase agreement and an amendment to the securities purchase agreement pursuant to which certain investors agreed to purchase, subject to the satisfaction of certain conditions, convertible debentures in the aggregate principal amount of $3,000,000. Assuming the completion of the remaining closing and sale and issuance of the remaining $1,600,000 in aggregate principal amount of the convertible debentures, the Company estimates that, after repayment of the bridge loans immediately following the sale and issuance of such debentures, the Company will still require additional cash to allow it to meet its current funding requirements through the second quarter of 2006. In the event the sale and issuance of such debentures occurs and the investors exercise their warrants and additional investment rights, the Company anticipates it will have adequate cash to meet its current funding requirements through the end of 2006.

The Company will continue to require additional debt or equity financing for its operations, which may not be readily available. The Company’s ability to continue as a going concern is subject to its ability to generate a profit or obtain necessary funding from outside sources.

Off-Balance Sheet Arrangements

At March 31, 2006, with the exception of the lease for its operating facility, and employment agreements entered with its three principal officers, the Company did not have any significant off balance sheet commitments.

Critical Accounting Policies

The Company accounts for equity instruments issued to employees for services based on the intrinsic value of the equity instruments issued. Equity instruments issued to non-employees that are fully vested and non-forfeitable are measured at fair value at the issuance date and expensed in the period over which the benefit is expected to be received.

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

In December 2004, the Financial Accounting Standards Board issued Statement Number 123 (“FAS 123 (R)”), Share-Based Payments. FAS 123 (R) requires all entities to recognize compensation expense in an amount equal to the fair value of share-based payments such as stock options granted to employees. The Company will be required to apply FAS 123 (R) on a modified prospective method. Under this method, the Company will be required to record compensation expense (as previous awards continue to vest) for the unvested portion of previously granted awards that remain outstanding at the date of adoption. In addition, the Company may elect to adopt FAS 123 (R) by restating previously issued financial statements, basing the amounts on the expense previously calculated and reported in the pro forma disclosures that had been required by FAS 123, FAS 123 (R) is effective for the first reporting period beginning after June 15, 2005. The Company has not yet determined the impact that FAS 123 (R) will have on its financial statements; however, it does not believe the impact of adopting this Statement will be material as there are no unvested options and warrants at September 30, 2005.

Item 3. CONTROLS AND PROCEDURES

Disclosure Controls and Procedures

Under the supervision and with the participation of the Company’s management, including its Chief Executive Officer and Chief Financial Officer, the Company conducted an evaluation of its disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act). Based on this evaluation and for the reasons set forth below, the Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were ineffective as of December 31, 2005, the end of the period covered by this annual report.

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

• Although the Company has hired accounting personnel as reported in its previous Form 10-QSB, the Company’s limited financing and available capital have restricted the Company’s ability to fully implement its procedures for the improvement of its internal control over financial reporting and to engage outside professionals and advisors to the extent the Company has desired to

support the Company’s accounting personnel in the preparation and/or audit of financial statements and reports to be filed with the SEC.

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

In addition, during the past year, Power3 faced staffing issues relative to its cash flow situation. The Company has retained outside consultants, on an interim basis, to provide accounting and legal expertise directed toward improving its reporting and control procedures. The Company has implemented additional controls over its daily operations and has drafted various Internal Controls memoranda.

Limitations on Effectiveness of Controls

Internal control over financial reporting cannot provide absolute assurance of achieving financial reporting objectives because of its inherent limitations. Internal control over financial reporting is a process that involves human diligence and compliance and is subject to lapses in judgement and breakdowns resulting from human failures. Internal control over financial reporting also can be circumvented by collusion or improper management override. Because of such limitations, there is a risk that material misstatements may not be prevented or detected on a timely basis by internal control over financial reporting. However, these inherent limitations are known features of the financial reporting process. Therefore, it is possible to design into the process, safeguards to reduce, though not eliminate, this risk.

Changes in Internal Control Over Financial Reporting

As previously disclosed in the Company’s Quarterly Report on Form 10-QSB for the quarterly period ending September 30, 2004, the Company implemented several actions during the third quarter of 2004 in an effort to improve its internal control over financial reporting. During the fourth quarter of 2004, the Company continued the implementation of more rigorous policies with respect to its disclosure and financial reporting review process including improvements of its infrastructure and processes to improve its internal control over financial reporting. The Company also is continuing its implementation of procedures to improve its review and processing of non-accounting documentation and contracts.

During 2005, the Company changed its auditing firm and implemented additional internal controls over documents and accounting that are designed to improve its reporting. The Company’s auditors have identified the above issues as material weaknesses and the Company is consulting with its auditors to remediate these issues.

Other than the changes described above, there were no changes in the Company’s internal control over financial reporting that occurred during the Company’s fiscal quarter ended March 31, 2006 that have materially affected, or are reasonably likely to materially affect, the Company’s internal controls over financial reporting.

PART II. OTHER INFORMATION

Legal Proceedings

In November 2004, Chapman Spira & Carson, LLC (“Chapman Spira”), an investment banking firm, filed a lawsuit in the Supreme Court of the State of New York for the County of New York against Advanced BioChem (the Predecessor), Power3 and Steven Rash. The suit alleges that Advanced BioChem and Power3 are liable to Chapman Spira for damages allegedly resulting from the breach of a

letter agreement between Chapman Spira and Advanced BioChem relating to the performance of strategic and investment banking services. Chapman Spira is seeking damages in the amount of $1,522,000 plus interest. The Company has filed an answer in the lawsuit. The Company disputes the allegations in the complaint and is vigorously defending this matter.

This action was commenced in April, 2005, by an equipment vendor and concerns equipment which the Company acquired in its May 18, 2004 transaction with Advanced BioChem, now known as Industrial Enterprises of America. Advanced BioChem reached a settlement agreement with the equipment vendor in April of 2003 under which Advanced BioChem would pay the equipment vendor $40,000 in installments through August, 2003. As of December 31, 2003, Advanced BioChem had a balance remaining of $20,000. In April, 2005, the equipment vendor filed a lawsuit against Advanced BioChem, certain former officers of Advanced BioChem and against Power3 in order to enforce its claim for the remaining balance which is past due. The Company has filed an answer, disputing the allegations in the complaint and is vigorously defending this matter.

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

In June, 2005, Charles Caudle and others filed a lawsuit in Harris County, Texas, against Advanced BioChem, Power3 and the officers and directors of both companies. The suit alleges that Advanced BioChem, Power3 and the officers and directors of Power3, are liable to plaintiffs for unspecified damages. The Company, and its officers and directors, has filed an answer denying all claims in the lawsuit. The Company disputes the allegations in the complaint and is vigorously defending this matter.

Plaintiff, Quinn Capital Consulting, Inc. commenced this action against Power3 and Steven B. Rash on May 19, 2005, alleging the breach of a consulting agreement and seeking 500,000 shares of the Company’s common stock. Plaintiff claims that pursuant to the agreement, the Company was required to issue Plaintiff 500,000 shares of the Company’s common stock. The Company disputes the allegations in the complaint, has filed an answer and is vigorously defending this matter.

In January of 2005, Plaintiff Kamy Behzadi, a previous employee of Advanced BioChem and Power3, filed suit against Advanced BioChem and Power3. Plaintiff was seeking 1,000,000 common shares of Power3 pursuant to an Employment Agreement with the Company. In May, 2005, Power3 filed a action against Behzadi regarding his employment with the Company. On March 22, 2006, both lawsuits were settled and all actions between the parties have been fully resolved, pending compliance with the settlement agreement.

On October 28, 2005, Centigrade Services, Inc. commenced this action against Power3 to collect an outstanding debt of $2,117.09 plus court costs. The Company has settled this matter and no further actions are expected on this issue.

On August 3, 2005, Focus Partners LLC filed suit against David Zazoff and Power3, seeking damages in the amount of $480,000 allegedly arising from the Company’s failure to pay consideration, in the form of Company’s stock, to Plaintiff, pursuant to an alleged consulting agreement entered into and between Plaintiff and the Company. Plaintiff alleges that the Company improperly paid such consideration to Zazoff, a former employee of Plaintiff. The Company answered the complaint on December 27, 2005. It denies the material allegations of the complaint and asserts that it has paid all consideration due and owing Plaintiff pursuant to the alleged consulting agreement. The Company has also asserted counterclaims against Plaintiff and cross-claims against Zazoff arising from, among other things, fraudulent acts of Plaintiff and Zazoff committed during the parties’ relationship. The parties are

presently engaged in discovery. The Company intends to vigorously defend this matter and prosecute its counterclaims and cross-claims.

On August 30, 2005, Carlotta Lansford, a previous consultant for Advanced BioChem, now known as Industrial Enterprises of America, commenced an action against Advanced BioChem and Power3. Plaintiff is seeking $3,295 in unpaid consulting and accounting fees. The Company believes this lawsuit will be settled prior to the court date, however no resolution has been achieved thus far. The Company disputes the allegations in this matter and is vigorously defending this matter. The debt is recorded in accounts payable by Power3.

On February 15, 2006, Bowne of Dallas LP commenced this action against Power3 seeking payment for services allegedly rendered by Plaintiff to Power3. Plaintiff seeks damages in the amount of $17,315.03. The Company believes this lawsuit will be settled prior to the court date, however no resolution has been achieved thus far. The Company disputes the allegations in the complaint and is vigorously defending this matter. The debt is recorded in accounts payable by Power3.

On October 28, 2005, Power3 received Notice of a Petition to Enforce Foreign Judgement citation filed against the Company by KForce regarding an employment fee adjudicated in December, 2003 in the state of Florida against the Company, in the amount of $15,872.77, together with $4,735.02 in interest. Power3 does not agree with the Foreign Judgement and is attempting to resolve the issue prior to enforcement. No resolution has been achieved on this issue at this time, however the Company is endeavoring to resolve the petition. This debt is recorded and outstanding in accounts payable by the Company. In this action, Plaintiff seeks the enforcement of a foreign judgement entered in December, 2003, in the State of Florida, in the amount of $15,872,77, with interest thereon, for non-payment of fees for services rendered by Plaintiff. The Company disputes the allegations in the complaint and is vigorously defending this matter.

Item 2. Unregistered Sale of Equity Securities and use of Proceeds

During the 1^st quarter of 2006, Power3 sold shares of its common stock under its 2004 Stock Compensation Plan as follows:

• On January 6, 2006, Power3 sold 500,000 shares of common stock to Congregation Beth Joseph for working capital

• On February 3, 2006, Power3 sold 400,000 shares of common stock to four private individuals for working capital

• On February 3, 2006, Power3 sold 500,000 shares of common stock to Congregation Beth Joseph for working capital

• On February 3, 2006, Power3 sold 214,286 shares of common stock to Congregation Beth Shmiel for working capital

• On March 8, 2006, Power3 sold 800,000 shares of common stock to 6 private individuals for working capital

Item 3. Defaults Upon Senior Securities

The Company is in default under the provisions of its October, 2004 Securities Purchase Agreement, and accompanying registration rights agreement and debentures. The default stems from the Company’s inability to obtain effectiveness of the registration statement on Form SB-2, as amended (File No. 333-122227) filed pursuant to the registration rights agreement.

EXHIBIT NO.		DESCRIPTION

10.1		Promissory Note, dated September 5, 2005, executed by Power3 and Cordillera Fund, in the amount of $200,000 (incorporated by reference to Exhibit 10.3 to the Company’s Form 8-K filed on September 9, 2005
10.2		Promissory Note, dated September 6, 2005, executed by Power3 and Dr. Ira Goldknopf in the amount of $80,000 (incorporated by reference to Exhibit 10.2 to the Company’s Form 8-K filed on September 9, 2005
10.3		Promissory Note (Amended version), dated August 29, 2005, executed by Power3 and John Fife in the amended amount of $446,500 (incorporated by reference to Exhibit 10.1 to the Company’s Form 8-K filed on September 9, 2005
10.4		Collaborative Research Agreement, dated October 13, 2005 by and between Power3 and Pfizer Inc. with Pfizer Inc.(incorporated by reference to the Company’s Form 8-K filed on October 19, 2005.)
10.5		Employment Agreement with John Burton dated September 15, 2005 (incorporated by reference to Exhibit 10.1 to the Company’s Form 8-K filed on September 21, 2005
10.6		Exclusive License Agreement dated effective June 28, 2005, by and between Power3 and Baylor College of Medicine (incorporated by reference to Exhibit 10.1 to the Company’s Form 10-QSB for the quarter ended September 30, 2004
10.7		Patent and Technology License Agreement dated August 1, 2004, by and between Power3 and The University of Texas System, on behalf of The University of Texas M.D. Anderson Cancer Center (incorporated by reference to Exhibit 10.2 to the Company’s Form 10-QSB for the quarter ended September 30, 2004
10.8		Patent and Technology License Agreement dated September 1, 2003 by and between The University of Texas System, on behalf of The University of Texas M.D. Anderson Cancer Center and Advanced BioChem (incorporated by reference to Exhibit 10.3 to the Company’s Form 10-QSB for the quarter ended September 30, 2004
10.9		Securities Purchase Agreement dated October 28, 2004 among the Company and each purchaser identified therein (incorporated by reference to Exhibit 10.1 to the Company’s Form 8-K filed on November 3, 2004
10.10		Amendment to Securities Purchase Agreement dated January 19, 2005, between the Company and each purchaser identified therein (incorporated by reference to Exhibit 10.8 of the Company’s Registration Statement on Form SB-2 (File No. 122227)
10.11		Power3’s Registration Statement (incorporated by reference to the SB-2 (File No. 122227) as filed on January 21, 2005
10.12		Amended and Restated Employment Agreement for Steven B. Rash (incorporated by reference to Exhibit 10.1 to the Company’s Form 8-K filed January 5, 2005
10.13		Amended and Restated Employment Agreement for Ira L. Goldknopf, PhD (incorporated by reference to Exhibit 10.2 to the Company’s Form 8-K filed on January 5, 2005)
10.14		Collaborative Research Agreement dated March 21, 2005, by and between New Horizons Diagnostics and Power3 (incorporated by reference to Exhibit 10.1 to the Company’s Form 8-K filed on March 28, 2005
10.15		Collaborative Research and Licensing Agreement dated May 17, 2005, by and between BioSite Incorporated and Power3 (incorporated by reference to Exhibit 10.13 to the Company’s Form 10-KSB filed on September 9, 2005

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.

	Power3 Medical Products, Inc. (Registrant)


Date: May 15, 2006		By:	/s/ Steven B. Rash
		Steven B. Rash
		Chairman and Chief Executive Officer

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

Signature	Title	Date

/s/ Steven B. Rash	Chairman and	May 15, 2006
Steven B. Rash	Chief Executive Officer

/s/ John P. Burton	Chief Financial Officer	May 15, 2006
John P. Burton

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

Condensed Balance Sheet (unaudited)

Condensed Statements of Operations (unaudited)

Condensed Statement of Cash Flows (unaudited)

Notes to Condensed Financial Statements (unaudited)

Item 1. Organization, Principal Activities and Basis of Presentation

Item 2. Management’s Discussion and Analysis or Plan of Operation

Item 3. Controls and Procedures

Part II. OTHER INFORMATION

Item 1. Legal Proceedings

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

Item 3. Defaults upon Senior Securities

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

Item 5. Other Information

Item 6. Exhibits

SIGNATURES

10.16		Promissory Note dated November 3, 2005 between Power3 and Trinity financing in the amount of $150,000 (incorporated by reference to Exhibit 10.1 to the Company’s Form 8K filed on November 8, 2005).
10.17		Promissory Note executed on December 12, 2005 between Power3 and Trinity Financing (incorporated by reference to Exhibit 10.1 to the Company’s Form 8K filed December 12, 2005).
10.18*		Promissory Note dated March 1, 2006 between Power3 and Steven B. Rash in the amount of $50,000.
10.19*		Promissory Note dated March 2, 2006 between Power3 and Dr. Ira Goldknopf in the amount of $89,400.
10.20*		Promissory Note, dated March 28, 2006, executed by Power3 and John Fife in the amount of $400,000.
10.21*		Stock Pledge Agreement for Fife Promissory Note, dated March 28, 2006.
10.22*		Agreement between Power3 and Glocap executed on January 5, 2006.
10.23*		Agreement between Power3 and The Kaminer Group executed on February 9, 2006.

31.1*	Certification
31.2*	Certification
32.1**	Certification Pursuant to Section 906
32.2**	Certification Pursuant to Section 906