UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q/A

(Amendment Number 1)

x QUARTERLY REPORT UNDER SECTION 13 0R 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended  March 31, 2009

¨ TRANSITION REPORT UNDER SECTION 13 0R 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from:

Commission file number: 002-95626-D

SIONIX CORPORATION

(Exact name of registrant as specified in its charter)

Nevada	87-0428526
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)
2801 Ocean Park Blvd, Suite 339, Santa Monica, California	90405
(Address of principal executive offices)	(Zip Code)

Issuer’s telephone number (847) 235-4566

(Former name, former address and former fiscal year, if changed since last report)

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

¨ Yes   ¨ No

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

Large accelerated filer ¨	Accelerated filer ¨
Non-accelerated filer ¨ (Do not check if a smaller reporting company)	Smaller reporting company x

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.  As of May 11, 2009 the number of shares of the registrant’s classes of common stock outstanding was 142,303,907.

EXPLANATORY NOTE

Between October 17, 2006 and February 27, 2007 the Sionix Corporation issued 25 secured convertible promissory notes for total proceeds to the Company of $750,000 (“Convertible Notes 1”). Convertible Notes 1 could be converted into shares of the Company’s common stock at a conversion price of $0.05 per share Convertible Notes 1 contained a provision that would automatically adjust the conversion price if equity securities or instruments convertible into equity securities were issued at a conversion price less than $0.05.

On June 6, 2007, the Company issued 5 convertible promissory notes for a total of $86,000 (“Convertible Notes 2”).  No warrants were issued in connection with Convertible Notes 2. Convertible Notes 2 mature on December 31, 2008 and are convertible into common stock at $0.01 per share.

As a result of the issuance of Convertible Notes 2, the conversion price for Convertible Notes 1 was adjusted down from $0.05 to $0.01.  The decrease in the conversion price increased the potential dilutive shares from 15,000,000 to 75,000,000, and this subsequently increased the total outstanding and potential dilutive shares over the authorized common share limit of 150,000,000.  Because there were insufficient authorized shares to fulfill all potential conversions, the Company should have classified all potentially dilutive securities as derivative liabilities as of June 6, 2007.  The Company researched its debt and equity instruments and determined that the potentially dilutive securities are as follows:

·   2001 Executive Officers Stock Option Plan

·   Advisory Board Compensation

·   Warrants Related to 2004 Stock Purchase Agreement

·   Convertible Notes 1

·   Convertible Notes 2

·   Subordinated Convertible Notes 3

·   Warrants related to Subordinated Convertible Notes 3

As a result of these transactions, we are filing amendment number 1 (“Amendment 1”) to our Form 10-Q (the “Original Report”) that was originally filed with the Securities and Exchange Commission (the “SEC”) on May 20, 2009 for the period ended March 31, 2009.

The primary purpose of this Amendment 1 is to disclose the restatement of our financial statements for the three and six months ended March 31, 2009 and cumulative inception to date operations for March 31, 2009.  A complete discussion of the restatement is included in the section of this Amendment 1 titled “Management’s Discussion and Analysis or Plan of Operation” and in Note 17 to our financial statements for the period ended March 31, 2009.

This Amendment 1 includes all of the information contained in the Original Report, and we have made no attempt in this Amendment 1 to modify or update the disclosures presented in the Original Report, except as identified.

The disclosures in this Amendment continue to speak as of the date of the Original Report, and do not reflect events occurring after the filing of the Original Report.  Accordingly, this Amendment should be read in conjunction with our other filings made with the SEC subsequent to the filing of the Original Report, including any amendments to those filings.  The filing of this Amendment 1 shall not be deemed to be an admission that the Original Report, when made, included any untrue statement of a material fact or omitted to state a material fact necessary to make a statement not misleading.

During the period ended March 31, 2009, certain investors converted $11,797 of convertible notes into 294,930 common shares at $0.04 per share; however, the conversion rate should have been $0.01.  At March 31, 2009, the Company owes an additional 12,248,173 shares to the investors related to the $11,797 converted during the period ended March 31, 2009 and the $151,512 converted during the period ended September 30, 2008.  The Company recorded a liability of $979,854 which is recorded in accrued expenses in the accompanying financial statements.  The change in the fair value of the shares will be recorded as a change in fair value of beneficial conversion liability.

The following adjustments were made to our financial statements for the periods ended March 31, 2009:

2

	As Previously Stated			Beneficial Conversion			Warrants and					As Restated
	March 31, 2009			Options			Options			Reclassifications		March 31, 2009
Balance Sheet
Other assets	$	34,165		$	-		$	-		$	155,000	$	189,165
Accrued expenses		2,734,069			979,854			-			155,000		3,868,923
Warrant and option liability		2,180,429			-			1,790,486			-		3,970,915
Beneficial conversion liability		-			4,740,412			-			-		4,740,412
Additional paid-in capital		13,383,049			-			(1,847,488	)		-		11,535,561
Deficit accumulated during developmental stage		(21,869,332	)		(5,720,266	)		57,002			-		(27,532,596	)
Statement of Operations (for the three months ended March 31, 2009)
Gain (loss) on change in fair value of warrant and option liability	$	(219,981	)	$	-		$	837,506		$	-	$	617,525
Gain on change in fair value of beneficial conversion liability		-			907,549			-			-		907,549
Statement of Operations (for the six months ended March 31, 2009)
Gain on change in fair value of warrant and option liability	$	1,631,387		$	-		$	1,490,193		$	-	$	3,121,580
Gain on change in fair value of beneficial conversion liability		26,000			4,742,622			-			-		4,768,622
Statement of Operations (since inception)
Gain on change in fair value of warrant and option liability	$	6,849,627		$	-		$	516,466		$	-	$	7,366,093
Gain on change in fair value of beneficial conversion liability		1,426,767			29,000,652			-			-		30,427,419
General and administrative expense		21,740,171			3,787,032			83,855			-		25,611,058
Interest expense and financing costs		(2,457,641	)		(30,536,702	)		(897,793	)		-		(33,892,136	)
Statement of Cash Flows (for the six months ended March 31, 2009)
Net income	$	149,324		$	4,742,622		$	1,490,193		$	-	$	6,382,139
Gain on change in fair value of warrant and option liability		(1,631,387	)		-			(1,490,193	)		-		(3,121,580	)
Gain on change in fair value of beneficial conversion liability		(26,000	)		(4,742,622	)		-			-		(4,768,622	)
Statement of Cash Flows (since inception)
Net loss	$	(21,744,332	)	$	(5,323,082	)	$	(465,182	)	$	-	$	(27,532,596	)
Gain on change in fair value of warrant and option liability		(6,849,627	)		-			(516,466	)		-		(7,366,093	)
Gain on change in fair value of beneficial conversion liability		(1,426,768	)		(29,000,652	)		-			-		(30,427,420	)
Non-cash compensation expense		-			3,787,032			83,855			-		3,870,887
Non-cash financing costs		-			30,536,702			897,793			-		31,434,495

3

Table of Contents

Part I - Financial Information
Item 1. Financial Statements	5
Balance Sheets as of March 31, 2009 (Unaudited) and September 30, 2008 (Restated)	5
Statements of Income (Operations) (Unaudited) for the three and six months ended March 31, 2009 and March 31, 2008 (Restated) and from inception (October 3, 1994) to March 31, 2009 (Restated)	6
Statement of Stockholders Equity (Deficit) (Unaudited) for the period from inception (October 3, 1994) to March 31, 2009 (Restated)	7
Statements of Cash Flows (Unaudited) for the three and six months ended March 31, 2009 and March 31, 2008 (Restated) and from inception (October 3, 1994) to March 31, 2009 (Restated)	8
Notes to unaudited condensed financial statements	9
Forward-Looking Statements
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	47
Item 3. Quantitative and Qualitative Disclosures About Market Risk	65
Item 4T. Controls and Procedures	65
Part II – Other Information
Item 1. Legal Proceedings	66
Item 1A. Risk Factors	66
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds	66
Item 3. Defaults Upon Senior Securities	67
Item 4. Submission of Matters to a Vote of Security Holders	68
Item 5. Other Information	68
Item 6. Exhibits	68
Signatures	69

4

Part I, Item 1.  Financial Statements.

SIONIX CORPORATION
A DEVELOPMENT STAGE COMPANY
BALANCE SHEETS
	March 31,			September 30,
	2009			2008
	(Unaudited)
	(As Restated)			(As Restated)
ASSETS
CURRENT ASSETS
Cash and cash equivalents	$	25,613		$	1,220,588
Inventory		608,565			-
Other current assets		189,165			138,895
TOTAL CURRENT ASSETS		823,343			1,359,483
PROPERTY AND EQUIPMENT, net		77,543			87,101
DEPOSITS		28,495			33,095
TOTAL ASSETS	$	929,381		$	1,479,679
LIABILITIES AND STOCKHOLDERS' DEFICIT
CURRENT LIABILITIES
Accounts payable	$	351,862		$	259,355
Accrued expenses		3,868,923			4,312,844
Customer deposits		1,460,000			1,260,000
Liquidated damages liability		78,750			153,750
Notes payable – related parties		107,000			114,000
Convertible notes, net of debt discounts of $781,333		1,781,333			2,041,443
10% subordinated convertible notes, net of debt discounts of $0		425,000			400,796
Warrant and option liability		3,970,915			6,869,244
Beneficial conversion liability		4,740,412			8,881,272
TOTAL CURRENT LIABILITIES		16,784,195			24,292,704
STOCKHOLDERS' DEFICIT
Common stock (150,000,000 shares authorized; 141,303,906 and 141,822,006 shares issued and outstanding at March 31, 2009, respectively and 134,756,213 and 134,274,313 shares issued and outstanding at September 30, 2008, respectively)		141,821			134,274
Additional paid-in capital		11,535,561			10,841,007
Shares to be issued		400			126,429
Deficit accumulated during development stage		(27,532,596	)		(33,914,735	)
TOTAL STOCKHOLDERS' DEFICIT		(15,854,814	)		(22,813,025	)
TOTAL LIABILITIES AND STOCKHOLDERS' DEFICIT	$	929,381		$	1,479,679

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

5

SIONIX CORPORATION
A DEVELOPMENT STAGE COMPANY
STATEMENT OF OPERATIONS
(UNAUDITED)
													Cumulative from
	For the three months						For the six months						Inception
	ended March 31,						ended March 31,						(October 3, 1994) to
	2009			2008			2009			2008			March 31, 2009
	(As Restated)			(As Restated)			(As Restated)			(As Restated)			(As Restated)
Revenues	$	-		$	-		$	-		$	-		$	-
Operating expenses
General and administrative		314,055			627,224			964,891			5,691,794			25,611,058
Research and development		178,265			329,028			357,229			565,932			3,394,102
Depreciation and amortization		7,615			8,157			15,104			16,314			572,479
Total operating expenses		499,935			964,409			1,337,224			6,274,040			29,577,639
Loss from operations		(499,935	)		(964,409	)		(1,337,224	)		(6,274,040	)		(29,577,639	)
Other income (expense)
Interest income		277			366			3,868			1,279			70,242
Interest expense and financing costs		(63,758	)		(554,065	)		(158,523	)		(680,350	)		(33,892,136	)
Gain on change in fair value of warrant and option liability		617,525			1,765,338			3,121,580			3,943,843			7,366,093
Gain on change in fair value of beneficial conversion liability		907,549			11,088,577			4,768,622			18,922,878			30,427,419
Impairment of intangibles		-			-			-			-			(1,267,278	)
Inventory obsolescence		-			-			-			-			(365,078	)
Legal settlement		-			-			-			-			344,949
Loss on settlement of debt		(16,184	)		-			(16,184	)		-			(371,595	)
Loss on lease termination		-			(129,166	)		-			(129,166	)		(129,166	)
Write-off of property and equipment		-			-			-			-			(125,015	)
Total other income		1,445,409			12,171,050			7,719,363			22,058,484			2,058,435
Income (loss) before income taxes		945,474			11,206,641			6,382,139			15,784,444			(27,519,204	)
Income taxes		-						-			900			13,392
Net income (loss)	$	945,474		$	11,206,641		$	6,382,139		$	15,783,544		$	(27,532,596	)
Basic income per share	$	0.01		$	0.10		$	0.05		$	0.15
Dilutive income per share	$	0.01		$	0.10			0.05		$	0.15
Basic weighted average number of
shares of common stock outstanding		136,973,884			107,494,374			136,277,277			107,494,374
Dilutive weighted average number of
shares of common stock outstanding		136,973,884			107,494,374			136,277,277			107,494,374

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

6

SIONIX CORPORATION
A DEVELOPMENT STAGE COMPANY
STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
FOR THE PERIOD FROM OCTOBER 3, 1994 (INCEPTION) TO MARCH 31, 2009
(UNAUDITED)
																						Deficit			Total
	Common Stock						Additional			Shares			Stock			Shares			Unamortized			Accumulated			Stockholders'
	Number						Paid-in			to be			Subscription			to be			Consulting			from			Equity
	of Shares			Amount			Capital			Issued			Receivable			Cancelled			Fees			Inception			(Deficit)
Stock issued for cash, October 3, 1994		10,000		$	10		$	90		$	-		$	-		$	-		$	-		$	-		$	100
Net loss		-			-			-			-			-			-			-			(1,521	)		(1,521	)
Balance at December 31, 1994		10,000			10			90			-			-			-			-			(1,521	)		(1,421	)
Shares issued for assignment rights		1,990,000			1,990			(1,990	)		-			-			-			-			-			-
Shares issued for services		572,473			572			135,046			-			-			-			-			-			135,618
Shares issued for debt		1,038,640			1,038			1,164,915			-			-			-			-			-			1,165,953
Shares issued for cash		232,557			233			1,119,027			-			-			-			-			-			1,119,260
Shares issued for subscription receivable		414,200			414			1,652,658			-			(1,656,800	)		-			-			-			(3,728	)
Shares issued for productions costs		112,500			113			674,887			-			(675,000	)		-			-			-			-
Net loss		-			-			-			-			-			-			-			(914,279	)		(914,279	)
Balance at December 31, 1995		4,370,370			4,370			4,744,633			-			(2,331,800	)		-			-			(915,800	)		1,501,403
Shares issued for reorganization		18,632,612			18,633			(58,033	)		-			-			-			-			-			(39,400	)
Shares issued for cash		572,407			573			571,834			-			-			-			-			-			572,407
Shares issued for services		24,307			24			24,283			-			-			-			-			-			24,307
Net loss		-			-			-			-			-			-			-			(922,717	)		(922,717	)
Balance at September 30, 1996		23,599,696			23,600			5,282,717			-			(2,331,800	)		-			-			(1,838,517	)		1,136,000
Shares issued for cash		722,733			723			365,857			-			-			-			-			-			366,580
Shares issued for services		274,299			274			54,586			-			-			-			-			-			54,860
Cancellation of shares		(542,138	)		(542	)		(674,458	)		-			675,000			-			-			-			-
Net loss		-			-			-			-			-			-			-			(858,915	)		(858,915	)
Balance at September 30, 1997		24,054,590			24,055			5,028,702			-			(1,656,800	)		-			-			(2,697,432	)		698,525
Shares issued for cash		2,810,000			2,810			278,190			-			-			-			-			-			281,000
Shares issued for services		895,455			895			88,651			-			-			-			-			-			89,546
Shares issued for compensation		2,200,000			2,200			217,800			-			-			-			-			-			220,000
Cancellation of shares		(2,538,170	)		(2,538	)		(1,534,262	)		-			1,656,800			-			-			-			120,000
Net loss		-			-			-			-			-			-			-			(1,898,376	)		(1,898,376	)
Balance at September 30, 1998		27,421,875			27,422			4,079,081			-			-			-			-			(4,595,808	)		(489,305	)
Shares issued for compensation		3,847,742			3,847			389,078			-			-			-			-			-			392,925
Shares issued for services		705,746			706			215,329			-			-			-			-			-			216,035
Shares issued for cash		9,383,000			9,383			928,917			-			-			-			-			-			938,300
Net loss		-			-			-			-			-			-			-			(1,158,755	)		(1,158,755	)
Balance at September 30, 1999		41,358,363			41,358			5,612,405			-			-			-			-			(5,754,563	)		(100,800	)
Shares issued for cash		10,303,500			10,304			1,020,046			-			-			-			-			-			1,030,350
Shares issued for compensation		1,517,615			1,518			1,218,598			-			-			-			-			-			1,220,116
Shares issued for services		986,844			986			253,301			-			-			-			-			-			254,287
Net loss		-			-			-			-			-			-			-			(2,414,188	)		(2,414,188	)
Balance at September 30, 2000		54,166,322			54,166			8,104,350			-			-			-			-			(8,168,751	)		(10,235	)
Shares issued for services		2,517,376			2,517			530,368			-			-			-			(141,318	)		-			391,567
Shares issued for cash		6,005,000			6,005			594,495			-			-			-			-			-			600,500
Shares to be issued for cash (100,000 shares)		-			-			-			10,000			-			-			-			-			10,000
Shares to be issued for debt (639,509 shares)		-			-			-			103,295			-			-			-			-			103,295
Net loss		-			-			-			-			-			-			-			(1,353,429	)		(1,353,429	)
Balance at September 30, 2001		62,688,698			62,688			9,229,213			113,295			-			-			(141,318	)		(9,522,180	)		(258,302	)
Shares issued for services		1,111,710			1,112			361,603			-			-			-			54,400			-			417,115
Shares issued as a contribution		100,000			100			11,200			-			-			-			-			-			11,300
Shares issued for compensation		18,838			19			2,897			-			-			-			-			-			2,916
Shares issued for cash		16,815,357			16,815			1,560,782			(10,000	)		-			-			-			-			1,567,597
Shares issued for debt		1,339,509			1,340			208,639			(103,295	)		-			-			-			-			106,684
Shares to be issued related to equity
financing (967,742 shares)		-			-			(300,000	)		300,000			-			-			-			-			-
Cancellation of shares		(7,533,701	)		(7,534	)		-			-			-			-			-			-			(7,534	)
Net loss		-			-			-			-			-			-			-			(1,243,309	)		(1,243,309	)
Balance at September 30, 2002		74,540,411			74,540			11,074,334			300,000			-			-			(86,918	)		(10,765,489	)		596,467
Shares issued for services		2,467,742			2,468			651,757			(300,000	)		-			-			-			-			354,225
Shares issued for capital equity line		8,154,317			8,154			891,846			-			-			-			-			-			900,000
Amortization of consulting fees		-			-			-			-			-			-			86,918			-			86,918
Cancellation of shares		(50,000	)		(50	)		50			-			-			-			-			-			-
Shares to be cancelled (7,349,204 shares)		-			-			7,349			-			-			(7,349	)		-			-			-
Net loss		-			-			-			-			-			-			-			(1,721,991	)		(1,721,991	)
Balance at September 30, 2003		85,112,470			85,112			12,625,336			-			-			(7,349	)		-			(12,487,480	)		215,619
Shares issued for capital equity line		19,179,016			19,179			447,706			-			-			-			-			-			466,885
Shares issued for services		5,100,004			5,100			196,997			-			-			-			(13,075	)		-			189,022
Share to be issued for cash (963,336 shares)		-			-			-			28,900			-			-			-			-			28,900
Shares to be issued for debt (500,000 shares)		-			-			-			15,000			-			-			-			-			15,000
Cancellation of shares		(7,349,204	)		(7,349	)		-			-			-			7,349			-			-			-
Issuance of warrants related to 2004 stock purchase		-			-			24,366			-			-			-			-			-			24,366
Net loss		-			-			-			-			-			-			-			(1,593,135	)		(1,593,135	)
Balance at September 30, 2004		102,042,286			102,042			13,294,405			43,900			-			-			(13,075	)		(14,080,615	)		(653,343	)
Amortization of consulting fees		-			-			-			-			-			-			13,075			-			13,075
Net loss		-			-			-			-			-			-			-			(722,676	)		(722,676	)
Balance at September 30, 2005		102,042,286			102,042			13,294,405			43,900			-			-			-			(14,803,291	)		(1,362,944	)
Net loss		-			-			-			-			-			-			-			(1,049,319	)		(1,049,319	)
Balance at September 30, 2006		102,042,286			102,042			13,294,405			43,900			-			-			-			(15,852,610	)		(2,412,263	)
Stock issued for consulting		4,592,915			4,593			80,336			-			-			-			-			-			84,929
Reclassification to warrant and option liability		-			-			(2,277,013	)		-			-			-			-			-			(2,277,013	)
Net loss		-			-			-			-			-			-			-			(33,612,516	)		(33,612,516	)
Balance at September 30, 2007, restated		106,635,201			106,635			11,097,728			43,900			-			-			-			(49,465,126	)		(38,216,863	)
Conversion of note payable into common stock		17,149,359			17,149			886,633			-			-			-			-			-			903,782
Common stock issued for services		1,539,750			1,540			254,330			-			-			-			-			-			255,870
Common stock issued for cash		8,950,003			8,950			784,550			(43,500	)		-			-			-			-			750,000
Common stock to be issued for cash		-			-			-			126,029			-			-			-			-			126,029
Issuance of warrants with stock		-			-			(2,182,234	)					-			-			-			-			(2,182,234	)
Net income		-			-			-			-			-			-			-			15,550,391			15,550,391
Balance at September 30, 2008, restated		134,274,313			134,274			10,841,007			126,429			-			-			-			(33,914,735	)		(22,813,025	)
Conversion of note payable into common stock		6,114,221			6,114			444,958			-			-			-			-			-			451,072
Common stock issued for services		600,139			600			125,429			(126,029	)		-			-			-			-			-
Common stock issued for property and equipment		833,333			833			124,167			-			-			-			-			-			125,000
Net income		-			-			-			-			-			-			-			6,382,139			6,382,139
Balance at March 31, 2009, restated		141,822,006		$	141,821		$	11,535,561		$	400		$	-		$	-		$	-		$	(27,532,596	)	$	(15,854,814	)

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

7

SIONIX CORPORATION
A DEVELOPMENT STAGE COMPANY
STATEMENT OF CASH FLOWS
(UNAUDITED)
							Cumulative
							from
	For the Six Months						Inception
	Ended March 31,						(October 3, 1994) to
	2009			2008			March 31, 2009
	(As Restated)			(As Restated)			(As Restated)
OPERATING ACTIVITIES:
Net income (loss)	$	6,382,139		$	15,783,544		$	(27,532,596	)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation		15,104			16,314			659,396
Amortization of beneficial conversion features discount and
warrant discount		27,094			833,775			2,074,433
Stock based compensation expense - employee		116,241			1,791,360			3,795,143
Stock based compensation expense - consultant		248,752			3,171,049			6,899,343
Gain on change in fair value of warrant and option liability		(3,121,580	)		(3,943,843	)		(7,366,093	)
Gain on change in fair value of beneficial conversion liability		(4,768,622	)		(18,922,878	)		(30,427,420	)
Non-cash compensation costs		-			-			3,870,887
Non-cash financing costs		-			-			31,434,495
Impairment of assets		-			-			514,755
Write-down of obsolete assets		-			-			38,862
Impairment of intangible assets		-			-			1,117,601
Loss on settlement of debt		16,184			-			400,761
Loss on termination of lease		-			129,166			129,166
Write-off of beneficial conversion features		-			(380,440	)		(576,000	)
Stock issued for services and rent		-			-			114,850
Accrual of liquidated damages		-			138,375			153,750
Other		-			-			(799,044	)
(Increase) decrease in assets:
Inventory		(608,565	)		-			(608,565	)
Other current assets		12,230			(33,650	)		(34,165	)
Other assets		(150,400	)		-			(128,495	)
Increase (decrease) in liabilities:
Accounts payable		92,508			345,724			508,027
Accrued expenses		189,486			174,508			2,834,698
Customer deposits		344,486			-			1,460,000
Net cash used in operating activities		(1,194,429	)		(896,996	)		(11,466,211	)
INVESTING ACTIVITIES:
Acquisition of property and equipment		(5,546	)		(29,164	)		(473,553	)
Acquisition of patents		-			-			(158,212	)
Net cash used in investing activities		(5,546	)		(29,164	)		(631,765	)
FINANCING ACTIVITIES:
Payment on notes payable to officer		-			(19,260	)		(218,502	)
Proceeds from notes payable, related party		-			-			457,433
Payments on notes payable to related party		-			(5,000	)		(15,000	)
Receipt from (payments to) equity line of credit		-			(27,336	)		428,664
Proceeds from convertible notes payable		-			-			2,861,000
Proceeds from 10% subordinated notes payable		-			425,000			425,000
Issuance of common stock		5,000			-			8,184,594
Receipt of cash for stock to be issued		-			283,000			400
Net cash provided by financing activities		5,000			656,404			12,123,589
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS		(1,194,975	)		(269,756	)		25,613
CASH AND CASH EQUIVALENTS, BEGINNING		1,220,588			372,511			-
CASH AND CASH EQUIVALENTS, ENDING	$	25,613		$	102,755		$	25,613
SUPPLEMENTAL INFORMATION:
Cash and cash equivalents paid for interest	$	-		$	-		$	-
Cash and cash equivalents paid for taxes	$	-		$	-		$	-

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

8

Sionix Corporation

A Development Stage Company

March 31, 2009

Notes to Financial Statements (Unaudited)

NOTE 1 ORGANIZATION AND DESCRIPTION OF BUSINESS

Sionix Corporation (the "Company") was incorporated in Utah in 1985.  The Company was formed to design, develop, and market automatic water filtration systems primarily for small water districts.

The Company completed its reincorporation as a Nevada corporation effective July 1, 2003. The reincorporation was completed pursuant to an Agreement and Plan of Merger between Sionix Corporation, a Utah corporation ("Sionix Utah") and its wholly-owned Nevada subsidiary, Sionix Corporation ("Sionix Nevada"). Under the merger agreement, Sionix Utah merged with and into Sionix Nevada, and each share of Sionix Utah’s Common Stock was automatically converted into one share of Common Stock, par value $0.001 per share, of Sionix Nevada. The merger was effected by the filing of Articles of Merger, along with the Agreement and Plan of Merger, with the Secretary of State of Nevada.

The Company is a development stage company as defined in Statement of Financial Accounting Standards (“SFAS”) No. 7, “Accounting and Reporting by Development Stage Enterprises.” The Company is in the development stage and its efforts have been principally devoted to research and development, organizational activities, and raising capital. All losses accumulated since inception have been considered as part of the Company’s development stage activities.

NOTE 2 SUMMARYOF SIGNIFICANT ACCOUNTING POLICIES

USE OF ESTIMATES

The preparation of financial statements in conformity with generally accepted accounting principles in the United States (“GAAP”) 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 and the reported amounts of revenues and expenses during the reporting period.  Actual results could differ from those estimates.  Significant estimates include collectability of accounts receivable, accounts payable, sales returns and recoverability of long-term assets.

CASH AND CASH EQUIVALENTS

Cash and cash equivalents represent cash and short-term highly liquid investments with original maturities of three months or less.

INVENTORY

Inventory is stated at the lower of cost, using the first in, first out method, or market. Management compares the cost of inventories with the market value, and an allowance is made for writing down the inventories to their market value, if lower.  As of March 31, 2009, the Company believes that no reserve is required. Inventory at March 31, 2009 was $608,585 and consisted of work in process.

PROPERTY AND EQUIPMENT

Property and equipment is stated at cost. The cost of additions and improvements are capitalized while maintenance and repairs are expensed as incurred. Depreciation of property and equipment is provided on a straight-line basis over the estimated useful lives of the assets.

9

Property and equipment are being depreciated and amortized on the straight-line basis over the following estimated useful lives:

	Years
Machinery and equipment		5
Furniture and fixtures		3-5
Leasehold improvements		3

ADVERTISING

The cost of advertising is expensed as incurred. There were no advertising costs for the three and six months ended March 31, 2009, respectively. Total advertising costs were $2,474 for the three and six months ended March 31, 2008, respectively.

ACCRUED DERIVATIVE LIABILITIES

The Company applies a two-step model to determine whether a financial instrument or an embedded feature is indexed to an issuer’s own stock and thus able to qualify for equity treatment. However, liability accounting is triggered as there were insufficient shares to fulfill all potential conversions. The Company determines which instruments or embedded features require liability accounting and records the fair values as an accrued derivative liability. The changes in the values of the accrued derivative liabilities are shown in the accompanying statements of operations as “gain on change in fair value of warrant and option liability” and “gain on change in fair value of beneficial conversion liability.”

STOCK BASED COMPENSATION

Effective October 1, 2006, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 123-R, “Share-Based Payment” (“SFAS 123-R”), which requires the measurement and recognition of compensation expense for all share-based payment awards made to employees and directors, including stock options, to be based on their fair values. SFAS 123-R supersedes Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”), which the Company previously followed in accounting for stock-based awards. In March 2005, the SEC issued Staff Accounting Bulletin No. 107 (SAB 107) to provide guidance on SFAS 123-R. The Company has applied SAB 107 in its adoption of SFAS 123-R.

EARNINGS PER SHARE

Statement of Financial Accounting Standards No. 128, “Earnings per share” requires the presentation of basic earnings per share and diluted earnings per share.  Basic and diluted earnings per share computations presented by the Company conform to the standard and are based on the weighted average number of shares of Common Stock outstanding during the year.

Basic earnings per share is computed by dividing net income or loss by the weighted average number of shares outstanding for the year.  “Diluted” earnings per share is computed by dividing net income or loss by the total of the weighted average number of shares outstanding, and the dilutive effect of outstanding stock options (applying the treasury stock method).

During the three and six months ended March 31, 2009 and 2008, the Company had net income; however, the net income was due to the change in the fair value of the warrant and option liability and in the change in the fair value of the beneficial conversion liability. If these securities had been converted at the beginning of the period, then the Company would have realized a loss for the nine month period ended June 30, 2008.  As such, these securities are determined to be anti-dilutive and the number of shares used to determine the basic and dilutive earnings per share is the same.

The following is a reconciliation of the numerators and denominators of the basic and diluted earnings per share computations:

	For the Three Months Ended March 31,
	2009						2008
	Net				Per		Net				Per
	Income		Shares		Share		Income		Shares		Share
Basic Earnings Per Share
Net (Loss) Income Available to Stockholders	$	945,474		136,973,884	$	0.01	$	11,206,641		107,494,374	$	0.10
Effect of Dilutive Securities				-		-		-		-		-
Diluted Earnings Per Share		945,474		136,973,884	$	0.01	$	11,206,641		107,494,374	$	0.10

10

	For the Six Months Ended March 31,
	2009						2008
	Net				Per		Net				Per
	Income		Shares		Share		Income		Shares		Share
Basic Earnings Per Share
Net Loss Available to Stockholders	$	6,382,139		136,277,277	$	0.00	$	15,783,544		107,494,374	$	0.15
Effect of Dilutive Securities						-		-		-		-
Diluted Earnings Per Share	$	6,382,139		136,277,277	$	0.00	$	15,783,544		107,494,374	$	0.14	)

FAIR VALUE OF FINANCIAL INSTRUMENTS

Statement of Financial Accounting Standard No. 107, Disclosures about Fair Value of Financial Instruments, requires that the Company disclose estimated fair values of financial instruments. The carrying amounts reported in the statements of financial position for assets and liabilities qualifying as financial instruments are a reasonable estimate of fair value.

CONCENTRATION OF CREDIT RISK

During the six months ended March 31, 2008 the Company had deposits in financial institutions over the federally insured limits of $100,000. The Company does not believe there is any credit risk related to these deposits due to the financial condition of the financial institution.

RELATED PARTY TRANSACTION

On October 14, 2008, the Company entered into an agreement to purchase machinery and equipment with a fair value of $125,000 from RJ Metal, Co. The Company issued 833,333 shares of Common Stock as payment.  The purchase qualified as a related party transaction because the Company’s interim Chief Executive Officer, who is also a director, is also a director, officer and significant stockholder of RJ Metal, Co. 

RECLASSIFICATIONS

Certain items in the prior year financial statements have been reclassified to conform to the current period’s presentation. These reclassifications have no effect on the previously reported net loss.

NOTE 3 PROPERTY AND EQUIPMENT

Property and equipment consisted of the following at:

	March 31,			September 30,
	2009			2008
	(Unaudited)
Machinery and equipment	$	271,972		$	266,426
Furniture and fixtures		41,176			41,176
Leasehold improvement		1,695			1,695
TOTAL PROPERTY AND EQUIPMENT		314,843			309,296
Less accumulated depreciation		(237,300	)		(222,195	)
NET PROPERTY AND EQUIPMENT	$	77,543		$	87,101

Depreciation expenses for the three and six months ended March 31, 2009 were $7,615 and $15,104, respectively. Depreciation expenses for the three and six months ended March 31, 2008 were $8,157 and $16,314, respectively

11

NOTE 4 ACCRUED EXPENSES (RESTATED)

Accrued expenses consisted of the following at:

	March 31,		September 30,
	2009		2008
	(Unaudited)
Accrued salaries	$	1,474,785	$	1,493,444
Advisory board compensation		576,000		576,000
Auto allowance accruals		104,785		94,408
Interest payable		346,957		272,016
Other accruals		1,366,396		1,876,976
TOTAL ACCRUED EXPENSES	$	3,868,923	$	4,312,844

NOTE 5 CUSTOMER DEPOSITS

In May 2008, the Company received an order for two water filtration systems, which required a deposit. The Company is in the design phase of the manufacturing process, and has not recognized any revenue related to these water filtration systems. As of March 31, 2009 and September 30, 2008 customer deposits were $1,420,000 and $1,260,000.

NOTE 6 NOTES PAYABLE – RELATED PARTIES

The Company has received advances in the form of unsecured promissory notes from stockholders in order to pay ongoing operating expenses. These notes bear interest at rates up to 13% and are due on demand. As of March 31, 2009 and September 30, 2008, notes payable amounted to $107,000 and $114,000. Accrued interest on the notes amounted to $78,539 and $74,482 at March 31, 2009 and September 30, 2008, respectively, and is included in accrued expenses. Interest expenses on these notes for the three and six months ended March 31, 2009 were $2,886 and $5,872, respectively. Interest expenses on these notes for the three and six months ended March 31, 2008 were $3,204 and $6,443, respectively

NOTE 7 CONVERTIBLE NOTES

Convertible Notes 1

Between October 2006 and February 2007, the Company completed an offering of $750,000 in principal amount of convertible notes, which bear interest at 10% per annum and mature at the earlier of (i) 18 months from the date of issuance (ii) an event of default or (iii) the closing of any equity related financing by the Company in which the gross proceeds are a minimum of $2,500,000. These notes are convertible into shares of the Company’s Common Stock at $0.05 per share or shares of any equity security issued by the Company at a conversion price equal to the price at which such security is sold to any other party. In the event that a registration statement covering the underlying shares was not declared effective within 180 days after the closing, the conversion price was to be reduced by $0.0025 per share for each 30 day period that the effectiveness of the registration statement was delayed but in no case could the conversion price to be reduced below $0.04 per share. As of March 31, 2009 the conversion price was $0.04 per share.

12

SFAS 133, paragraph 12 was applied to determine if the embedded beneficial conversion features should be bifurcated from the convertible notes. The Company determined that the economic characteristics of the embedded beneficial conversion features are not clearly and closely related to the convertible notes, the embedded beneficial conversion feature and convertible notes are not remeasured at fair value at each balance sheet date, and a separate contract with the same terms would be a derivative pursuant to SFAS 133, paragraphs 6-11. Therefore, the embedded beneficial conversion features were bifurcated from the convertible notes. SFAS 133, paragraph 6 was applied to determine if the embedded beneficial conversion features were within the scope and definition of a derivative. The embedded beneficial conversion features had one or more underlings and one or more notional amounts, required no initial investment and required or permitted net settlement. Therefore, the embedded beneficial conversion features were determined to be derivatives. The terms of the conversion feature only allow the counterparty to convert the notes into shares of Common Stock. Therefore, EITF 00-19, paragraphs 12-33 were included in the analysis to determine the classification of the conversion feature. The Company included SFAS 150 in the analysis of the convertible notes. SFAS 150 requires three classes of freestanding financial instruments, as defined in paragraphs 8 through 17, to be classified as liabilities. The first class, as defined in paragraph 9, is financial instruments that are mandatorily redeemable financial instruments. There are no terms or conditions that require the Company to unconditionally redeem the convertible notes by transferring assets at a specified or determinable date. The second class, as defined in paragraph 11, is financial instruments that require the repurchase of shares of Common Stock by transferring assets. There are no terms or conditions that require the Company to repurchase shares of Common Stock. The third class, as defined in paragraph 12, is financial instruments that require the issuance of a variable number of shares of Common Stock. There are no terms or conditions that require the Company to issue a variable number of shares of Common Stock. Therefore, the Company concluded that the convertible notes were not within the scope of SFAS 150.

The fair value of the embedded beneficial conversion features was $750,000 at the date of issuance using the Black-Scholes valuation model with the following assumptions: risk free rate of return ranging from 2.02% to 5.09%; volatility ranging from 268% to 275%; dividend yield of 0%; and expected term of 1.5 years.

Based on the calculation of the fair value of the embedded beneficial conversion feature, the Company allocated $750,000 to the beneficial conversion feature and the beneficial conversion feature discount, and none to the convertible note at the date of issuance. The embedded beneficial conversion feature discount is amortized to interest expense over the term of the note, which is $41,667 per month.

As of March 31, 2009, the outstanding principal amount of the convertible notes was $523,333 and there was no unamortized embedded beneficial conversion feature discount. As of August 27, 2008, the convertible notes had matured and the outstanding principal amount of $533,333 and accrued interest of $86,981 were due. Since the convertible notes matured, $10,000 of principal has been converted into 250,000 shares of Common Stock and the Company has not repaid the remaining outstanding amount of the convertible notes.

As of September 30, 2008, the outstanding principal amount of the convertible notes was $533,333 and there was no unamortized embedded beneficial conversion feature discount.

For the three and six months ended March 31, 2009, interest expense was $13,083 and $26,638, respectively, which was included in the other income (expense) section of the statement of operations.

For the three and six months ended March 31, 2008, interest expense was $18,958 and $38,334, respectively, and amortization expense for the embedded beneficial conversion feature discount was $125,000 and $250,000, respectively, which was included in interest expense in the other income (expense) section of the statement of operations.

Calico Capital Management, LLC acted as a financial advisor for Convertible Notes 1 and 2 for the Company and received a fee of $75,000. Southridge Investment Group LLC, Ridgefield, Connecticut (“Southridge) acted as an agent for the Company in arranging the transaction for Convertible Notes 1 and 2. The Company recorded these fees as an expense during the period.

Convertible Notes 2

On June 6, 2007, the Company completed an offering of $86,000 in principal amount of convertible notes, which bear interest at 10% per annum and are due and payable upon the earlier of (i) the occurrence of an Event of Default or (ii) the Maturity Date, which is defined as any business day that is not sooner than December 31, 2008, as the holder of the notes may specify in written notice delivered to the Company not less than 30 days prior to such specified date. These notes are convertible into shares of the Company’s Common Stock at $0.01 per share or shares of any equity security issued by the Company at a conversion price equal to the price at which such security is sold to any other party. There are no registration rights associated with these notes.

13

SFAS 133, paragraph 12 was applied to determine if the embedded beneficial conversion features should be bifurcated from the convertible notes. The Company determined that the economic characteristics of the embedded beneficial conversion features are not clearly and closely related to the convertible notes, the embedded beneficial conversion feature and convertible notes are not remeasured at fair value at each balance sheet date, and a separate contract with the same terms would be a derivative pursuant to SFAS 133, paragraphs 6-11. Therefore, the embedded beneficial conversion features were bifurcated from the convertible notes. SFAS 133, paragraph 6 was applied to determine if the embedded beneficial conversion features were within the scope and definition of a derivative. The embedded beneficial conversion features had one or more underlings and one or more notional amounts, required no initial investment and required or permitted net settlement. Therefore, the embedded beneficial conversion features were determined to be derivatives. The terms of the conversion feature only allow the counterparty to convert the notes into shares of common stock. Therefore, EITF 00-19, paragraphs 12-33 were included in the analysis to determine the classification of the conversion feature. The Company included SFAS 150 in the analysis of the convertible notes. SFAS 150 requires three classes of freestanding financial instruments, as defined in paragraphs 8 through 17, to be classified as liabilities. The first class, as defined in paragraph 9, is financial instruments that are mandatorily redeemable financial instruments. There are no terms or conditions that require the Company to unconditionally redeem the convertible notes by transferring assets at a specified or determinable date. The second class, as defined in paragraph 11, is financial instruments that require the repurchase of shares of Common Stock by transferring assets. There are no terms or conditions that require the Company to repurchase shares of Common Stock. The third class, as defined in paragraph 12, is financial instruments that require the issuance of a variable number of shares of Common Stock. There are no terms or conditions that require the Company to issue a variable number of shares of Common Stock. Therefore, the Company concluded that the convertible notes were not within the scope of SFAS 150.

The fair value of the embedded beneficial conversion features was $86,000 at the date of issuance using the Black-Scholes valuation model with the following assumptions: risk free rate of return of 4.96%; volatility of 259.58%; dividend yield of 0% and expected term of 1.5 years.

Based on the calculation of the fair value of the embedded beneficial conversion feature, the Company allocated $86,000 to the beneficial conversion feature and the beneficial conversion feature discount, and none to the convertible note. The embedded beneficial conversion feature discount is amortized to interest expense over the term of the note, which is $4,778 per month.

As of March 31, 2009, the outstanding principal amount of the convertible notes was $8,000 and there was no unamortized embedded beneficial conversion feature discount. As of December 31, 2008, the convertible notes had matured and the outstanding principal amount of $26,000 and accrued interest of $4,153 were due. Since the convertible notes matured, $18,000 of principal has been converted into 1,800,000 shares of Common Stock and the Company has not repaid the remaining outstanding amount of the convertible notes.

As of September 30, 2008, the outstanding principal amount of the convertible notes was $26,000 and unamortized embedded beneficial conversion feature discount was $2,890.

For the three and six months ended March 31, 2009, interest expense was $626 and $1,290, and amortization expense for the embedded beneficial conversion feature discount was $2,890, which was included in interest expense in the other income (expense) section of the statement of operations.

For the three and six months ended March 31, 2008, interest expense was $2,144 and $4,335, respectively, and amortization expense for the embedded beneficial conversion feature discount was $14,333 and $28,666, which was included in interest expense in the other income (expense) section of the statement of operations.

Calico Capital Management, LLC acted as a financial advisor for Convertible Notes 1 and 2 for the Company and received a fee of $75,000. Southridge acted as an agent for the Company in arranging the transaction for Convertible Notes 1 and 2. The Company recorded these fees as an expense during the period.

Convertible Notes 3

On July 17, 2007, the Company completed an offering of $1,025,000 in principal amount of Subordinated Convertible Debentures to a group of institutional and accredited investors, which bear interest at the rate of 8% per annum, and mature 12 months from the date of issuance. Convertible Notes 3 are convertible into shares of the Company’s Common Stock at an initial conversion rate of $0.22 per share, subject to anti-dilution adjustments. As part of the above offering the Company issued warrants to purchase 2,329,546 shares of Common Stock at an initial exercise price of $0.50 per share. An amendment dated March 13, 2008 reduces the conversion rate of the notes to $0.15 per share and the exercise price of the warrants to $0.30 per share.

Under the terms of a Registration Rights Agreement signed in conjunction with this offering, the Company is required to file a registration statement under the Securities Act of 1933 in order to register the resale of the shares of Common Stock issuable upon conversion of the  Convertible Notes 3 and the warrant shares (collectively, the "Registrable Securities"). If the Company did not file a registration statement with respect to the Registrable Securities within 45 days following the closing of the offering, or if the registration statement was not declared effective by the Securities and Exchange Commission within 90 days, then the Company was required to pay to each purchaser damages equal to 1.5% of the purchase price paid by the purchaser for Convertible Notes 3 for each 30 day period that followed these deadlines. The aggregate amount of damages payable by the Company is limited to 15% of the purchase price. The Company had until August 31, 2007 to file the registration statement and has accrued $153,750 of expenses as liquidated damages. For the three and six months ended March 31, 2009, $75,000 of the liquidating damages were converted into 937,500 shares of Common Stock For the three and six months ended March 31, 2008, the Company recorded $92,250 and $138,375 as liquidated damages, respectively. No derivative liability is recorded as the amount of liquidated damage is fixed with a maximum ceiling.

14

The Company applied APB 14, paragraph 15 to determine the allocation of the proceeds of the convertible debt, which states that proceeds from the sale of debt with stock purchase warrants should be allocated between the debt and warrants, and paragraph 16 states that the proceeds should be allocated based on the relative fair values of the two securities at the time of issuance.

The fair value of the warrants was $741,341 at the date of issuance calculated using the Black-Scholes valuation model with the following assumptions: risk free rate of return ranging from  4.96% to 5.02%; volatility ranging from 219.89% to 226.04%; dividend yield of 0%; and expected term of 5 years. As a result, the relative fair value of the warrants was $430,189.

SFAS 133, paragraph 12 was applied to determine if the embedded beneficial conversion features should be bifurcated from the convertible notes. The Company determined that the economic characteristics of the embedded beneficial conversion features are not clearly and closely related to the convertible notes, the embedded beneficial conversion feature and convertible notes are not remeasured at fair value at each balance sheet date, and a separate contract with the same terms would be a derivative pursuant to SFAS 133, paragraphs 6-11. Therefore, the embedded beneficial conversion features were bifurcated from the convertible notes. SFAS 133, paragraph 6 was applied to determine if the embedded beneficial conversion features were within the scope and definition of a derivative. The embedded beneficial conversion features had one or more underlings and one or more notional amounts, required no initial investment and required or permitted net settlement. Therefore, the embedded beneficial conversion features were determined to be derivatives. The terms of the conversion feature only allow the counterparty to convert the notes into shares of Common Stock. Therefore, EITF 00-19, paragraphs 12-33 were included in the analysis to determine the classification of the conversion feature.  The Company included SFAS 150 in the analysis of the convertible notes. SFAS 150 requires three classes of freestanding financial instruments, as defined in paragraphs 8 through 17, to be classified as liabilities. The first class, as defined in paragraph 9, is financial instruments that are mandatorily redeemable financial instruments. There are no terms or conditions that require the Company to unconditionally redeem the convertible notes by transferring assets at a specified or determinable date. The second class, as defined in paragraph 11, is financial instruments that require the repurchase of shares of Common Stock by transferring assets. There are no terms or conditions that require the Company to repurchase shares of Common Stock. The third class, as defined in paragraph 12, is financial instruments that require the issuance of a variable number of shares of Common Stock. There are no terms or conditions that require the Company to issue a variable number of shares of Common Stock. Therefore, the Company concluded that the convertible notes were not within the scope of SFAS 150.

The fair value of the embedded beneficial conversion features was $594,811 at the date of issuance using the Black-Scholes valuation model with the following assumptions: risk free rate of return ranging from  4.96% to 5.02%; volatility ranging from 219.89% to 226.04%; dividend yield of 0%; and expected term of 1 year.

Southridge acted as the Company’s agent in arranging the transaction and received a placement fee of $102,500. Southridge also received warrants to purchase 465,909 shares of the Company’s Common Stock on the same terms and conditions as the warrants issued to the purchasers. The Company recorded the placement fees as an expense. The grant date fair value of the warrants amounted to $124,060 and was calculated using the Black-Scholes valuation model, using the following assumptions: risk free rate of return of 5.01%, volatility of 226.04%, dividend yield of 0% and expected term of 5 years.

As of March 31, 2009, the outstanding principal amount of the convertible notes was $250,000, there was no unamortized warrant discount or embedded beneficial conversion feature discount, and the number of outstanding warrants was 2,329,546. As of July 16, 2008, the convertible notes had matured and the outstanding principal amount of $485,000 and accrued interest of $67,417 were due. Since the convertible notes matured, $235,000 of principal has been converted into 1,566,667 shares of Common Stock and the Company has not repaid the remaining outstanding principal amount or accrued interest of the convertible notes.

As of September 30, 2008, the outstanding principal amount of the convertible notes was $485,000, there was no unamortized warrant discount or embedded beneficial conversion feature discount, and the number of outstanding warrants was 2,329,546.

For the three and six months ended March 31, 2009, interest expense was $7,105 and $16,595, respectively, which was included in the other income (expense) section of the statement of income (operations).

For the three and six months ended March 31, 2008, interest expense was $20,444 and $40,663, amortization expense for the warrant discount was $111,031 and $218,578, which was included in interest expense in the other income (expense) section of the statement of operations, and amortization expense for the beneficial conversion feature discount was $153,553 and $302,255, which was also included in interest expense in the other income (expense) section of the statement of income (operations).

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12% SUBORDINATED CONVERTIBLE NOTES

On July 29, 2008, the Company completed an offering of $1,000,000 in principal amount of Subordinated Debentures to a group of institutional and accredited investors.  The 12% Subordinated Convertible Notes mature on July 29, 2009 or   sooner if declared due and payable by the holder upon the occurrence of an event of default, and bear interest at the rate of 12% per annum. The Debentures will be convertible into Common Stock at a conversion price of $0.25 per share (the “Conversion Price”) from and after such time as the authorized Common Stock is increased in accordance with applicable federal and state laws. In the event of an offering of Common Stock, or securities convertible into Common Stock, at a price, conversion price or exercise price less than the conversion price (a “dilutive issuance”), then the conversion price of any then outstanding subordinated convertible notes will be reduced to equal such lower price, except in connection with certain exempt issuances.  In an event of default, the conversion price will be reduced to $0.15 per share. As part of the above offering, the Company issued warrants to purchase 3,333,333 shares of Common Stock, which expire five years from the date of grant, are exercisable at an exercise price of $0.30 per share from and after such time as the authorized Common Stock is increased in accordance with applicable federal and state laws, and may be exercised on a cashless basis at the election of the holder.  In the event of a dilutive issuance, the exercise price of the warrants will be reduced to equal the price of the securities issued in the dilutive issuance, except in connection with certain exempt issuances.

The requirement to increase the number of authorized shares of Common Stock is a condition that has not occurred, is not certain to occur, and is outside the control of the Company. Therefore, the Company has not recognized the related beneficial conversion feature or the warrants related to these notes. If and when this condition does occur, the Company will recognize the beneficial conversion feature and warrants at fair value on the date the number of authorized shares is increased. The note will be converted into 4,000,000 shares of Common Stock at a conversion price of $0.25 per share. These shares were excluded from the earnings per share calculation as the effect of dilutive securities is anti-dilutive.

Calico Capital Management, LLC acted as a financial advisor for the Company and received a fee of $40,000. LBS Financial Services, LLC acted as an agent for the Company in arranging the transaction and received a fee of $120,000. The Company recorded these fees as an expense during the period.

As of March 31, 2009 and September 30, 2008, the principal outstanding totaled $1,000,000.

For the three and six months ended March 31, 2009, interest expense was $29,589 and $59,836, respectively.

NOTE 8 10% SUBORDINATED NOTES PAYABLE

In January 2008, the Company completed an offering of $425,000 in principal amount of Subordinated Debentures to a group of institutional and accredited investors.  The Subordinated Debentures mature on December 31, 2008, and bear interest at the rate of 10% per annum. As part of the above offering, the Company issued warrants to purchase 850,000 shares of Common Stock, which expire six years from the date of grant.

The Company applied APB 14, paragraphs 15 and 16, to determine the allocation of the proceeds of the convertible debt. Paragraph 15 states that proceeds from the sale of debt with stock purchase warrants should be allocated between the debt and warrants, and paragraph 16 states that the proceeds should be allocated based on the relative fair values of the two securities at the time of issuance.

The grant date fair value of the warrants was determined to be $125,462 which was calculated using the Black-Scholes valuation model, using the following assumptions: risk free rate of return ranging from 2.64% to 3.26%, volatility ranging from 97.08% to 98.27%, dividend yield of 0%; and expected life of 6 years. As a result, the relative fair value of the warrants was determined to be $96,814.

As of March 31, 2009, the principal outstanding totaled $425,000, and there was no unamortized warrant discount. As of December 31, 2008, the notes had matured and the outstanding principal amount of $425,000 and accrued interest of $41,081 were due.

As of September 30, 2008, the principal outstanding totaled $425,000, and unamortized warrant discount was $24,204.

For the three and six months ended March 31, 2009, interest expense was $10,479 and $21,192, respectively.

For the three and six months ended March 31, 2008, interest expense was $8,938, and amortization expense for the warrant discount was $24,204, which was included in interest expense in the other income (expense) section of the statement of operations.

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NOTE 9 WARRANT LIABILITY

2001 Executive Officers Stock Option Plan

In October 2000, the Company amended its employment agreements with its executive officers. In conjunction with the amendments the Company adopted the 2001 Executive Officers Stock Option Plan. The plan has reserved 7,576,680 shares of Common Stock and has issued options for the purchase of 7,034,140 shares of Common Stock.  The options expire 5 years from the date of issuance.

On the grant date, the Company applied SFAS 133, paragraph 6 to determine if the options were within the scope and definition of a derivative. The options had one or more underlings, one or more notional amounts, required no initial investment, and required or permitted net settlement. Therefore, the options were determined to be derivatives. In order to determine how to classify the options, the Company followed the guidance of paragraphs 7 and 8 of EITF 00-19, which states that contracts that require settlement in shares are equity instruments. In order to determine the value of the options, the Company applied EITF 00-19, paragraph 9, which states that contracts that require the company to deliver shares as part of a physical settlement or net-share settlement should be initially measured at fair value. In accordance with EITF 00-19, the options were recorded in additional paid-in capital at fair value on the date of issuance.

In accordance with EITF 00-19, the options were reclassified as of July 17, 2007 from additional paid-in capital to warrant liability on the balance sheet, at the fair value of $2,271,879 using the Black-Scholes valuation model with the following assumptions: risk free rate of return of 5.02%; volatility of 219.89%; dividend yield of 0%; and expected term of 3.67 years.

The Company followed the guidance of EITF 00-19, paragraph 9, which states that all contracts classified as liabilities should be measured at fair value at each balance sheet date, with changes in fair value reported in earnings and disclosed in the financial statements as long as the contracts remain classified as liabilities. The Company analyzed the options as of March 31, 2009 by following the guidance of SFAS 133, paragraph 6 to ascertain if the options issued remained derivatives as of March 31, 2009. All of the criteria in the original analysis were met, and the options issued were determined to be within the scope and definition of a derivative. The Company next followed the guidance of EITF 00-19, paragraph 19, which states that if a company is required to obtain shareholder approval to increase the company’s authorized shares in order to net-share or physically settle a contract, share settlement is not controlled by the company, and the contract is required to be classified as a liability. The Company next applied EITF 00-19, paragraph 10, which states that if classification changes as the result of an event, the contract should be reclassified as of the date of the event at fair value. The event responsible for the change in classification was the issuance of the Convertible Note 3 on July 17, 2007.

The fair value of the options was $251,036 as of March 31, 2009, calculated using the Black-Scholes valuation model with the following assumptions: risk free rate of return of 0.57%; volatility of 109.22%; dividend yield of 0%; and expected term of 2.00 years.

The fair value of the options was $484,440 as of September 30, 2008, calculated using the Black-Scholes model with the following assumptions: risk free rate of return of 1.78%; volatility of 84.94%; dividend yield of 0%; and expected term of 2.5 years.

For the three and six months ended March 31, 2009, the increase (decrease) in the fair value of the options was recorded by increasing (decreasing) warrant liability on the balance sheet by $18,522 and $(233,404), respectively.

For the three and six months ended March 31, 2008, the decrease in the fair value of the options was recorded by decreasing warrant liability on the balance sheet by $766,474 and $1,469,800, respectively.

Warrants Related to Convertible Notes 3

On July 17, 2007 the Company completed an offering of $1,025,000 of Convertible Notes 3 to a group of institutional and accredited investors which included warrants to purchase 2,795,454 shares of Common Stock (2,329,546 shares of Common Stock to holders of the Convertible Notes 3 and 465,908 shares of Common Stock as a placement fee) at an exercise price of $0.50 per share. An amendment dated March 13, 2008 reduces the exercise price of the warrants to $0.30 per share.

On the date of grant, the Company followed the guidance of SFAS 133, paragraph 6, to determine if the warrants were within the scope and definition of a derivative. The warrants had one or more underlings and one or more notional amounts, required no initial investment and required or permitted net settlement. Therefore, the warrants were determined to be derivatives at the date of issuance. In order to determine how to classify the warrants, the Company followed the guidance of EITF 00-19, paragraphs 7 and 8, which state that contracts that require net-cash settlement (including a requirement to net cash settle the contract if an event occurs and if that event is outside the control of the company) are liability instruments. In order to determine the value of the options, the Company followed the guidance of EITF 00-19, paragraph 9, which states that contracts which require the company to deliver shares as part of a physical settlement or net-share settlement should be initially measured at fair value.

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The fair value of the warrants was $554,249 ($430,189 attributable to the holders of the Convertible Notes 3 and $124,060 attributable to the placement fee) at the date of issuance calculated using the Black-Scholes valuation model with the following assumptions: risk free rate of return ranging from 4.96% to 5.02%; volatility ranging from 219.89% to 226.04%; dividend yield of 0%; and expected term of 5 years.

The Company followed the guidance of EITF 00-19, paragraph 9, which states that all contracts classified as liabilities should be measured at fair value at each balance sheet date, with changes in fair value reported in earnings and disclosed in the financial statements as long as the contracts remain classified as liabilities. The Company analyzed the options as of March 31, 2009 by following the guidance of SFAS 133, paragraph 6 to ascertain if the options issued remained derivatives as of March 31, 2009. All of the criteria in the original analysis were met, and the options issued were determined to be within the scope and definition of a derivative. The Company next followed the guidance of EITF 00-19, paragraph 19, which states that if a company is required to obtain shareholder approval to increase the company’s authorized shares in order to net-share or physically settle a contract, share settlement is not controlled by the company, and the contract is required to be classified as a liability.

The fair value of the warrants was determined to be $96,411 ($79,391 attributable to the holders of the Convertible Notes 3 and $17,020 attributable to the placement fee) as of March 31, 2009, which was calculated using the Black-Scholes valuation model with the following assumptions: risk free rate of return of 0.57%; volatility of 109.22%; dividend yield of 0%; and expected term of 3.17 to 3.25 years.

The fair value of the warrants was determined to be $153,789 ($125,440 attributable to the holders of the Convertible Notes 3 and $28,349 attributable to the placement fee) as of September 30, 2008, which was calculated using the Black-Scholes model with the following assumptions: risk free rate of return of 1.78%; volatility of 84.94%; dividend yield of 0%; and expected term of 3.67 to 3.75 years.

For the three and six months ended March 31, 2009, the increase (decrease) in the fair value of the warrants was recorded by increasing (decreasing) warrant liability on the balance sheet by $15,720 ($12,778 attributable to the holders of the Convertible Notes 3 and $2,942 attributable to the placement fee) and $(57,378) ($(46,048) attributable to the holders of the Convertible Notes 3 and $(11,329) attributable to the placement fee), respectively.

For the three and six months ended March 31, 2008, the decrease in the fair value of the warrants was recorded by decreasing warrant liability on the balance sheet by $185,827 ($143,242 and attributable to the holders of the Convertible Notes 3 and $42,585 attributable to the placement fee) and $363,982 ($268,469 and attributable to the holders of the Convertible Notes 3 and $95,513 attributable to the placement fee), respectively.

Warrant Issued to Legal Counsel

The Company entered into an agreement with its legal counsel to issue 150,000 shares of Common Stock and a five year warrant to purchase up to 150,000 shares of Common Stock at an exercise price of $0.25 per share for services.

On the grant date, the Company followed the guidance of FASB 133, paragraph 6, to determine if the warrant was within the scope and definition of a derivative. The warrant had one or more underlings and one or more notional amounts, required no initial investment and required or permitted net settlement. Therefore, the warrant was determined to be a derivative at the date of issuance. In order to determine how to classify the warrant, the Company followed the guidance of EITF 00-19, paragraphs 7 and 8, which state that contracts that require net-cash settlement (including a requirement to net cash settle the contract if an event occurs and if that event is outside the control of the company) are liability instruments. In order to determine the value of the warrant, the Company followed the guidance of EITF 00-19, paragraph 9, which states that contracts which require a company to deliver shares as part of a physical settlement or net-share settlement should be initially measured at fair value.

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The fair value of the warrant was $32,394 at the date of issuance and was calculated using the Black-Scholes valuation model with the following assumptions: risk free interest rate of 3.93%, volatility of 116.99%, dividend yield of 0% and expected term of 5 years.

The Company followed the guidance of EITF 00-19, paragraph 9, which states that all contracts classified as liabilities should be measured at fair value at each balance sheet date, with changes in fair value reported in earnings and disclosed in the financial statements as long as the contracts remain classified as liabilities. The Company analyzed the options as of March 31, 2009 by following the guidance of SFAS 133, paragraph 6 to ascertain if the options issued remained derivatives as of March 31, 2009. All of the criteria in the original analysis were met, and the options issued were determined to be within the scope and definition of a derivative. The Company next followed the guidance of EITF 00-19, paragraph 19, which states that if a company is required to obtain shareholder approval to increase the company’s authorized shares in order to net-share or physically settle a contract, share settlement is not controlled by the company, and the contract is required to be classified as a liability.

The fair value of the warrant was determined to be $6,353 as of March 31, 2009, using the Black-Scholes valuation model with the following assumptions: risk free rate of return of 0.57%; volatility of 109.22%; dividend yield of 0%; and expected term of 3.50 years.

For the three and six months ended March 31, 2009, the increase (decrease) in the fair value of the warrant was recorded by increasing (decreasing) warrant liability on the balance sheet by $906 and $(4,155), respectively.

Warrants Issued to Advisory Board Members

On December 13, 2007, the Company’s Board of Directors approved the issuance of five year warrants to the Company’s three advisory board members to purchase a total of 8,640,000 shares of the Company’s Common Stock at an exercise price of $0.25 per share.

The Company followed the guidance of FASB 133, paragraph 6, to determine if the warrants were within the scope and definition of a derivative at the date of issuance. The warrants had one or more underlings and one or more notional amounts, required no initial investment and required or permitted net settlement. Therefore, the warrants were determined to be derivatives at the date of issuance. In order to determine how to classify the warrants, the Company followed the guidance of EITF 00-19, paragraphs 7 and 8, which state that contracts that require net-cash settlement (including a requirement to net cash settle the contract if an event occurs and if that event is outside the control of the company) are liability instruments. In order to determine the value of the warrants, the Company followed the guidance of EITF 00-19, paragraph 9, which states that contracts which require a company to deliver shares as part of a physical settlement or net-share settlement should be initially measured at fair value.

The fair value of the warrants was $1,557,705 at the date of issuance and was calculated using the Black-Scholes option valuation model with the following assumptions: risk free interest rate of 3.22%, expected volatility of 99.86%, dividend yields of 0% and expected term of 5 years.

The Company followed the guidance of EITF 00-19, paragraph 9, which states that all contracts classified as liabilities should be measured at fair value at each balance sheet date, with changes in fair value reported in earnings and disclosed in the financial statements as long as the contracts remain classified as liabilities. The Company analyzed the options as of March 31, 2009 by following the guidance of SFAS 133, paragraph 6 to ascertain if the options issued remained derivatives as of March 31, 2009. All of the criteria in the original analysis were met, and the options issued were determined to be within the scope and definition of a derivative. The Company next followed the guidance of EITF 00-19, paragraph 19, which states that if a company is required to obtain shareholder approval to increase the company’s authorized shares in order to net-share or physically settle a contract, share settlement is not controlled by the company, and the contract is required to be classified as a liability.

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The fair value of the warrants was determined to be $378,136 as of March 31, 2009, using the Black-Scholes valuation model with the following assumptions: risk free rate of return of 0.57%; volatility of 109.22%; dividend yield of 0%; and expected term of 3.67 years.

The fair value of the warrants was determined to be $620,453 as of September 30, 2008, using the Black-Scholes model with the following assumptions: risk free rate of return of 1.78%; volatility of 84.94%; dividend yield of 0%; and expected term of 4.17 years.

For the three and six months ended March 31, 2009, the increase (decrease) in the fair value of the warrants was recorded by increasing (decreasing) warrant liability on the balance sheet by $53,039 and $(242,317), respectively.

For the three and six months ended March 31, 2008, the decrease in the fair value of the warrants was recorded by decreasing warrant liability on the balance sheet by $983,628 and $1,008,033, respectively.

Option Issued to Director

On December 13, 2007, the Company’s Board of Directors approved the issuance of a five year option to a Company director to purchase a total of 1,000,000 shares of the Company’s common stock at an exercise price of $0.25 per share.

The Company followed the guidance of FASB 133, paragraph 6, to determine if the option was within the scope and definition of a derivative at the date of issuance. The option had one or more underlings and one or more notional amounts, required no initial investment and required or permitted net settlement. Therefore, the option was determined to be a derivative at the date of issuance. In order to determine how to classify the option, the Company followed the guidance of EITF 00-19, paragraphs 7 and 8, which state that contracts that require net-cash settlement (including a requirement to net cash settle the contract if an event occurs and if that event is outside the control of the company) are liability instruments. In order to determine the value of the option, the Company followed the guidance of EITF 00-19, paragraph 9, which states that contracts which require the company to deliver shares as part of a physical settlement or net-share settlement should be initially measured at fair value.

The fair value of the option was $171,520 at the date of issuance and was calculated using the Black-Scholes option valuation model with the following assumptions: risk free interest rate of 3.22%, expected volatility of 99.86%, dividend yields of 0% and expected term of 5 years.

The Company followed the guidance of EITF 00-19, paragraph 9, which states that all contracts classified as liabilities should be measured at fair value at each balance sheet date, with changes in fair value reported in earnings and disclosed in the financial statements as long as the contracts remain classified as liabilities. The Company analyzed the option as of March 31, 2009 by following the guidance of SFAS 133, paragraph 6 to ascertain if the option remained a derivative as of March 31, 2009. All of the criteria in the original analysis were met, and the option was determined to be within the scope and definition of a derivative. The Company next followed the guidance of EITF 00-19, paragraph 19, which states that if a company is required to obtain shareholder approval to increase the company’s authorized shares in order to net-share or physically settle a contract, share settlement is not controlled by the company, and the contract is required to be classified as a liability.

The fair value of the option was determined to be $43,766 as of March 31, 2009, using the Black-Scholes valuation model with the following assumptions: risk free rate of return of 0.57%; volatility of 109.22%; dividend yield of 0%; and expected term of 3.67 years.

The fair value of the option was determined to be $71,812 as of September 30, 2008, using the Black-Scholes model with the following assumptions: risk free rate of return of 1.78%; volatility of 84.94%; dividend yield of 0%; and expected term of 4.17 years.

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For the three and six months ended March 31, 2009, the increase (decrease) in the fair value of the option was recorded by increasing (decreasing) warrant liability on the balance sheet by $6,139 and $(28,046), respectively.

For the three and six months ended March 31, 2008, the decrease in the fair value of the option was recorded by decreasing warrant liability on the balance sheet by $113,845 and $107,900, respectively.

Option Issued to Former Chief Financial Officer

On December 13, 2007, the Company’s Board of Directors approved the issuance to the Chief Financial Officer of a five year option to purchase a total of 1,000,000 shares of the Company’s common stock at an exercise price of $0.25 per share.

The Company followed the guidance of FASB 133, paragraph 6, to determine if the option was within the scope and definition of a derivative at the date of issuance. The option had one or more underlings and one or more notional amounts, required no initial investment and required or permitted net settlement. Therefore, the option was determined to be a derivative at the date of issuance. In order to determine how to classify the option, the Company followed the guidance of EITF 00-19, paragraphs 7 and 8, which state that contracts that require net-cash settlement (including a requirement to net cash settle the contract if an event occurs and if that event is outside the control of the company) are liability instruments. In order to determine the value of the option, the Company followed the guidance of EITF 00-19, paragraph 9, which states that contracts which require the company to deliver shares as part of a physical settlement or net-share settlement should be initially measured at fair value.

The fair value of the option was $171,520 at the date of issuance and was calculated using the Black-Scholes option valuation model with the following assumptions: risk free interest rate of 3.22%, expected volatility of 99.86%, dividend yield of 0% and expected term of 5 years.

The Company followed the guidance of EITF 00-19, paragraph 9, which states that all contracts classified as liabilities should be measured at fair value at each balance sheet date, with changes in fair value reported in earnings and disclosed in the financial statements as long as the contracts remain classified as liabilities. The Company analyzed the option as of March 31, 2009 by following the guidance of SFAS 133, paragraph 6 to ascertain if the option remained a derivative as of March 31, 2009. All of the criteria in the original analysis were met, and the option was determined to be within the scope and definition of a derivative. The Company next followed the guidance of EITF 00-19, paragraph 19, which states that if a company is required to obtain shareholder approval to increase the company’s authorized shares in order to net-share or physically settle a contract, share settlement is not controlled by the company, and the contract is required to be classified as a liability.

The fair value of the option was determined to be $43,766 as of March 31, 2009, using the Black-Scholes valuation model with the following assumptions: risk free rate of return of 0.57%; volatility of 109.22%; dividend yield of 0%; and expected term of 3.67 years.

The fair value of the option was determined to be $71,812 as of September 30, 2008, using the Black-Scholes model with the following assumptions: risk free rate of return of 1.78%; volatility of 84.94%; dividend yield of 0%; and expected term of 4.17 years.

For the three and six months ended March 31, 2009, the increase (decrease) in the fair value of the options was recorded by increasing (decreasing) warrant liability on the balance sheet by $6,139 and $(28,046), respectively.

For the three and six months ended March 31, 2008, the decrease in the fair value of the options was recorded by decreasing warrant liability on the balance sheet by $113,845 and $107,900, respectively.

Option Issued to Former Chief Executive Officer

On December 19, 2007, the Company entered into a one year Employment Agreement with Richard H. Papalian pursuant to which Mr. Papalian had been appointed as the Company’s Chief Executive Officer. As compensation for his services, the Company granted Mr. Papalian a five year option to purchase up to 8,539,312 shares of the Company’s Common Stock at an exercise price of $0.25 per share. As per the terms of the stock option agreement, the right to purchase 340,000 shares of Common Stock is not exercisable until the notes dated June 6, 2007 (Convertible Notes 2 as discussed in Note 7 above) are eligible for conversion into shares of Common Stock. These options were not issued from the 2001 Executive Officers Stock Option Plan.   On August 14, 2008, Mr. Papalian resigned as the Company’s Chief Executive Officer

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On the grant date, the Company applied FASB 133, paragraph 6 to determine if the option was within the scope and definition of a derivative. The option had one or more underlings and one or more notional amounts, required no initial investment, and required or permitted net settlement. Therefore, the option was determined to be a derivative. In order to determine how to classify the option, the Company followed the guidance of EITF 00-19, paragraphs 7 and 8, which state that contracts that require net-cash settlement (including a requirement to net cash settle the contract if an event occurs and if that event is outside the control of the company) are liability instruments. In order to determine the value of the option, the Company applied EITF 00-19, paragraph 9, which states that contracts that require the company to deliver shares as part of a physical settlement or net-share settlement should be initially measured at fair value.

The fair value of the option was $1,448,321 at the date of issuance, which was calculated using the Black-Scholes model with the following assumptions: risk free rate of return of 3.26%; volatility of 98.01%; dividend yield of 0%; and expected term of 5 years.

The Company followed the guidance of EITF 00-19, paragraph 9, which states that all contracts classified as liabilities should be measured at fair value at each balance sheet date, with changes in fair value reported in earnings and disclosed in the financial statements as long as the contracts remain classified as liabilities. The Company analyzed the option as of March 31, 2009 by following the guidance of SFAS 133, paragraph 6 to ascertain if the option remained a derivative as of March 31, 2009. All of the criteria in the original analysis were met, and the option was determined to be within the scope and definition of a derivative. The Company next followed the guidance of EITF 00-19, paragraph 19, which states that if a company is required to obtain shareholder approval to increase the company’s authorized shares in order to net-share or physically settle a contract, share settlement is not controlled by the company, and the contract is required to be classified as a liability.

The fair value of the option was determined to be $128,388 as of March 31, 2009, using the Black-Scholes valuation model with the following assumptions: risk free rate of return of 0.57%; volatility of 109.22%; dividend yield of 0%; and expected term of 3.67 years.

The fair value of the option was determined to be $613,223 as of September 30, 2008, using the Black-Scholes model with the following assumptions: risk free rate of return of 1.78%; volatility of 84.94%; dividend yield of 0%; and expected term of 4.17 years.

For the three and six months ended March 31, 2009, the increase (decrease) in the fair value of the option was recorded by increasing (decreasing) warrant liability on the balance sheet by $18,008 and $(484,835), respectively.

For the three and six months ended March 31, 2008, the decrease in the fair value of the option was recorded by decreasing warrant liability on the balance sheet by $972,165 and $905,054, respectively.

Warrant Issued to Consultant

On December 19, 2007, the Company entered into a one year Consulting Agreement with Mark Maron pursuant to which Mr. Maron has been appointed as Special Adviser to the Company. As compensation for his services, the Company granted Mr. Maron a five year warrant to purchase up to 8,539,312 shares of the Company’s Common Stock at an exercise price of $0.25 per share. As per the terms of the warrant agreement, the right to purchase 340,000 shares of Common Stock is not exercisable until the notes dated June 6, 2007 (Convertible Notes 2 as discussed in Note 7 above) are eligible for conversion into shares of Common Stock.  The warrant was not issued from the 2001 Executive Officers Stock Option Plan.

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The Company followed the guidance of FASB 133, paragraph 6, to determine if the warrant was within the scope and definition of a derivative at the date of issuance. The warrant had one or more underlings and one or more notional amounts, required no initial investment and required or permitted net settlement. Therefore, the warrant was determined to be a derivative at the date of issuance. In order to determine how to classify the warrant, the Company followed the guidance of EITF 00-19, paragraphs 7 and 8, which state that contracts that require net-cash settlement (including a requirement to net cash settle the contract if an event occurs and if that event is outside the control of the company) are liability instruments. In order to determine the value of the warrant, the Company followed the guidance of EITF 00-19, paragraph 9, which states that contracts which require the company to deliver shares as part of a physical settlement or net-share settlement should be initially measured at fair value.

The fair value of the warrant was $1,448,321 at the date of issuance and was calculated using the Black-Scholes option valuation model with the following assumptions: risk free interest rate of 3.26%, expected volatility of 98.01%, dividend yield of 0% and expected term of 5 years.

The Company followed the guidance of EITF 00-19, paragraph 9, which states that all contracts classified as liabilities should be measured at fair value at each balance sheet date, with changes in fair value reported in earnings and disclosed in the financial statements as long as the contracts remain classified as liabilities. The Company analyzed the warrant as of March 31, 2009 by following the guidance of SFAS 133, paragraph 6 to ascertain if the warrant remained a derivative as of March 31, 2009. All of the criteria in the original analysis were met, and the warrant was determined to be within the scope and definition of a derivative. The Company next followed the guidance of EITF 00-19, paragraph 19, which states that if a company is required to obtain shareholder approval to increase the company’s authorized shares in order to net-share or physically settle a contract, share settlement is not controlled by the company, and the contract is required to be classified as a liability.

The fair value of the warrant was determined to be $373,729 as of March 31, 2009, using the Black-Scholes valuation model with the following assumptions: risk free rate of return of 0.57%; volatility of 109.22%; dividend yield of 0%; and expected term of 3.67 years.

The fair value of the warrant was determined to be $613,223 as of September 30, 2008, using the Black-Scholes model with the following assumptions: risk free rate of return of 1.78%; volatility of 84.94%; dividend yield of 0%; and expected term of 4.17 years.

For the three and six months ended March 31, 2009, the increase (decrease) in the fair value of the warrants was recorded by increasing (decreasing) warrant liability on the balance sheet by $52,421 and $(239,494), respectively.

For the three and six months ended March 31, 2008, the decrease in the fair value of the warrants was recorded by decreasing warrant liability on the balance sheet by $972,165 and $905,054, respectively.

Warrants Related to 10% Subordinated Debentures

In January 2008, the Company completed an offering of $425,000 in principal amount of Subordinated Debentures to a group of institutional and accredited investors. As part of the above offering, the Company issued warrants to purchase 850,000 shares of Common Stock.

The Company followed the guidance of FASB 133, paragraph 6, to determine if the warrants were within the scope and definition of a derivative at the date of issuance. The warrants had one or more underlings and one or more notional amounts, required no initial investment and required or permitted net settlement. Therefore, the warrants were determined to be derivatives at the date of issuance. In order to determine how to classify the warrants, the Company followed the guidance of EITF 00-19, paragraphs 7 and 8, which state that contracts that require net-cash settlement (including a requirement to net cash settle the contract if an event occurs and if that event is outside the control of the company) are liability instruments. In order to determine the value of the warrants, the Company followed the guidance of EITF 00-19, paragraph 9, which states that contracts which require a company to deliver shares as part of a physical settlement or net-share settlement should be initially measured at fair value.

23

The fair value of the warrants was determined to be $96,814 at the date of issuance, which was calculated using the Black-Scholes valuation model, using the following assumptions: risk free rate of return of 2.64% to 3.26%, volatility ranging from 97.08% to 98.27%, dividend yield of 0% and expected life of six years.

The Company followed the guidance of EITF 00-19, paragraph 9, which states that all contracts classified as liabilities should be measured at fair value at each balance sheet date, with changes in fair value reported in earnings and disclosed in the financial statements as long as the contracts remain classified as liabilities. The Company analyzed the warrants as of March 31, 2009 by following the guidance of SFAS 133, paragraph 6 to ascertain if the warrants issued remained derivatives as of March 31, 2009. All of the criteria in the original analysis were met, and the warrants were determined to be within the scope and definition of a derivative. The Company next followed the guidance of EITF 00-19, paragraph 19, which states that if a company is required to obtain shareholder approval to increase the company’s authorized shares in order to net-share or physically settle a contract, share settlement is not controlled by the company, and the contract is required to be classified as a liability.

The fair value of the warrants was determined to be $36,060 as of March 31, 2009, using the Black-Scholes valuation model with the following assumptions: risk free rate of return of 0.57%; volatility of 109.22%; dividend yield of 0%; and expected term of 4.83 years.

The fair value of the warrants was determined to be $52,609 as of September 30, 2008, using the Black-Scholes model with the following assumptions: risk free rate of return of 1.78%; volatility of 84.94%; dividend yield of 0%; and expected term of 5.33 years.

For the three and six months ended March 31, 2009, the increase (decrease) in the fair value of the warrants was recorded by increasing (decreasing) warrant liability on the balance sheet by $5,970 and $(16,548), respectively.

For the three and six months ended March 31, 2008, the decrease in the fair value of the warrants was recorded by decreasing warrant liability on the balance sheet by $51,429.

Warrants Related to $750,000 Stock Issuance

On May 28, 2008 the Company completed an offering of units consisting of Common Stock and warrants to purchase shares of its Common Stock to a group of institutional and accredited investors.  The Company raised a total of $750,000 through this offering.  The Company issued warrants to purchase 15,000,000 shares of Common Stock at an exercise price of $0.10 per share. The warrants expire three years from the date of issuance.

The Company followed the guidance of FASB 133, paragraph 6, to determine if the warrants were within the scope and definition of a derivative at the date of issuance. The warrants had one or more underlings and one or more notional amounts, required no initial investment and required or permitted net settlement. Therefore, the warrants were determined to be derivatives at the date of issuance. In order to determine how to classify the warrants, the Company followed the guidance of EITF 00-19, paragraphs 7 and 8, which state that contracts that require net-cash settlement (including a requirement to net cash settle the contract if an event occurs and if that event is outside the control of the company) are liability instruments. In order to determine the value of the warrants, the Company followed the guidance of EITF 00-19, paragraph 9, which states that contracts which require a company to deliver shares as part of a physical settlement or net-share settlement should be initially measured at fair value.

The fair value of the warrants was determined to be $483,476 at the date of issuance, which was calculated using the Black-Scholes valuation model, using the following assumptions: risk free rate of return ranging from 1.32% to 2.17%; volatility ranging from 72.4% to 77.86%; dividend yield of 0%; and expected term of 3 years.

The Company followed the guidance of EITF 00-19, paragraph 9, which states that all contracts classified as liabilities should be measured at fair value at each balance sheet date, with changes in fair value reported in earnings and disclosed in the financial statements as long as the contracts remain classified as liabilities. The Company analyzed the warrants as of March 31, 2009 by following the guidance of SFAS 133, paragraph 6 to ascertain if the warrants issued remained derivatives as of March 31, 2009. All of the criteria in the original analysis were met, and the warrants issued were determined to be within the scope and definition of a derivative. The Company next followed the guidance of EITF 00-19, paragraph 19, which states that if a company is required to obtain shareholder approval to increase the company’s authorized shares in order to net-share or physically settle a contract, share settlement is not controlled by the company, and the contract is required to be classified as a liability.

24

The fair value of the warrants was determined to be $348,642 as of March 31, 2009, using the Black-Scholes valuation model with the following assumptions: risk free rate of return of 0.57%; volatility of 109.22%; dividend yield of 0%; and expected term of 1.92 to 2.08 years.

For the three and six months ended March 31, 2009, the increase (decrease) in the fair value of the warrants was recorded by increasing (decreasing) warrant liability on the balance sheet by $4,609 and $(119,437), respectively.

For the three and six months ended March 31, 2008, the decrease in the fair value of the warrants was recorded by decreasing warrant liability on the balance sheet by $8,754.

Warrant Issued to Legal Counsel

On June 24, 2008, the Company entered into an agreement with its legal counsel to issue 600,139 shares of Common Stock and a six year warrant to purchase up to 400,000 shares of Common Stock at an exercise price of $0.15 per share for services previously rendered.

The Company followed the guidance of FASB 133, paragraph 6, to determine if the warrant was within the scope and definition of a derivative at the date of issuance. The warrant had one or more underlings and one or more notional amounts, required no initial investment and required or permitted net settlement. Therefore, the warrant was determined to be a derivative at the date of issuance. In order to determine how to classify the warrant, the Company followed the guidance of EITF 00-19, paragraphs 7 and 8, which state that contracts   that require net-cash settlement (including a requirement to net cash settle the contract if an event occurs and if that event is outside the control of the company) are liability instruments. In order to determine the value of the warrant, the Company followed the guidance of EITF 00-19, paragraph 9, which states that contracts which require a company to deliver shares as part of a physical settlement or net-share settlement should be initially measured at fair value.

The fair value of the warrant was $60,645 at the date of issuance and was calculated using the Black-Scholes valuation model with the following assumptions: risk free interest rate of 2.36%, expected volatility of 74.90%, dividend yields of 0% and expected term of 6 years.

The Company followed the guidance of EITF 00-19, paragraph 9, which states that all contracts classified as liabilities should be measured at fair value at each balance sheet date, with changes in fair value reported in earnings and disclosed in the financial statements as long as the contracts remain classified as liabilities. The Company analyzed the warrant as of March 31, 2009 by following the guidance of SFAS 133, paragraph 6 to ascertain if the warrant remained a derivative as of March 31, 2009. All of the criteria in the original analysis were met, and the warrant was determined to be within the scope and definition of a derivative. The Company next followed the guidance of EITF 00-19, paragraph 19, which states that if a company is required to obtain shareholder approval to increase the company’s authorized shares in order to net-share or physically settle a contract, share settlement is not controlled by the company, and the contract is required to be classified as a liability.

The fair value of the warrant was determined to be $23,910 as of March 31, 2009, using the Black-Scholes valuation model with the following assumptions: risk free rate of return of 0.57%; volatility of 109.22%; dividend yield of 0%; and expected term of 5.17 years.

The fair value of the warrant was determined to be $38,802 as of September 30, 2008, using the Black-Scholes model with the following assumptions: risk free rate of return of 1.78%; volatility of 84.94%; dividend yield of 0%; and expected term of 5.75 years.

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For the three and six months ended March 31, 2009, the increase (decrease) in the fair value of the warrant was recorded by increasing (decreasing) warrant liability on the balance sheet by $1,616 and $(14,891), respectively.

Warrant Issued to Director (John Pavia)

On July 11, 2008, the Company’s Board of Directors approved the issuance of a five year warrant to a director to purchase a total of 500,000 shares of the Company’s Common Stock at an exercise price of $0.25 per share.

The Company followed the guidance of FASB 133, paragraph 6, to determine if the warrant was within the scope and definition of a derivative at the date of issuance. The warrant had one or more underlings and one or more notional amounts, required no initial investment and required or permitted net settlement. Therefore, the warrant was determined to be a derivative at the date of issuance. In order to determine how to classify the warrant, the Company followed the guidance of EITF 00-19, paragraphs 7 and 8, which state that contracts   that require net-cash settlement (including a requirement to net cash settle the contract if an event occurs and if that event is outside the control of the company) are liability instruments. In order to determine the value of the warrant, the Company followed the guidance of EITF 00-19, paragraph 9, which states that contracts which require a company to deliver shares as part of a physical settlement or net-share settlement should be initially measured at fair value.

The fair value of the warrant was $51,582 at the date of issuance and was calculated using the Black-Scholes valuation model with the following assumptions: risk free interest rate of 2.30%, expected volatility of 71.69%, dividend yield of 0% and expected term of 5 years.

The Company followed the guidance of EITF 00-19, paragraph 9, which states that all contracts classified as liabilities should be measured at fair value at each balance sheet date, with changes in fair value reported in earnings and disclosed in the financial statements as long as the contracts remain classified as liabilities. The Company analyzed the warrant as of March 31, 2009 by following the guidance of SFAS 133, paragraph 6 to ascertain if the warrant issued remained a derivative as of March 31, 2009. All of the criteria in the original analysis were met, and the warrant issued was determined to be within the scope and definition of a derivative. The Company next followed the guidance of EITF 00-19, paragraph 19, which states that if a company is required to obtain shareholder approval to increase the company’s authorized shares in order to net-share or physically settle a contract, share settlement is not controlled by the company, and the contract is required to be classified as a liability.

The fair value of the warrant was determined to be $24,136 as of March 31, 2009, using the Black-Scholes valuation model with the following assumptions: risk free rate of return of 0.57%; volatility of 109.22%; dividend yield of 0%; and expected term of 4.25 years.

The fair value of the warrant was determined to be $38,759 as of September 30, 2008, using the Black-Scholes model with the following assumptions: risk free rate of 1.78%; volatility of 84.94%; dividend yield of 0%; and expected term of 4.75 years.

For the three and six months ended March 31, 2009, the increase (decrease) in the fair value of the warrant was recorded by increasing (decreasing) warrant liability on the balance sheet by $3,179 and $(14,623), respectively.

Warrant Issued to Director (Marcus Woods)

On July 11, 2008, the Company’s Board of Directors approved the issuance of a five year warrant to a director to purchase a total of 500,000 shares of the Company’s Common Stock at an exercise price of $0.25 per share.

The Company followed the guidance of FASB 133, paragraph 6, to determine if the warrant was within the scope and definition of a derivative at the date of issuance. The warrant had one or more underlings and one or more notional amounts, required no initial investment and required or permitted net settlement. Therefore, the warrant was determined to be a derivative at the date of issuance. In order to determine how to classify the warrant, the Company followed the guidance of EITF 00-19, paragraphs 7 and 8, which state that contracts   that require net-cash settlement (including a requirement to net cash settle the contract if an event occurs and if that event is outside the control of the company) are liability instruments. In order to determine the value of the warrant, the Company followed the guidance of EITF 00-19, paragraph 9, which states that contracts which require a company to deliver shares as part of a physical settlement or net-share settlement should be initially measured at fair value.

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The fair value of the warrant was $51,582 at the date of issuance and was calculated using the Black-Scholes valuation model with the following assumptions: risk free interest rate of 2.30%, expected volatility of 71.69%, dividend yield of 0% and expected term of 5 years.

The Company followed the guidance of EITF 00-19, paragraph 9, which states that all contracts classified as liabilities should be measured at fair value at each balance sheet date, with changes in fair value reported in earnings and disclosed in the financial statements as long as the contracts remain classified as liabilities. The Company analyzed the warrant as of March 31, 2009 by following the guidance of SFAS 133, paragraph 6 to ascertain if the warrant remained a derivative as of March 31, 2009. All of the criteria in the original analysis were met, and the warrant was determined to be within the scope and definition of a derivative. The Company next followed the guidance of EITF 00-19, paragraph 19, which states that if a company is required to obtain shareholder approval to increase the company’s authorized shares in order to net-share or physically settle a contract, share settlement is not controlled by the company, and the contract is required to be classified as a liability.

The fair value of the warrant was determined to be $24,136 as of March 31, 2009, using the Black-Scholes valuation model with the following assumptions: risk free rate of return of 0.57%; volatility of 109.22%; dividend yield of 0%; and expected term of 4.25 years.

The fair value of the warrant was determined to be $38,759 as of September 30, 2008, using the Black-Scholes model with the following assumptions: risk free rate of return of 1.78%; volatility of 84.94%; dividend yield of 0%; and expected term of 4.75 years.

For the three and six months ended March 31, 2009, the increase (decrease) in the fair value of the warrant was recorded by increasing (decreasing) warrant liability on the balance sheet by $3,179 and $(14,623), respectively.

Warrant Issued to Legal Counsel

On July 22, 2008, the Company entered into an agreement with its legal counsel to issue 641,000 shares of Common Stock and a six year warrant to purchase up to 641,000 shares of Common Stock at an exercise price of $0.15 per share for services previously rendered.

The Company followed the guidance of FASB 133, paragraph 6, to determine if the warrant was within the scope and definition of a derivative at the date of issuance. The warrant had one or more underlings and one or more notional amounts, required no initial investment and required or permitted net settlement. Therefore, the warrant was determined to be a derivative at the date of issuance. In order to determine how to classify the warrant, the Company followed the guidance of EITF 00-19, paragraphs 7 and 8, which state that contracts   that require net-cash settlement (including a requirement to net cash settle the contract if an event occurs and if that event is outside the control of the company) are liability instruments. In order to determine the value of the warrant, the Company followed the guidance of EITF 00-19, paragraph 9, which states that contracts which require a company to deliver shares as part of a physical settlement or net-share settlement should be initially measured at fair value.

The fair value of the warrant was $82,779 at the date of issuance and was calculated using the Black-Scholes valuation model with the following assumptions: risk free interest rate of 2.27%, expected volatility of 70.18%, dividend yield of 0% and expected term of 6 years.

27

The Company followed the guidance of EITF 00-19, paragraph 9, which states that all contracts classified as liabilities should be measured at fair value at each balance sheet date, with changes in fair value reported in earnings and disclosed in the financial statements as long as the contracts remain classified as liabilities. The Company analyzed the warrant as of March 31, 2009 by following the guidance of SFAS 133, paragraph 6 to ascertain if the warrant remained a derivative as of March 31, 2009. All of the criteria in the original analysis were met, and the warrant was determined to be within the scope and definition of a derivative. The Company next followed the guidance of EITF 00-19, paragraph 19, which states that if a company is required to obtain shareholder approval to increase the company’s authorized shares in order to net-share or physically settle a contract, share settlement is not controlled by the company, and the contract is required to be classified as a liability.

The fair value of the warrant was determined to be $38,571 as of March 31, 2009, using the Black-Scholes valuation model with the following assumptions: risk free rate of return of 0.57%; volatility of 109.22%; dividend yield of 0%; and expected term of 5.25 years.

The fair value of the warrant was determined to be $62,512 as of September 30, 2008, using the Black-Scholes model with the following assumptions: risk free rate of 1.78%; volatility of 84.94%; dividend yield of 0%; and expected term of 5.75 years.

For the three and six months ended March 31, 2009, the increase (decrease) in the fair value of the warrant was recorded by increasing (decreasing) warrant liability on the balance sheet by $2,577 and $(23,941), respectively.

Warrant Issued to Advisory Board Member

On September 23, 2008, the Company issued a five year warrant to a member of the Company’s advisory board to purchase 1,500,000 shares of the Company’s Common Stock at an exercise price of $0.25 per share.

The Company followed the guidance of FASB 133, paragraph 6, to determine if the warrant was within the scope and definition of a derivative at the date of issuance. The warrant had one or more underlings and one or more notional amounts, required no initial investment and required or permitted net settlement. Therefore, the warrant was determined to be a derivative at the date of issuance. In order to determine how to classify the warrant, the Company followed the guidance of EITF 00-19, paragraphs 7 and 8, which state that contracts   that require net-cash settlement (including a requirement to net cash settle the contract if an event occurs and if that event is outside the control of the company) are liability instruments. In order to determine the value of the warrant, the Company followed the guidance of EITF 00-19, paragraph 9, which states that contracts which require a company to deliver shares as part of a physical settlement or net-share settlement should be initially measured at fair value.

The fair value of the warrant was $144,641 at the date of issuance and was calculated using the Black-Scholes valuation model with the following assumptions: risk free interest rate of 2.01%, expected volatility of 78.92%, dividend yield of 0% and expected term of 5 years.

The Company followed the guidance of EITF 00-19, paragraph 9, which states that all contracts classified as liabilities should be measured at fair value at each balance sheet date, with changes in fair value reported in earnings and disclosed in the financial statements as long as the contracts remain classified as liabilities. The Company analyzed the warrant as of March 31, 2009 by following the guidance of SFAS 133, paragraph 6 to ascertain if the warrant remained a derivative as of March 31, 2009. All of the criteria in the original analysis were met, and the warrant was determined to be within the scope and definition of a derivative. The Company next followed the guidance of EITF 00-19, paragraph 19, which states that if a company is required to obtain shareholder approval to increase the company’s authorized shares in order to net-share or physically settle a contract, share settlement is not controlled by the company, and the contract is required to be classified as a liability.

The fair value of the warrant was determined to be $74,171 as of March 31, 2009, using the Black-Scholes valuation model with the following assumptions: risk free rate of return of 0.57%; volatility of 109.22%; dividend yield of 0%; and expected term of 4.42 years.

The fair value of the warrant was determined to be $118,551 as of September 30, 2008, using the Black-Scholes model with the following assumptions: risk free rate of return of 1.78%; volatility of 84.94%; dividend yield of 0%; and expected term of 4.83 years.

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For the three and six months ended March 31, 2009, the increase (decrease) in the fair value of the warrant was recorded by increasing (decreasing) warrant liability on the balance sheet by $9,582 and $(44,380), respectively.

Option Issued to Former Chief Executive Officer

On November 11, 2008 the Company’s Board of Directors approved the issuance to the Chief Executive Officer of a five year option to purchase a total of 3,500,000 shares of the Company’s common stock at an exercise price of $0.25 per share.

On the grant date, the Company applied FASB 133, paragraph 6 to determine if the option was within the scope and definition of a derivative. The option had one or more underlings and one or more notional amounts, required no initial investment, and required or permitted net settlement. Therefore, the option was determined to be a derivative. In order to determine how to classify the option, the Company followed the guidance of EITF 00-19, paragraphs 7 and 8, which state that contracts   that require net-cash settlement (including a requirement to net cash settle the contract if an event occurs and if that event is outside the control of the company) are liability instruments. In order to determine the value of the option, the Company applied EITF 00-19, paragraph 9, which states that contracts that require the company to deliver shares as part of a physical settlement or net-share settlement should be initially measured at fair value.

The fair value of the option was $238,244 at the date of issuance, which was calculated using the Black-Scholes valuation model with the following assumptions: risk free rate of return of 1.16%; volatility of 89.31%; dividend yield of 0%; and expected term of 5 years.

The Company followed the guidance of EITF 00-19, paragraph 9, which states that all contracts classified as liabilities should be measured at fair value at each balance sheet date, with changes in fair value reported in earnings and disclosed in the financial statements as long as the contracts remain classified as liabilities. The Company analyzed the option as of March 31, 2009 by following the guidance of SFAS 133, paragraph 6 to ascertain if the option remained a derivative as of March 31, 2009. All of the criteria in the original analysis were met, and the option was determined to be within the scope and definition of a derivative. The Company next followed the guidance of EITF 00-19, paragraph 19, which states that if a company is required to obtain shareholder approval to increase the company’s authorized shares in order to net-share or physically settle a contract, share settlement is not controlled by the company, and the contract is required to be classified as a liability.

The fair value of the option was determined to be $177,019 as of March 31, 2009, using the Black-Scholes valuation model with the following assumptions: risk free rate of return of 0.57%; volatility of 109.22%; dividend yield of 0%; and expected term of 4.58 years.

For the three and six months ended March 31, 2009, the increase (decrease) in the fair value of the option was recorded by increasing (decreasing) warrant liability on the balance sheet by $22,418 and $(61,225), respectively.

Option Issued to Director (Rodney Anderson)

On March 30, 2009 the Company issued an option to a director to purchase a total of 1,380,114 shares of the Company’s common stock at an exercise price of $0.15 per share. The right to purchase 690,057 shares of Common Stock vested on the date of grant and the right to purchase 172,514 shares of Common Stock vests on June 30, September 30, December 31, 2009 and March 31, 2010, respectively.

On the grant date, the Company applied FASB 133, paragraph 6 to determine if the options were within the scope and definition of a derivative. The options had one or more underlings and one or more notional amounts, required no initial investment, and required or permitted net settlement. Therefore, the options were determined to be a derivative. In order to determine how to classify the options, the Company followed the guidance of EITF 00-19, paragraphs 7 and 8, which state that contracts   that require net-cash settlement (including a requirement to net cash settle the contract if an event occurs and if that event is outside the control of the company) are liability instruments. In order to determine the value of the options, the Company applied EITF 00-19, paragraph 9, which states that contracts that require the company to deliver shares as part of a physical settlement or net-share settlement should be initially measured at fair value.

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The fair value of the vested options was $41,847 at the date of issuance, which was calculated using the Black-Scholes valuation model with the following assumptions: risk free rate of return of 0.58%; volatility of 109.22%; dividend yield of 0%; and expected term of 5 years.

The Company followed the guidance of EITF 00-19, paragraph 9, which states that all contracts classified as liabilities should be measured at fair value at each balance sheet date, with changes in fair value reported in earnings and disclosed in the financial statements as long as the contracts remain classified as liabilities. The Company analyzed the options as of March 31, 2009 by following the guidance of SFAS 133, paragraph 6 to ascertain if the options remained a derivative as of March 31, 2009. All of the criteria in the original analysis were met, and the options were determined to be within the scope and definition of a derivative. The Company next followed the guidance of EITF 00-19, paragraph 19, which states that if a company is required to obtain shareholder approval to increase the company’s authorized shares in order to net-share or physically settle a contract, share settlement is not controlled by the company, and the contract is required to be classified as a liability.

The fair value of the vested options was determined to be $40,392 as of March 31, 2009, using the Black-Scholes valuation model with the following assumptions: risk free rate of return of 0.57%; volatility of 109.22%; dividend yield of 0%; and expected term of 4.58 years.

For the three and six months ended March 31, 2009, the decrease in the fair value of the vested options was recorded by decreasing warrant liability on the balance sheet by $1,455.

Option Issued to Director (Robert Hasson)

On March 30, 2009 the Company issued an option to a director to purchase a total of 958,412 shares of the Company’s common stock at an exercise price of $0.15 per share. The right to purchase 479,206 shares of Common Stock vested on the date of grant and the right to purchase 119,802 shares of Common Stock vests on June 30, September 30, December 31, 2009 and March 31, 2010, respectively.

On the grant date, the Company applied FASB 133, paragraph 6 to determine if the options were within the scope and definition of a derivative. The options had one or more underlings and one or more notional amounts, required no initial investment, and required or permitted net settlement. Therefore, the options were determined to be a derivative. In order to determine how to classify the options, the Company followed the guidance of EITF 00-19, paragraphs 7 and 8, which state that contracts   that require net-cash settlement (including a requirement to net cash settle the contract if an event occurs and if that event is outside the control of the company) are liability instruments. In order to determine the value of the options, the Company applied EITF 00-19, paragraph 9, which states that contracts that require the company to deliver shares as part of a physical settlement or net-share settlement should be initially measured at fair value.

The fair value of the vested options was $29,060 at the date of issuance, which was calculated using the Black-Scholes valuation model with the following assumptions: risk free rate of return of 0.58%; volatility of 109.22%; dividend yield of 0%; and expected term of 5 years.

The Company followed the guidance of EITF 00-19, paragraph 9, which states that all contracts classified as liabilities should be measured at fair value at each balance sheet date, with changes in fair value reported in earnings and disclosed in the financial statements as long as the contracts remain classified as liabilities. The Company analyzed the options as of March 31, 2009 by following the guidance of SFAS 133, paragraph 6 to ascertain if the options remained a derivative as of March 31, 2009. All of the criteria in the original analysis were met, and the options were determined to be within the scope and definition of a derivative. The Company next followed the guidance of EITF 00-19, paragraph 19, which states that if a company is required to obtain shareholder approval to increase the company’s authorized shares in order to net-share or physically settle a contract, share settlement is not controlled by the company, and the contract is required to be classified as a liability.

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The fair value of the vested options was determined to be $28,050 as of March 31, 2009, using the Black-Scholes valuation model with the following assumptions: risk free rate of return of 0.57%; volatility of 109.22%; dividend yield of 0%; and expected term of 4.58 years.

For the three and six months ended March 31, 2009, the decrease in the fair value of the vested options was recorded by decreasing warrant liability on the balance sheet by $1,010.

Option Issued to Employee

On March 30, 2009 the Company issued an option to an employee to purchase a total of 1,495,124 shares of the Company’s common stock at an exercise price of $0.15 per share. The right to purchase 747,562 shares of Common Stock vested on the date of grant and the right to purchase 186,891 shares of Common Stock vests on June 30, September 30, December 31, 2009 and March 31, 2010, respectively.

On the grant date, the Company applied FASB 133, paragraph 6 to determine if the options were within the scope and definition of a derivative. The options had one or more underlings and one or more notional amounts, required no initial investment, and required or permitted net settlement. Therefore, the options were determined to be a derivative. In order to determine how to classify the options, the Company followed the guidance of EITF 00-19, paragraphs 7 and 8, which state that contracts   that require net-cash settlement (including a requirement to net cash settle the contract if an event occurs and if that event is outside the control of the company) are liability instruments. In order to determine the value of the options, the Company applied EITF 00-19, paragraph 9, which states that contracts that require the company to deliver shares as part of a physical settlement or net-share settlement should be initially measured at fair value.

The fair value of the vested options was $45,334 at the date of issuance, which was calculated using the Black-Scholes valuation model with the following assumptions: risk free rate of return of 0.58%; volatility of 109.22%; dividend yield of 0%; and expected term of 5 years.

The Company followed the guidance of EITF 00-19, paragraph 9, which states that all contracts classified as liabilities should be measured at fair value at each balance sheet date, with changes in fair value reported in earnings and disclosed in the financial statements as long as the contracts remain classified as liabilities. The Company analyzed the options as of March 31, 2009 by following the guidance of SFAS 133, paragraph 6 to ascertain if the options remained a derivative as of March 31, 2009. All of the criteria in the original analysis were met, and the options were determined to be within the scope and definition of a derivative. The Company next followed the guidance of EITF 00-19, paragraph 19, which states that if a company is required to obtain shareholder approval to increase the company’s authorized shares in order to net-share or physically settle a contract, share settlement is not controlled by the company, and the contract is required to be classified as a liability.

The fair value of the vested options was determined to be $43,758 as of March 31, 2009, using the Black-Scholes valuation model with the following assumptions: risk free rate of return of 0.57%; volatility of 109.22%; dividend yield of 0%; and expected term of 4.58 years.

For the three and six months ended March 31, 2009, the decrease in the fair value of the vested options was recorded by decreasing warrant liability on the balance sheet by $1,576.

NOTE 10 BENEFICIAL CONVERSION FEATURES LIABILITY

The Company issued convertible notes between October 17, 2006 and July 17, 2007 that matured between June 17, 2008 and December 31, 2008, and included embedded beneficial conversion features that allowed the holders of the convertible notes to convert their notes into Common Stock shares at rates between $.01 and $.22. The convertible notes accrue interest at rates between 8% and 10%, and any accrued but unpaid interest is also convertible by the holder of the convertible notes into shares of Common Stock at the same rate.

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The Company followed the guidance of SFAS 133, paragraph 6, to ascertain if the embedded beneficial conversion features were derivatives at the date of issue. The embedded beneficial conversion features had one or more underlings and one or more notional amounts, required no initial investment and required or permitted net settlement. Therefore, the embedded beneficial conversion features were determined to be derivatives. In order to determine the classification of the embedded conversion features, the Company applied paragraph 19 of EITF 00-19, which states that if a company is required to obtain shareholder approval to increase the company’s authorized shares in order to net-share or physically settle a contract, share settlement is not controlled by the company, and the contract is required to be classified as a liability. In order to determine the value of the embedded conversion features, the Company followed the guidance of EITF 00-19, paragraph 9, which states that all contracts classified as liabilities are to be measured at fair value at each balance sheet date, with changes in fair value reported in earnings and disclosed in the financial statements as long as the contracts remain classified as liabilities.

The fair value of the embedded beneficial conversion features was $1,430,811 at the date of issuance using the Black-Scholes valuation model with the following assumptions: risk free rate of return ranging from 2.02% to 5.09%; volatility ranging from 108.5% to 274.86%; dividend yield of 0%; and expected term of 1 to 1.5 years.

The Company followed the guidance of SFAS 133, paragraph 6, to ascertain if the embedded beneficial conversion features remained derivatives as of September 30, 2007. All of the criteria in the original analysis were met, and the embedded beneficial conversion features were determined to be within the scope and definition of a derivative. The Company followed the guidance of SFAS 133, paragraph 12, to determine if the embedded beneficial conversion features should be separated from the convertible notes. All of the criteria in the original analysis were met, and the embedded beneficial conversion features were separated from the convertible notes. In order to determine the classification of the embedded conversion features, the Company applied paragraph 19 of EITF 00-19, which states that if a company is required to obtain shareholder approval to increase the company’s authorized shares in order to net-share or physically settle a contract, share settlement is not controlled by the company, and the contract is required to be classified as a liability. In order to determine the value of the embedded conversion features, the Company followed the guidance of EITF 00-19, paragraph 9, which states that all contracts classified as liabilities are to be measured at fair value at each balance sheet date, with changes in fair value reported in earnings and disclosed in the financial statements as long as the contracts remain classified as liabilities.

The fair value of the embedded beneficial conversion features was $26,000 as of September 30, 2008, which was calculated using the Black-Scholes model with the following assumptions: risk free rate of return of 1.78%; volatility of 84.94%; dividend yield of 0% and expected term of .25.

For the three and six months ended March 31, 2009, the increase (decrease) in the fair value of the option was recorded by increasing (decreasing) warrant liability on the balance sheet by $22,418 and $(61,225), respectively.

For the three and six months ended March 31, 2009, the decrease in the fair value of the embedded beneficial conversion feature was recorded by decreasing beneficial conversion features liability on the balance sheet by $26,000.

For the three and six months ended March 31, 2008, the decrease in the fair value of the embedded beneficial conversion feature was recorded by decreasing beneficial conversion features liability on the balance sheet by $347,740 and $555,929, respectively.

NOTE 11 STOCKHOLDERS’ EQUITY

COMMON STOCK

The Company has 150,000,000 authorized shares of Common Stock, par value $0.001 per share.  As of March 31, 2009 and September 30, 2008, the Company had 142,303,907 and 134,756,213 shares of Common Stock issued and outstanding, respectively. As of March 31, 2009, there are 481,900 shares of Common Stock subject to cancellation. Subsequent to cancellation, the total issued and outstanding shares of Common Stock would be 141,822,007.

The Company has 150,000,000 authorized shares of Common Stock, par value $0.001 per share.  As of March 31, 2009 and September 30, 2008, the Company had 142,303,906 and 134,756,213 shares of Common Stock issued, respectively. As of September 30, 2009 and 2008, there were 481,900 shares of Common Stock subject to cancellation. Subsequent to cancellation, the total outstanding shares of Common Stock would be 141,822,006 and 134,274,313, respectively.

During the six months ended March 31, 2009 the Company issued 5,614,221 shares of Common Stock for the payment of $263,000 of debt, $54,672 of accrued interest, $7 of late fees and penalties and $75,000 of liquidated damages at conversion prices between $0.04 and $0.15. The Company also issued 500,000 shares of Common Stock for the settlement of outstanding debt due to a related party of $7,000 in principal and accrued interest of $1,816 and the receipt of $5,000 in cash. Additionally, the Company issued 833,333 shares of common stock for $125,000 for machinery and equipment from RJ Metal Co. Lastly, the Company issued 600,139 shares of Common Stock to legal counsel for services having a value of $60,014.  The fair value of the Common Stock on the date of issuance was $126,029.

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STOCK OPTIONS

A summary of the Company’s option activity is listed below:

	Weighted
	Average				Aggregate
	Exercise		Number		Intrinsic
	Price		of Options		Value
Outstanding at October 1, 2008	$	0.19		17,573,452	$	-
Granted		0.15		7,333,650		-
Expired		-		-		-
Forfeited		0.25		(5,605,786)		-
Exercised		-		-		-
Outstanding at March 31, 2009	$	0.19		19,301,316	$	-

Options outstanding as of March 31, 2009:

			Weighted
			Average
			Remaining	Weighted Average
Exercise	Options	Options	Contractual	Exercise Price
Price	Outstanding	Exercisable	Life	Outstanding		Exercisable
$0.15 - $0.25	19,301,316	17,384,491	3.47		$0.19		$0.20

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									Weighted
									Average
	Outstanding				Exercisable				Remaining
Option			Exercise				Exercise		Contractual
Holder	Amount		Price		Amount		Price		Life
2001 Executive Officers Stock Option Plan		7,034,140	$	0.15		7,034,140	$	0.15		2.00
Director		1,000,000		0.25		1,000,000		0.25		3.67
Former Chief Financial Officer		1,000,000		0.25		1,000,000		0.25		3.67
Former Chief Executive Officer		2,933,526		0.25		2,933,526		0.25		3.67
Former Chief Executive Officer		3,500,000		0.25		3,500,000		0.25		4.58
Director		1,380,114		0.15		690,057		0.15		4.92
Director		958,412		0.15		479,206		0.15		4.92
Employee		1,495,124		0.15		747,562		0.15		4.92

STOCK WARRANTS

A summary of the Company’s warrant activity is listed below:

	Weighted
	Average				Aggregate
	Exercise		Number		Intrinsic
	Price		of Options		Value
Outstanding at October 1, 2008	$	0.20		42,849,099	$	-
Granted		-		-		-
Expired		-		-		-
Forfeited		-		-		-
Exercised		-		-		-
Outstanding at March 31, 2009	$	0.20		42,849,099	$	-

Warrants outstanding as of March 31, 2009:

			Weighted
			Average
			Remaining	Weighted Average
Exercise	Warrants	Options	Contractual	Exercise Price
Price	Outstanding	Exercisable	Life	Outstanding		Exercisable
$0.10 - $0.40	42,849,099	39,515,766	3.12		$0.20		$0.20

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									Weighted
									Average
	Outstanding				Exercisable				Remaining
Warrant			Exercise				Exercise		Contractual
Holder	Amount		Price		Amount		Price		Life
Convertible Notes 3		2,795,454	$	0.30		2,795,454	$	0.30		3.25
Richardson & Patel LLP		150,000		0.25		150,000		0.25		3.50
Advisory Board Members		8,640,000		0.25		8,640,000		0.25		3.67
Consultant		8,539,312		0.25		8,539,312		0.25		3.67
10% Subordinated Notes Payable		850,000		0.40		850,000		0.40		4.83
Stockholders		15,000,000		0.10		15,000,000		0.10		2.02
Richardson & Patel LLP		400,000		0.15		400,000		0.15		5.17
Director		500,000		0.25		500,000		0.25		4.25
Director		500,000		0.25		500,000		0.25		4.25
Richardson & Patel LLP		641,000		0.15		641,000		0.15		5.25
Advisory Board Member		1,500,000		0.25		1,500,000		0.25		4.42
Debt Financing		3,333,333		0.30		-		0.30		4.33

NOTE 12 GOING CONCERN (Restated)

The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. This basis of accounting contemplates the recovery of the Company’s assets and the satisfaction of its liabilities in the normal course of business. Through March 31, 2009, the Company has incurred cumulative losses of $27,532,596 including net income for the six months ended March 31, 2009 of $6,382,139. As the Company has no cash flow from operations,  its  ability to transition from a development stage company to an operating company is entirely dependent upon obtaining adequate cash to finance its overhead, research and development activities, and acquisition of production equipment. It is unknown when, if ever, the Company will achieve a level of revenues adequate to support its costs and expenses. In order for the Company to meet its basic financial obligations, including rent, salaries, debt service and operations, it plans to seek additional equity or debt financing. Because of the Company’s history and current debt levels, there is considerable doubt that the Company will be able to obtain financing. The Company’s ability to meet its cash requirements for the next twelve months depends on its ability to obtain such financing. Even if financing is obtained, any such financing will likely involve additional fees and debt service requirements which may significantly reduce the amount of cash we will have for our operations. Accordingly, there is no assurance that the Company will be able to implement its plans.

The Company expects to continue to incur substantial operating losses for the foreseeable future, and it cannot predict the extent of the future losses or when it may become profitable, if ever. The Company expects to incur increasing sales and marketing, research and development and general and administrative expenses. Also, the Company has a substantial amount of short-term debt, which will need to be repaid or refinanced, unless it is converted into equity. As a result, if the Company begins to generate revenues from operations, those revenues will need to be significant in order to cover current and anticipated expenses. These factors raise substantial doubt about the Company's ability to continue as a going concern unless it is able to obtain substantial additional financing in the short term and generate revenues over the long term. If the Company is unable to obtain financing, it would likely discontinue its operations.

As mentioned in Notes 7 and 8, the Company has convertible notes and subordinated notes payable that have matured. The Company is in the process of renegotiating the terms of the notes with the note holders to extend the maturity date. If the Company is unsuccessful in extending the maturity date, the Company may not be able to continue as a going concern.

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Management expects an order for 14 additional water treatment systems from the customer who purchased two water treatment systems. Additionally, management will continue to identify new markets and demonstrate the water treatment unit to potential customers. Management will closely monitor and evaluate expenses to identify opportunities to reduce operating expenses.

NOTE 13 COMMITMENTS

As of August 1, 2008, we entered into a 36 month lease for an industrial site consisting of approximately 12,000 square feet of administrative offices and a manufacturing facility.  Monthly lease payments for the period from August 1, 2008 through July 31, 2009 are $8,650 plus common area maintenance charges; monthly lease payments for the period from August 1, 2009 through July 31, 2010 are $8,995 plus common area maintenance charges and monthly lease payments for the period from August 1, 2010 through July 31, 2011 are $9,355 plus common area maintenance charges.  The lease agreement includes an option to extend the lease for an additional 36 months. If the option is exercised, monthly payments over the three year term would be $9,730 plus common area maintenance charges from August 1, 2011 through July 31, 2012, $10,118 plus common area maintenance charges from August 1, 2012 through July 31, 2012, and $10,523 plus common area maintenance charges from August 1, 2013 through July 31, 2014. The future aggregate minimum annual lease payments arising from this lease agreement are as follows.

For the Fiscal Year Ended September 30,
2009	$	52,590
2010		108,660
2011		93,550

Total rent expense under the operating lease was approximately $18,470 for the year ended September 30, 2008. 

NOTE 14 SUPPLEMENTAL CASH FLOW INFORMATION

The Company had the following noncash transactions.

The Company issued 6,114,221 shares of Common Stock for the payment of $270,000 of debt, $6,909 of accrued interest, $77,979 of late fees and penalties and $75,000 of liquidated damages at conversion prices between $0.04 and $0.15.

The Company issued 833,333 shares of Common Stock for the purchase of machinery and equipment from RJ Metal, Co. having a value of $125,000.

The Company issued 600,139 shares of Common Stock for legal services having a value of $60,014.  The fair value of the Common Stock on the date of issuance was $126,029.

NOTE 15 SUBSEQUENT EVENT

On May 13, 2009, convertible note holders converted a total of $11,632 of accrued interest into 290,798 shares of Common Stock.

On May 13, 2009, the Company entered into a letter of understanding regarding the issuance of a total of $300,000 in principal amount of notes payable of which notes having a principal value of $35,000 will mature on May 22, 2009 and notes having a principal value of $265,000 will mature on August 21, 2009. The notes will include a provision that will permit the holders, upon the occurrence of a default, to convert the outstanding principal and unpaid accrued interest into shares of Common Stock at $0.10 per share. The Company will issue to the placement agent compensation consisting of five year warrants to purchase a total of 600,000 shares of Common Stock at $0.20 to $0.30 per share and $47,500 in cash. Terms of the warrants include a cashless exercise option and anti-dilution provisions.  The securities being offered will not be or have not been registered under the Securities Act of 1933, as amended, and may not be offered or sold in the United States absent registration or an applicable exemption from registration requirements.

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NOTE 16 RESTATEMENT

Subsequent to filing Form 10-QSB for the six months ended March 31, 2008, the Company determined that the beneficial conversion feature discounts and warrant discounts related to the issuance of the convertible notes payable were not properly accounted for, and certain warrants and options were omitted. As a result, the Company recorded the following adjustments.

2001 Executive Officers Stock Option Plan

In October 2000, the Company amended its employment agreements with each of the executive officers. A result of the amendments was that the Company adopted the 2001 Executive Officers Stock Option Plan. The plan has reserved 7,576,680 shares of Common Stock and has issued options to purchase 7,034,140 shares of Common Stock that expire 5 years from the date of issuance.

Balance Sheet

On the grant date, the Company applied FASB 133, paragraph 6 to determine if the options were within the scope and definition of a derivative. The options: had one or more underlings and one or more notional amounts, required no initial investment, and required or permitted net settlement. Therefore, the options were determined to be derivatives. Emerging Issue Task Force, paragraphs 7 and 8 were then applied to determine the classification. These paragraphs state that contracts that require settlement in shares are equity instruments. EITF 00-19, paragraph 9 was applied to determine the value of the options. This paragraph states that contracts that require the company to deliver shares as part of a physical settlement or net-share settlement should be initially measured at fair value. In accordance with EITF 00-19, the options were recorded in additional paid-in capital at fair value on the date of issuance.

The Company began the analysis for the restatement as of and for the fiscal year ended September 30, 2007 by applying FASB 133, paragraph 6 to ascertain if the options remained derivatives as of September 30, 2007. All of the criteria in the original analysis were met, and the options were determined to be within the scope and definition of a derivative. EITF 00-19, paragraph 19 was applied next, which states that if a company is required to obtain shareholder approval to increase the company’s authorized shares in order to net-share or physically settle a contract, share settlement is not controlled by the company, and the contract is required to be classified as a liability. EITF 00-19, paragraph 10 was then applied. Paragraph 10 states that if classification changes as the result of an event, the contract should be reclassified as of the date of the event at fair value. The event responsible for the change in classification was the issuance of the $1,025,000 Convertible Bridge Notes on July 17, 2007.

In accordance with EITF 00-19, the options were reclassified as of July 17, 2007 from additional paid-in capital to warrant liabilities on the balance sheet, at the fair value of $2,271,879. The value was calculated using the Black-Scholes valuation model with the following assumptions: risk free rate of return of 5.02%; volatility of 219.89%; dividend yield of 0%; and expected term of 3.67 years.

EITF 00-19, paragraph 9 was then applied, which states that all contracts classified as liabilities should be measured at fair value at each balance sheet date, with changes in fair value reported in earnings and disclosed in the financial statements as long as the contracts remain classified as liabilities.

The Company began the analysis for the restatement by applying FASB 133, paragraph 6 to ascertain if the options remained derivatives as of March 31, 2008. All of the criteria in the original analysis were met, and the options were determined to be within the scope and definition of a derivative. EITF 00-19, paragraph 8 was applied which states that if share settlement is not controlled by the company, the contract is required to be classified as a liability. Paragraph 9, which states that contracts classified as liabilities should be measured at fair value at each balance sheet date, with changes in fair value reported in earnings and disclosed in the financial statements as long as the contracts remain classified as liabilities, was also applied.

The fair value of the options was determined to be $457,114 as of March 31, 2008 and was calculated using the Black-Scholes valuation model with the following assumptions: risk free rate of return of 1.56%; volatility of 72.53%; dividend yield of 0%; and expected term of 3 years.

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The decrease in the fair value of the options was $766,474 for the three months ended March 31, 2008, and recorded by decreasing the warrant liability on the balance sheet.

The decrease in the fair value of the options was $1,469,800 for the six months ended March 31, 2008, and recorded by decreasing the warrant liability on the balance sheet.

Statement of Operations

EITF 00-19, paragraph 9 was applied which requires all contracts classified as liabilities to be measured at fair value, with changes in fair value reported in earnings as long as the contracts remain classified as liabilities.

The change in the fair value of the options for the three months ended March 31, 2008 was $766,474 and included in decrease in warrant liability in the other income (expense) section of the statement of operations.

The change in the fair value of the options for the six months ended March 31, 2008 was $1,469,800 and included in decrease in warrant liability in the other income (expense) section of the statement of operations.

Statement of Cash Flows

The change in the statement of cash flows for the six months ended March 31, 2008 was the result of the change in the fair value of the options of $1,469,800.

Advisory Board Compensation

On October 1, 2004, the Company formed an advisory board consisting of four members. Each member was to receive $5,000 monthly from October 1, 2004 to February 22, 2007 for a total of $576,000, convertible by the advisory board members into 11,520,000 shares of Common Stock at a rate of $0.05 per share. On December 13, 2007 the advisory board members agreed to forfeit the ability to convert their compensation into shares of Common Stock in exchange for warrants exercisable at $0.25 per share. The Company determined that the accrued expense, embedded beneficial conversion feature, embedded beneficial conversion feature discount, and related amortization expense were not recorded at the date of issuance, or prior to the restatement of the financial statements as of March 31, 2008, no payments have been made to any advisory board members, there has been no conversion by any Advisory Board members of the accrued liability into shares of Common Stock, and no warrant has been exercised.

Balance Sheet

The Company began the analysis for the restatement by applying paragraph 6 of Financial Accounting Standard Board (FASB) Statement No. 133, Accounting for Derivative Instruments and Hedging Activities, to ascertain if the embedded beneficial conversion features were derivatives at the date of issuance. The embedded beneficial conversion features had one or more underlings and one or more notional amounts; required no initial investment; and required or permitted net settlement. Therefore, the embedded beneficial conversion features were determined to be within the scope and definition of a derivative at the date of issuance. Next, FASB 133, paragraph 12 was applied to determine if the embedded beneficial conversion features should be separated from the accrued expense. The Company determined that the economic characteristics of the embedded beneficial conversion features are not clearly and closely related to the accrued expense; the embedded beneficial conversion features and accrued expense are not remeasured at fair value at each balance sheet date; and a separate contract with the same terms would be a derivative pursuant to FASB 133, paragraphs 6-11. Therefore, the embedded beneficial conversion features were separated from the accrued expense to determine the classification and valuation. EITF 00-19, paragraphs 7 and 8 were applied to determine the classification. Paragraph 7 states that contracts which require net-cash settlement are liabilities, and paragraph 8 states that contracts which give the counterparty (advisory board members) a choice of net-cash settlement or settlement in shares are liabilities. Therefore, the embedded conversion features were determined to be liabilities. EITF 00-19, paragraph 9 was applied to determine the value. Paragraph 9 of EITF 00-19 states all contracts classified as liabilities should be measured at fair value at each balance sheet date, with changes in fair value reported in earnings and disclosed in the financial statements as long as the contracts remain classified as liabilities.

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The fair value of the monthly embedded beneficial conversion features was determined to be $576,000 as of September 30, 2007, and was calculated using the Black-Scholes valuation model with the following assumptions: risk free rate of return of 4.05%; volatility of 126.94%; dividend yield of 0%; and expected term of 2.08 to 4.42 years.

On December 13, 2007 the advisory board members agreed to forfeit the ability to convert their compensation into shares of common stock in exchange for warrants. As a result, the beneficial conversion feature of $576,000 and the unamortized beneficial conversion feature discount of $195,560 were written off for a net of $380,440.

The beneficial conversion features discount amortization was $15,104 for the three and six months ended March 31, 2008, which increased accrued expenses.

Statement of Operations

EITF 00-19, paragraph 9 was applied which requires all contracts classified as liabilities to be measured at fair value, with changes in fair value reported in earnings as long as the contracts remain classified as liabilities.

There was no increase in the fair value of the beneficial conversion features for the three or six months ended March 31, 2008.

The beneficial conversion feature discount amortization was determined to be $15,104 and has been included in general and administrative expenses in the operating expenses section of the statement of operations for the three and six months ended March 31, 2008.

The beneficial conversion feature of $576,000 and the beneficial conversion feature discount of $195,560 were written off for a net of $380,440 and has been included in the other income (expense) section of the statement of income (operations) for the three and six months ended March 31, 2008.

Statement of Cash Flows

Changes in the statement of cash flows were the result of the amortization of the beneficial conversion features discount of $15,104, and the net write off of beneficial conversion feature and beneficial conversion feature discount of $380,440 on the statement of operations.

Warrants Related to 2004 Stock Purchase Agreement

Under the terms of a 2004 Stock Purchase Agreement, the Company issued warrants to purchase 1,463,336 shares of Common Stock at an exercise price of $0.03 which expire from February 9, 2007 to August 25, 2007. The Company determined that the warrants and related expense were not recorded at the date of issuance or prior to the restatement and there has been no exercise of the warrants into shares of Common Stock.

Balance Sheet

The Company began the analysis by applying FASB 133, paragraph 6 to determine if the warrants were within the scope and definition of a derivative at the date of issuance. The warrants: had one or more underlings, and one or more notional amounts; required no initial investment; and required or permitted net settlement. Therefore, the warrants were determined to be derivatives at the date of issuance. EITF 00-19, paragraphs 7 and 8 were then applied to determine classification. These paragraphs state that contracts   which require settlement in shares are equity instruments. EITF 00-19, paragraph 9 was applied to determine the value of the options. Paragraph 9 of EITF 00-19 states that contracts which require the company to deliver shares as part of a physical settlement or net-share settlement should be initially measured at fair value.

The fair value of the warrants was determined to be $24,366 at the date of issuance which was calculated using the Black-Scholes valuation model with the following assumptions: risk free rate of return ranging from 1.21% to 2.14%; volatility ranging from 141.91% to 170.27%; dividend yield of 0%; and expected term of 5 years. The warrants were considered an expense prior to October 1, 2006. Therefore, $24,366 was recorded to additional paid-in capital and deficit accumulated during development stage.

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EITF 00-19, paragraph 19 was applied next. Paragraph 19 states that if a company is required to obtain shareholder approval to increase the company’s authorized shares in order to net-share or physically settle a contract, share settlement is not controlled by the company and the contract is required to be classified as a liability. EITF 00-19, paragraph 10 was then applied. This paragraph states that if classification changes as the result of an event, the contract should be reclassified as of the date of the event at fair value. The event responsible for the change in classification was the issuance of the $1,025,000 Convertible Bridge Notes on July 17, 2007.

In accordance with EITF 00-19, the warrants were reclassified as of July 17, 2007 from additional paid-in capital to warrant liabilities on the balance sheet at the fair value of $70,029, which was calculated using the Black-Scholes valuation model with the following assumptions: risk free rate of return of 5.02%; volatility of 219.89%; dividend yield of 0%; and expected term of .08 years.

EITF 00-19, paragraph 9 was also applied in the analysis. Paragraph 9 states that all contracts classified as liabilities must be measured at fair value at each balance sheet date, with changes in fair value reported in earnings and disclosed in the financial statements as long as the contracts remain classified as liabilities.

The fair value of the warrants was $0 as of September 30, 2007, due to their expiration.

The decrease in the fair value of the warrants was $70,029 for the year ended September 30, 2007, which was recorded to warrant liability and accumulated deficit during development stage as of March 31, 2008.

Statement of Operations

There was no change in the fair value of the warrants for the three months ended March 31, 2008, due to their expiration.

Statement of Cash Flows

There was no change in the statement of cash flows for the three months ended March 31, 2008.

Beneficial Conversion Features

As of March 31, 2008, the Company had Convertible Bridge Notes outstanding totaling $1,811,000, which were issued between October 17, 2006 and July 17, 2007. The bridge notes included an embedded beneficial conversion feature that allowed the holders of the convertible notes to convert their notes into shares of Common Stock at rates between $0.01 and $0.22. The bridge notes mature between June 17, 2008 and December 31, 2008. The bridge notes accrue interest at rates between 8% and 10%, and any accrued but unpaid interest is also convertible by the holder of the bridge notes into shares of Common Stock at the same rate.

Balance Sheet

The Company began the analysis for the restatement as of and for the six months ended March 31, 2008 by applying FASB 133, paragraph 6 to ascertain if the embedded beneficial conversion features remained derivatives subsequent to the date of issuance. All of the criteria in the original analysis were met, and the embedded beneficial conversion features issued were determined to be within the scope and definition of a derivative. FASB 133, paragraph 12 was applied to determine if the embedded beneficial conversion features should be separated from the convertible bridge notes. All of the criteria in the original analysis were met, and the embedded beneficial conversion features were separated from the convertible bridge notes. EITF 00-19, paragraphs 7 and 8 were applied to determine the classification. Paragraph 7 states that contracts which require net-cash settlement are liabilities, and paragraph 8 states that contracts which give the counterparty (holders of the convertible notes) a choice of net-cash settlement or settlement in shares are liabilities. Therefore the embedded conversion features were determined to be liabilities. The change in the determination of the classification from equity to a liability was based on the rights of the holders of the convertible notes to convert the notes into shares of Common Stock. Therefore, share settlement is not controlled by the Company. EITF 00-19, paragraph 9 was applied to determine the value of the embedded beneficial conversion features. Paragraph 9 states that all contracts classified as liabilities must be measured at fair value at each balance sheet date, with changes in fair value reported in earnings and disclosed in the financial statements as long as the contracts remain classified as liabilities.

40

The fair value of the monthly embedded beneficial conversion features was determined to be $874,882 as of March 31, 2008, which was calculated using the Black-Scholes valuation model with the following assumptions: risk free rate of return of 1.56%; volatility of 72.53%; dividend yield of 0%; and expected term of .08 to .33 years.

The decrease in the fair value of the beneficial conversion features was determined to be $347,850 for the three months ended March 31, 2008, and was recorded in beneficial conversion features liability on the balance sheet.

The decrease in the fair value of the beneficial conversion features was determined to be $555,929 for the six months ended March 31, 2008, and was recorded in beneficial conversion features liability on the balance sheet.

The amortization of the beneficial conversion features discount was $285,610 for the three months ended March 31, 2008, which increased convertible notes.

The amortization of the beneficial conversion features discount was $573,646 for the six months ended March 31, 2008, which increased convertible notes.

Statement of Operations

The beneficial conversion features were analyzed in accordance with EITF 00-19, paragraph 9, which requires all contracts classified as liabilities to be measured at fair value, with changes in fair value reported in earnings as long as the contracts remain classified as liabilities.

The decrease in the fair value of the beneficial conversion features was determined to be $347,850 for the three months ended March 31, 2008, and was recorded in increase (decrease) in beneficial conversion features liability, in the other income (expense) section of the statement of operations.

The decrease in the fair value of the beneficial conversion features was determined to be $555,929 for the six months ended March 31, 2008, and was recorded in increase (decrease) in beneficial conversion features liability, in the other income (expense) section of the statement of operations.

The amortization of the beneficial conversion features discount was $285,610 for the three months ended March 31, 2008, and was recorded in interest expense in the other income (expense) section of the statement of operations.

The amortization of the beneficial conversion features discount was $573,646 for the six months ended March 31, 2008, and was recorded in interest expense in the other income (expense) section of the statement of operations.

Statement of Cash Flows

Changes in the statement of cash flows for the three months ended March 31, 2008 were the result of the decrease in the fair value of the beneficial conversion features liability of $347,850 and the amortization of the beneficial conversion features discounts of $285,610 on the statement of operations.

Changes in the statement of cash flows for the six months ended March 31, 2008 were the result of the decrease in the fair value of the beneficial conversion features liability of $555,929 and the amortization of the beneficial conversion features discounts of $573,646 on the statement of operations.

Warrants related to $1,025,000 of Convertible Bridge Notes

On July 17, 2007 the Company completed an offering of $1,025,000 of convertible notes to a group of institutional and accredited investors which included warrants to purchase 2,795,454 shares of Common Stock (2,329,546 shares of Common Stock to holders of the convertible bridge notes, 465,908 shares of Common Stock as a placement fee) at an exercise price of $0.50 per share. An amendment to the convertible notes dated March 13, 2008 reduced the exercise price to $0.30 per share.

41

Balance Sheet

The Company began the analysis for the restatement of the financial statements as of and for the six months ended March 31, 2008 by applying FASB 133, paragraph 6 to ascertain if the warrants issued remained derivatives as of March 31, 2008. All of the criteria in the original analysis were met, and the warrants issued were determined to be within the scope and definition of a derivative. EITF 00-19, paragraph 19 was applied next to determine classification. Paragraph 19 states that if a company is required to obtain shareholder approval to increase the company’s authorized shares in order to net-share or physically settle a contract, share settlement is not controlled by the company, and the contract is required to be classified as a liability. EITF 00-19, paragraph 9 was applied to determine the value of the warrants. Paragraph 9 states that all contracts classified as liabilities must be measured at fair value at each balance sheet date, with changes in fair value reported in earnings and disclosed in the financial statements as long as the contracts remain classified as liabilities.

The fair value of the warrants was determined to be $135,950 as of March 31, 2008, and was calculated using the Black-Scholes valuation model with the following assumptions: risk free rate of return of 1.56%; volatility of 72.53%; dividend yield of 0%; and expected term of 4.17 to 4.25 years.

The decrease in the fair value of the warrants was determined to be $185,827 for the three months ended March 31, 2008, and recorded by decreasing warrant liabilities on the balance sheet by $185,827 ($143,242 related to the holders of the convertible bridge notes, and $42,585 related to the placement fee).

The decrease in the fair value of the warrants was determined to be $363,982 for the six months ended March 31, 2008, and recorded by decreasing warrant liabilities on the balance sheet by $363,982 ($268,470 related to the holders of the convertible bridge notes, and $95,512 related to the placement fee).

The amortization of the warrant discount was $213,353 for the six months ended March 31, 2008, which increased convertible notes.

Statement of Operations

EITF 00-19, paragraph 9 was applied which requires all contracts classified as liabilities to be measured at fair value, with changes in fair value reported in earnings as long as the contracts remain classified as liabilities.

The decrease in the fair value of the warrants was determined to be $185,827 for the three months ended March 31, 2008, and recorded in decrease in warrants in the other income (expense) section of the statement of operations.

The decrease in the fair value of the warrants was determined to be $363,982 for the six months ended March 31, 2008, and recorded in decrease in warrants in the other income (expense) section of the statement of operations.

The increase in the amortization of the warrant discount of $30,065 is included in interest expense in the other income (expense) section of the statement of operations.

Statement of Cash Flows

Changes in the statement of cash flows for the six months ended March 31, 2008 were the result of the decrease in the amount of $363,982 in the fair value of the warrants at the date of issuance on the statement of operations, and the increase in the amortization of the warrant discount of $30,065 on the balance sheet.

Warrant Issued to Consultant

On December 19, 2007, the Company entered into a one year Consulting Agreement with Mark Maron pursuant to which Mr. Maron was appointed as Special Adviser to the Company. As compensation for his services, the Company granted Mr. Maron a five year warrant to purchase up to 8,539,312 shares of the Company’s Common Stock at an exercise price of $0.25 per share. As per the terms of the warrant agreement, the right to purchase 340,000 shares of Common Stock is not exercisable until the notes dated June 6, 2007 (Convertible Notes 2 as discussed in Note 6 to our financial statements) are eligible for conversion into shares of Common Stock.  The warrant was not issued from the 2001 Executive Officers Stock Option Plan.

42

Balance Sheet

The Company followed the guidance of FASB 133, paragraph 6, to determine if the warrant was within the scope and definition of a derivative at the date of issuance. The warrant had one or more underlings and one or more notional amounts, required no initial investment and required or permitted net settlement. Therefore, the warrant was determined to be a derivative at the date of issuance. In order to determine how to classify the warrant, the Company followed the guidance of EITF 00-19, paragraphs 7 and 8, which state that contracts   that require net-cash settlement (including a requirement to net cash settle the contract if an event occurs and if that event is outside the control of the company) are liability instruments. In order to determine the value of the warrant, the Company followed the guidance of EITF 00-19, paragraph 9, which states that contracts which require the company to deliver shares as part of a physical settlement or net-share settlement should be initially measured at fair value.

The fair value of the warrant was determined to be $1,448,321 at the date of issuance and was calculated using the Black-Scholes valuation model with the following assumptions: risk free interest rate of 3.26%, expected volatility of 98.01%, dividend yields of 0% and expected term of 5 years.

The Company then applied EITF 00-19, paragraph 9, which states that all contracts classified as liabilities are to be measured at fair value at each balance sheet date, with changes in fair value reported in earnings and disclosed in the financial statements as long as the contracts remain classified as liabilities.

The Company analyzed the warrant by applying FASB 133, paragraph 6 to ascertain if the warrant remained a derivative as of December 31, 2007. All of the criteria in the original analysis were met, and the warrant issued was determined to be within the scope and definition of a derivative. EITF 00-19, paragraph 8 was applied which states that if share settlement is not controlled by the company, the contract is required to be classified as a liability. Paragraph 9 was also applied, which states that contracts classified as liabilities should be measured at fair value at each balance sheet date, with changes in fair value reported in earnings and disclosed in the financial statements as long as the contracts remain classified as liabilities.

The fair value of the warrant was determined to be $543,267 as of March 31, 2008, and was calculated using the Black-Scholes valuation model with the following assumptions: risk free rate of return of 1.56%; volatility of 72.53%; dividend yield of 0%; and expected term of 4.67 years.

The decrease in the fair value of the warrant was $972,165 for the three months ended March 31, 2008, and was recorded by decreasing the warrant liability on the balance sheet.

The decrease in the fair value of the warrant was $905,054 for the six months ended March 31, 2008, and was recorded by decreasing the warrant liability on the balance sheet.

Statement of Operations

The decrease in the fair value of the warrant was $972,165 for the three months ended March 31, 2008, and was recorded by decreasing the warrant liability on the balance sheet.

The decrease in the fair value of the warrant was $905,054 for the six months ended March 31, 2008, and was recorded by decreasing the warrant liability on the balance sheet.

Statement of Cash Flows

The change in the statement of cash flows for the six months ended March 31, 2008 was the result of the change in the fair value of the warrant of $905,054.

43

Option Issued to Chief Executive Officer

On December 19, 2007, the Company entered into a one year Employment Agreement with Richard H. Papalian pursuant to which Mr. Papalian had been appointed as the Company’s Chief Executive Officer. As compensation for his services, the Company granted to Mr. Papalian a five year option to purchase up to 8,539,312 shares of the Company’s Common Stock at an exercise price of $0.25 per share. As per the terms of the stock option agreement, the right to purchase 340,000 shares of Common Stock is not exercisable until the notes dated June 6, 2007 (Convertible Notes 2 as discussed in Note 6 to our financial statements) are eligible for conversion into shares of Common Stock. These options were not issued from the 2001 Executive Officers Stock Option Plan.   On the grant date, the Company applied FASB 133, paragraph 6 to determine if the option was within the scope and definition of a derivative. The option had one or more underlings and one or more notional amounts, required no initial investment, and required or permitted net settlement. Therefore, the option was determined to be a derivative. In order to determine how to classify the option, the Company followed the guidance of EITF 00-19, paragraphs 7 and 8, which state that contracts   that require net-cash settlement (including a requirement to net cash settle the contract if an event occurs and if that event is outside the control of the company) are liability instruments. In order to determine the value of the option, the Company applied EITF 00-19, paragraph 9, which states that contracts that require the company to deliver shares as part of a physical settlement or net-share settlement should be initially measured at fair value.

Balance Sheet

The fair value of the option was determined to be $1,448,321 at the date of issuance, and was calculated using the Black-Scholes valuation model with the following assumptions: risk free rate of return of 3.26%; volatility of 98.01%; dividend yield of 0%; and expected term of 5 years.

The Company then applied EITF 00-19, paragraph 9, which states that all contracts classified as liabilities are to be measured at fair value at each balance sheet date, with changes in fair value reported in earnings and disclosed in the financial statements as long as the contracts remain classified as liabilities.

The Company analyzed the option as of March 31, 2008 by applying FASB 133, paragraph 6 to ascertain if the option remained a derivative as of March 31, 2008. All of the criteria in the original analysis were met, and the option was determined to be within the scope and definition of a derivative. EITF 00-19, paragraph 8 was applied which states that if share settlement is not controlled by a company, the contract is required to be classified as a liability. Paragraph 9, which states that contracts classified as liabilities should be measured at fair value at each balance sheet date, with changes in fair value reported in earnings and disclosed in the financial statements as long as the contracts remain classified as liabilities, was also applied.

The fair value of the option was determined to be $543,267 as of March 31, 2008, and was calculated using the Black-Scholes valuation model with the following assumptions: risk free rate of return of 1.56%; volatility of 72.53%; dividend yield of 0%; and expected term of 4.67 years.

The decrease in the fair value of the option was $972,165 for the three months ended March 31, 2008, and was recorded by decreasing the warrant liability on the balance sheet.

The decrease in the fair value of the option was $905,054 for the six months ended March 31, 2008, and was recorded by decreasing the warrant liability on the balance sheet.

Statement of Operations

The decrease in the fair value of the option was $972,165 for the three months ended March 31, 2008, and was recorded by decreasing the warrant liability on the balance sheet.

The decrease in the fair value of the option was $905,054 for the six months ended March 31, 2008, and was recorded by decreasing the warrant liability on the balance sheet.

Statement of Cash Flows

The change in the statement of cash flows for the six months ended March 31, 2008 was the result of the change in the fair value of the option of $905,054.

44

Option Issued to Director

On December 13, 2007, the Company’s Board of Directors approved the issuance to a director of a five year option to purchase a total of 1,000,000 shares of the Company’s common stock at an exercise price of $0.25 per share.

Balance Sheet

The Company followed the guidance of FASB 133, paragraph 6, to determine if the option was within the scope and definition of a derivative at the date of issuance. The option had one or more underlings and one or more notional amounts, required no initial investment and required or permitted net settlement. Therefore, the option was determined to be a derivative at the date of issuance. In order to determine how to classify the option, the Company followed the guidance of EITF 00-19, paragraphs 7 and 8, which state that contracts   that require net-cash settlement (including a requirement to net cash settle the contract if an event occurs and if that event is outside the control of the company) are liability instruments. In order to determine the value of the option, the Company followed the guidance of EITF 00-19, paragraph 9, which states that contracts which require the company to deliver shares as part of a physical settlement or net-share settlement should be initially measured at fair value.

The fair value of the option was determined to be $171,520 at the date of issuance and was calculated using the Black-Scholes valuation model with the following assumptions: risk free interest rate of 3.22%; expected volatility of 99.86%; dividend yield of 0%; and expected term of 5 years.

The Company then applied EITF 00-19, paragraph 9, which states that all contracts classified as liabilities are to be measured at fair value at each balance sheet date, with changes in fair value reported in earnings and disclosed in the financial statements as long as the contracts remain classified as liabilities.

The Company analyzed the option by applying FASB 133, paragraph 6 to ascertain if the option remained a derivative as of March 31, 2008. All of the criteria in the original analysis were met, and the option was determined to be within the scope and definition of a derivative. EITF 00-19, paragraph 8 was applied which states that if share settlement is not controlled by the company, the contract is required to be classified as a liability. Paragraph 9, which states that contracts classified as liabilities should be measured at fair value at each balance sheet date, with changes in fair value reported in earnings and disclosed in the financial statements as long as the contracts remain classified as liabilities, was also applied.

The fair value of the option was determined to be $63,620 as of March 31, 2008, using the Black-Scholes valuation model with the following assumptions: risk free rate of return of 1.56%; volatility of 72.53%; dividend yield of 0%; and expected term of 4.67 years.

The decrease in the fair value of the option was $113,845 for the three months ended March 31, 2008, and recorded by decreasing the warrant liability on the balance sheet.

The decrease in the fair value of the option was $107,900 for the six months ended March 31, 2008, and recorded by decreasing the warrant liability on the balance sheet.

Statement of Operations

The decrease in the fair value of the option was $113,845 for the three months ended March 31, 2008, and recorded by decreasing the warrant liability on the balance sheet.

The decrease in the fair value of the option was $107,900 for the six months ended March 31, 2008, and recorded by decreasing the warrant liability on the balance sheet.

Statement of Cash Flows

The change in the statement of cash flows for the six months ended March 31, 2008 was the result of the change in the fair value of the option of $107,900.

45

Option Issued to Chief Financial Officer

On December 13, 2007, the Company’s Board of Directors approved the issuance to the Chief Financial Officer of a five year option to purchase a total of 1,000,000 shares of the Company’s common stock at an exercise price of $0.25 per share.

Balance Sheet

The Company followed the guidance of FASB 133, paragraph 6, to determine if the option was within the scope and definition of a derivative at the date of issuance. The option had one or more underlings and one or more notional amounts, required no initial investment and required or permitted net settlement. Therefore, the option was determined to be a derivative at the date of issuance. In order to determine how to classify the option, the Company followed the guidance of EITF 00-19, paragraphs 7 and 8, which state that contracts   that require net-cash settlement (including a requirement to net cash settle the contract if an event occurs and if that event is outside the control of the company) are liability instruments. In order to determine the value of the option, the Company followed the guidance of EITF 00-19, paragraph 9, which states that contracts which require the company to deliver shares as part of a physical settlement or net-share settlement should be initially measured at fair value.

The fair value of the option was determined to be $171,520 at the date of issuance and was calculated using the Black-Scholes valuation model with the following assumptions: risk free interest rate of 3.22%; expected volatility of 99.86%; dividend yield of 0%; and expected term of 5 years.

The Company then applied EITF 00-19, paragraph 9, which states that all contracts classified as liabilities are to be measured at fair value at each balance sheet date, with changes in fair value reported in earnings and disclosed in the financial statements as long as the contracts remain classified as liabilities.

The Company analyzed the option by applying FASB 133, paragraph 6 to ascertain if the option remained a derivative as of March 31, 2008. All of the criteria in the original analysis were met, and the option issued was determined to be within the scope and definition of a derivative. EITF 00-19, paragraph 8 was applied which states that if share settlement is not controlled by the company, the contract is required to be classified as a liability. Paragraph 9, which states that contracts classified as liabilities should be measured at fair value at each balance sheet date, with changes in fair value reported in earnings and disclosed in the financial statements as long as the contracts remain classified as liabilities, was also applied.

The fair value of the option was determined to be $63,620 as of March 31, 2008 using the Black-Scholes valuation model with the following assumptions: risk free rate of return of 1.56%; volatility of 72.53%; dividend yield of 0%; and expected term of 4.67 years.

The decrease in the fair value of the option was $113,845 for the three months ended March 31, 2008, and recorded by decreasing the warrant liability on the balance sheet.

The decrease in the fair value of the option was $107,900 for the six months ended March 31, 2008, and recorded by decreasing the warrant liability on the balance sheet.

Statement of Operations

The decrease in the fair value of the option was $113,845 for the three months ended March 31, 2008, and recorded by decreasing the warrant liability on the balance sheet.

The decrease in the fair value of the option was $107,900 for the six months ended March 31, 2008, and recorded by decreasing the warrant liability on the balance sheet.

Statement of Cash Flows

The change in the statement of cash flows for the six months ended March 31, 2008 was the result of the change in the fair value of the option of $107,900.

Table 1 - 2008

46

													Beneficial			Warrant
													Conversion			Related to
													Features			$1,025,000 of
				2001						Warrants			and			Convertible
				Executive						Related to			Beneficial			Bridge Notes
	As			Officers			Advisory			2004 Stock			Conversion			and						Option Issued						Warrant Issued						Warrants Related
	Previously			Option			Board			Purchase			Features			Warrant			Warrant Issued			to Chief Executive			Warrant Issued			to Chief			10% Subordinated			to $750,000						As
	Stated			Plan			Compensation			Agreement			Discount			Discount			to Consultant			Officer			to Director			Financial Officer			Notes Payable			Stock Issuance			Other			Restated
Balance Sheet
Cash and cash equivalent	$	102,604																																			$	151		$	102,755
Accounts payable		470,137																																				32,987			503,124
Accrued expenses		1,847,254						576,000																																	2,423,254
Convertible Notes, net		1,306,593												12,913			206,465																								1,525,971
10% subordinated notes payable		332,182																														20,169						38			352,389
Warrant liability		974,632			457,114			549,672									36,522			128,358			128,358			63,620			63,620						156,268						2,558,164
Beneficial conversion feature liability		857,678												17,204																											874,882
Additional paid-in capital		12,815,792			(2,271,879	)		(269,848	)		(45,663	)		473,797			135,406																								10,837,605
Deficit accumulated during development stage		(19,149,208	)		1,814,765			(855,824	)		45,663			(503,914	)		(378,393	)		(128,358	)		(128,358	)		(63,620	)		(63,620	)		(20,169	)		(156,268	)		(32,874	)		(19,620,178	)
Statement of Operations (for the three months ended March 31, 2008)
General and administrative	$	395,890																																$	165,022		$	32,540		$	593,452
Research and development		328,694																																				334			329,028
Interest expense		(492,546	)											16,677			(78,022	)														(20,169	)								(574,060	)
Decrease (increase) in warrant liability		273,778			766,474			983,628									(36,522	)		972,165			972,165			113,845			113,845						8,754						4,168,132
Increase in beneficial conversion feature liability		364,944												(17,204	)																										347,740
Basic and dilutive loss per share		-																																							-
Statement of Operations (for the six months ended March 31, 2008)
General and administrative	$	1,526,663					$	1,557,705											$	1,033,412		$	1,033,412		$	171,520		$	171,520					$	165,022		$	32,540		$	5,691,794
Research and development		565,598																																				334			565,932
Interest expense		(906,150	)											32,816			(167,287	)														(20,169	)								(1,060,790	)
Decrease (increase) in warrant liability		427,991			1,469,800			1,008,033									(12,580	)		905,054			905,054			107,900			107,900						8,754						4,927,906
Increase in beneficial conversion feature liability		637,688												(81,759	)																										555,929
Write-off of beneficial conversion feature								380,440																																	380,440
Basic and dilutive loss per share		-																																							-
Statement of Cash Flows (for the six months ended March 31, 2008)
Net loss	$	(2,077,833	)	$	1,469,800		$	(169,232	)				$	(48,943	)	$	(179,867	)	$	(128,358	)	$	(128,358	)	$	(63,620	)	$	(63,620	)	$	(20,169	)	$	(156,268	)	$	(32,874	)	$	(1,599,342	)
Amortization of beneficial conversion features discount and warrant discount		669,025						10,072						(32,816	)		167,287															20,169						38			833,775
Stock based compensation expense-employee		414,908																		1,033,412						171,520			171,520												1,791,360
Stock based compensation expense-consultant		439,909						1,557,705															1,008,413												165,022						3,171,049
(Decrease) increase in warrant liability		(427,991	)		(1,469,800	)		(1,008,033	)								12,580			(905,054	)		(905,054	)		(107,900	)		(107,900	)					(8,754	)					(4,927,906	)
Increase in beneficial conversion feature liaiblity		(637,688	)											81,759																											(555,929	)
Write-off of beneficial conversion feature								(380,440	)																																(380,440	)
Accounts payable		312,738																																				32,987			345,725
Accrued expenses		159,581						576,000																																	735,581
Cash and cash equivalents		102,604																																				151			102,755

47

NOTE 17 RESTATEMENT

As discussed in Note 16 – RESTATEMENT, the Company restated its September 30, 2007 financial statements in response to a comment letter from the Securities and Exchange Commission.  However, the restatement did not properly account for certain derivative transactions, as discussed below, which resulted in the Company restating its September 30, 2007 financial statements for a third time and restating its September 30, 2008 financial statements.  Due to the items discussed below, the Company is also restating its March 31, 2009 financial statements.

The Company issued 25 secured convertible promissory notes between October 17, 2006 and February 27, 2007 for total proceeds to the Company of $750,000 (“Convertible Notes 1”). Convertible Notes 1 could be converted into shares of the Company’s common stock at a conversion price of $0.05 per share. Convertible Notes 1 contained a provision that would automatically adjust the conversion price if equity securities or instruments convertible into equity securities were issued at a conversion price of less than $0.05.

On June 6, 2007, the Company issued 5 convertible promissory notes for a total of $86,000 (“Convertible Notes 2”).  No warrants were issued in connection with Convertible Notes 2. Convertible Notes 2 mature on December 31, 2008 and are convertible into common stock at $0.01 per share.

As a result of the issuance of Convertible Notes 2, the conversion price for Convertible Notes 1 was adjusted down from $0.05 to $0.01.  The decrease in the conversion price increased the potential dilutive shares from 15,000,000 to 75,000,000, and this subsequently increased the total outstanding and potential dilutive shares over the authorized common share limit of 150,000,000.  Because there were insufficient authorized shares to fulfill all potential conversions, the Company should have classified all potentially dilutive securities as derivative liabilities as of June 6, 2007.  The Company researched its debt and equity instruments and determined that the potentially dilutive securities are as follows:

·   Warrants and Options

·   Beneficial Conversion Features

The Company analyzed the effect of the recalculation on the balance sheet and the statements of operations and cash flows as of March 31, 2009. The analysis and results were as follows:

Warrants and Options Liability

As of March 31, 2009, the Company had 42,849,099 warrants outstanding and 17,384,491 options outstanding that were vested at that date.

Balance Sheet

The Company determined that because there were not sufficient authorized shares available that the embedded conversion feature met the definition of a derivative based on Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities", (SFAS 133) as of June 6, 2007.

At March 31, 2009, the Company determined the fair value of all warrants and options to be $2,763,660 and $1,207,255, respectively, using the Black-Scholes model with the following assumptions:

·   risk free rate of return between 0.57% and 1.67%;

·   volatility between 153% and 260%;

·   dividend yield of 0%; and

·   expected term between 1.95 years and 5.24 years.

Statement of Operations

For the three and six months ended March 31, 2009, the Company recorded $837,506 and an additional $1,490,193, respectively, as a gain on change in fair value of warrant and option liability.

Statement of Cash Flows

Changes in the statement of cash flows were the result of the decrease in fair value of the warrant and option liability of $1,490,193.

Beneficial Conversion Liability

As of March 31, 2009, the Company had $781,333 in convertible notes that could be converted into 67,006,499 shares.  During the period ended March 31, 2009, certain investors converted $11,797 of convertible notes into 294,930 common shares at $0.04 per share; however, the conversion rate should have been $0.01.  At March 31, 2009, the Company owes an additional 12,248,173 shares to the investors related to the $11,797 converted during the period ended March 31, 2009 and the $151,512 converted during the period ended September 30, 2008.  The Company recorded a liability of $979,854, which is recorded in accrued expenses in the accompanying financial statements.  The change in the fair value of the shares will be recorded as a change in fair value of beneficial conversion liability.

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Balance Sheet

The Company determined that because there were not sufficient authorized shares available that the embedded conversion feature met the definition of a derivative based on SFAS 133 as of June 6, 2007.

At March 31, 2009, the Company determined the fair value of the embedded conversion options to be $4,740,412 using the Black-Scholes model with the following assumptions:

·   risk free rate of return of 0.57%;

·   volatility between of 180%;

·   dividend yield of 0%; and

·   expected term of 0.75 years.

Statement of Operations

For the three and six months ended March 31, 2009, the Company recorded $907,549 and an additional $4,742,622, respectively, as a gain on change in beneficial conversion liability.

Statement of Cash Flows

Changes in the statement of cash flows were the result of the $4,742,622 change in fair value of the beneficial conversion liability.

The following table shows the effect of each of the changes discussed above on the Company’s balance sheet, statement of operation, and statement of cash flows for the three and six months ended March 31, 2009.

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	As Previously Stated			Beneficial Conversion			Warrants and					As Restated
	March 31, 2009			Options			Options			Reclassifications		March 31, 2009
Balance Sheet
Other assets	$	34,165		$	-		$	-		$	155,000	$	189,165
Accrued expenses		2,734,069			979,854			-			155,000		3,868,923
Warrant and option liability		2,180,429			-			1,790,486			-		3,970,915
Beneficial conversion liability		-			4,740,412			-			-		4,740,412
Additional paid-in capital		13,383,049			-			(1,847,488	)		-		11,535,561
Deficit accumulated during developmental stage		(21,869,332	)		(5,720,266	)		57,002			-		(27,532,596	)
Statement of Operations (for the three months ended March 31, 2009)
Gain (loss) on change in fair value of warrant and option liability	$	(219,981	)	$	-		$	837,506		$	-	$	617,525
Gain on change in fair value of beneficial conversion liability		-			907,549			-			-		907,549
Statement of Operations (for the six months ended March 31, 2009)
Gain on change in fair value of warrant and option liability	$	1,631,387		$	-		$	1,490,193		$	-	$	3,121,580
Gain on change in fair value of beneficial conversion liability		26,000			4,742,622			-			-		4,768,622
Statement of Operations (since inception)
Gain on change in fair value of warrant and option liability	$	6,849,627		$	-		$	516,466		$	-	$	7,366,093
Gain on change in fair value of beneficial conversion liability		1,426,767			29,000,652			-			-		30,427,419
General and administrative expense		21,740,171			3,787,032			83,855			-		25,611,058
Interest expense and financing costs		(2,457,641	)		(30,536,702	)		(897,793	)		-		(33,892,136	)
Statement of Cash Flows (for the six months ended March 31, 2009)
Net income	$	149,324		$	4,742,622		$	1,490,193		$	-	$	6,382,139
Gain on change in fair value of warrant and option liability		(1,631,387	)		-			(1,490,193	)		-		(3,121,580	)
Gain on change in fair value of beneficial conversion liability		(26,000	)		(4,742,622	)		-			-		(4,768,622	)
Statement of Cash Flows (since inception)
Net loss	$	(21,744,332	)	$	(5,323,082	)	$	(465,182	)	$	-	$	(27,532,596	)
Gain on change in fair value of warrant and option liability		(6,849,627	)		-			(516,466	)		-		(7,366,093	)
Gain on change in fair value of beneficial conversion liability		(1,426,768	)		(29,000,652	)		-			-		(30,427,420	)
Non-cash compensation expense		-			3,787,032			83,855			-		3,870,887
Non-cash financing costs		-			30,536,702			897,793			-		31,434,495

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Part I, Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations.

The information in this quarterly report on Form 10-Q contains forward-looking statements.  These forward-looking statements involve risks and uncertainties, including statements regarding our capital needs, business strategy and expectations.  Any statements contained in this report that are not statements of historical facts may be deemed to be forward-looking statements.  In some cases, you can identify forward-looking statements by terminology such as may, will, should, expect, plan, intend, anticipate, believe, estimate, predict, potential or continue, the negative of such terms or other comparable terminology.  Actual events or results may differ materially from those events or results included in the forward-looking statements.  In evaluating these statements, you should consider various factors, including the risks outlined from time to time in the reports we file with the Securities and Exchange Commission.  Some, but not all, of these risks include, among other things:

· our inability to obtain the financing we need to continue our operations;

· changes in regulatory requirements that adversely affect our business;

· loss of our key personnel; and

· risks over which we have no control, such as the general global downturn in the economy which may adversely affect spending by government agencies.

We do not intend to update forward-looking statements.  You should refer to and carefully review the information in future documents we file with the Securities and Exchange Commission.

Overview

Sionix Corporation (referred to as “the Company”, “we”, “us” or “our”) is a development stage company as defined in Statement of Financial Accounting Standards (“SFAS”) No. 7, Accounting and Reporting by Development Stage Enterprises.  The Company is based in Anaheim, California.  Its business is the design, development and marketing of automatic water filtration systems primarily for small water districts.  The Company received an order for two water filtration systems in June, 2008.  The Company anticipates that the water treatment systems will be manufactured and delivered within the next few months. Subsequent to the delivery of the water treatment systems, revenue will be recognized and the Company will no longer meet the definition of a development stage company.

Until additional orders and customer deposits are received, we anticipate that most of our capital needs will need to be funded by debt or equity financing.  To date we have earned no revenues.

Application of Critical Accounting Policies and Estimates 

The preparation of our financial statements in accordance with U.S. GAAP requires management to make judgments, assumptions and estimates that affect the amounts reported. A critical accounting estimate is an assumption about highly uncertain matters and could have a material effect on the consolidated financial statements if another, also reasonable, amount were used or a change in the estimate is reasonably likely from period to period. We base our assumptions on historical experience and on other estimates that we believe are reasonable under the circumstances. Actual results could differ significantly from these estimates. There were no changes in accounting policies or significant changes in accounting estimates during the three and six months ended March 31, 2009. Management believes the following critical accounting policies reflect its more significant estimates and assumptions.

Revenue Recognition. Although the Company has yet to complete sales, it plans to follow the guidance provided by SAB 104 for recognition of revenues. The Company does not plan to recognize revenue unless there is persuasive evidence of an arrangement, title and risk of loss has passed to the customer, delivery has occurred or the services have been rendered, the sales price is fixed or determinable and collection of the related receivable is reasonably assured. In general, the Company plans to require a deposit from a customer before a unit is fabricated and shipped.  It is the Company's policy to require an arrangement with its customers, either in the form of a written contract or purchase order containing all of the terms and conditions governing the arrangement, prior to the recognition of revenue. Title and risk of loss will generally pass to the customer at the time of delivery of the product to a common carrier. At the time of the transaction, the Company will assess whether the sales price is fixed or determinable and whether or not collection is reasonably assured. If the sales price is not deemed to be fixed or determinable, revenue will be recognized as the amounts become due from the customer. The Company does not plan to offer a right of return on its products and the products will generally not be subject to customer acceptance rights. The Company plans to assess collectability based on a number of factors, including past transaction and collection history with a customer and the creditworthiness of the customer. The Company plans to perform ongoing credit evaluations of its customers' financial condition. If the Company determines that collectability of the sales price is not reasonably assured, revenue recognition will be deferred until such time as collection becomes reasonably assured, which is generally upon receipt of payment from the customer. The Company plans to include shipping and handling costs in revenue and cost of sales.

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Support Services. The Company plans to provide support services to customers primarily through service contracts, and it will recognize support services revenue ratably over the term of the service contract or as services are rendered.

Warranties.  The Company's products are generally subject to warranty, and related costs will be provided for in cost of sales when revenue is recognized. Once the Company has a history of sales, the Company's warranty obligation will be based upon historical product failure rates and costs incurred in correcting a product failure. If actual product failure rates or the costs associated with fixing failures differ from historical rates, adjustments to the warranty liability may be required in the period in which determined.

Allowance for Doubtful Accounts. The Company will evaluate the adequacy of its allowance for doubtful accounts on an ongoing basis through detailed reviews of its accounts and notes receivables.  Estimates will be used in determining the Company's allowance for doubtful accounts and will be based on historical collection experience, trends including prevailing economic conditions and adverse events that may affect a customer's ability to repay, aging of accounts and notes receivable by category, and other factors such as the financial condition of customers. This evaluation is inherently subjective because estimates may be revised in the future as more information becomes available about outstanding accounts.

Inventory Valuation. Inventories will be stated at the lower of cost or market, with costs generally determined on a first-in first-out basis. We plan to utilize both specific product identification and historical product demand as the basis for determining excess or obsolete inventory reserve. Changes in market conditions, lower than expected customer demand or changes in technology or features could result in additional obsolete inventory that is not saleable and could require additional inventory reserve provisions.

Goodwill and other Intangibles. Goodwill and intangible assets with indefinite lives will be tested annually for impairment in accordance with the provisions of Financial Accounting Standards Board Statement No. 142 “Goodwill and Other Intangible Assets” (FAS 142). We will use our judgment in assessing whether assets may have become impaired between annual impairment tests. We perform our annual test for indicators of goodwill and non-amortizable intangible asset impairment in the fourth quarter of our fiscal year or sooner if indicators of impairment exist.

Legal Contingencies. From time to time we may be a defendant in litigation. As required by Financial Accounting Standards Board Statement No. 5 “Accounting for Contingencies” (FAS 5), we are required to determine whether an estimated loss from a loss contingency should be accrued by assessing whether a loss is deemed probable and the loss amount can be reasonably estimated, net of any applicable insurance proceeds. Estimates of potential outcomes of these contingencies are developed in consultation with outside counsel. While this assessment is based upon all available information, litigation is inherently uncertain and the actual liability that may be incurred to fully resolve litigation cannot be predicted with any assurance of accuracy. Final settlement of these matters could possibly result in significant effects on our results of operations, cash flows and financial position.

Warrant Liability. The Company calculates the fair value of warrants and options using the Black-Scholes valuation model. Assumptions used in the calculation include the risk free interest rate, volatility of the stock price, and dividend yield. Estimates used in the calculation include the expected term of the warrants or options.

Accrued Derivative Liabilities. The Company applies a two-step model to determine whether a financial instrument or an embedded feature is indexed to an issuer’s own stock and thus able to qualify for equity treatment. However, liability accounting is triggered as there were insufficient shares to fulfill all potential conversions. The Company determines which instruments or embedded features require liability accounting and records the fair values as an accrued derivative liability. The changes in the values of the accrued derivative liabilities are shown in the accompanying statements of operations as “gain on change in fair value of warrant and option liability” and “gain on change in fair value of beneficial conversion liability.”

Restatement for the Six Months Ended March 31, 2008

Subsequent to filing Form 10-QSB for the six months ended March 31, 2008, the Company determined that the beneficial conversion feature discounts and warrant discounts related to the issuance of the convertible notes payable were not properly accounted for, and certain warrants and options were omitted. As a result, the Company recorded the following adjustments.

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2001 Executive Officers Stock Option Plan

In October 2000, the Company amended its employment agreements with each of the executive officers. A result of the amendments was that the Company adopted the 2001 Executive Officers Stock Option Plan. The plan has reserved 7,576,680 shares of Common Stock and has issued options to purchase 7,034,140 shares of Common Stock that expire 5 years from the date of issuance.

Balance Sheet

On the grant date, the Company applied FASB 133, paragraph 6 to determine if the options were within the scope and definition of a derivative. The options: had one or more underlings and one or more notional amounts, required no initial investment, and required or permitted net settlement. Therefore, the options were determined to be derivatives. Emerging Issue Task Force, paragraphs 7 and 8 were then applied to determine the classification. These paragraphs state that contracts that require settlement in shares are equity instruments. EITF 00-19, paragraph 9 was applied to determine the value of the options. This paragraph states that contracts that require the company to deliver shares as part of a physical settlement or net-share settlement should be initially measured at fair value. In accordance with EITF 00-19, the options were recorded in additional paid-in capital at fair value on the date of issuance.

The Company began the analysis for the restatement as of and for the fiscal year ended September 30, 2007 by applying FASB 133, paragraph 6 to ascertain if the options remained derivatives as of September 30, 2007. All of the criteria in the original analysis were met, and the options were determined to be within the scope and definition of a derivative. EITF 00-19, paragraph 19 was applied next, which states that if a company is required to obtain shareholder approval to increase the company’s authorized shares in order to net-share or physically settle a contract, share settlement is not controlled by the company, and the contract is required to be classified as a liability. EITF 00-19, paragraph 10 was then applied. Paragraph 10 states that if classification changes as the result of an event, the contract should be reclassified as of the date of the event at fair value. The event responsible for the change in classification was the issuance of the $1,025,000 Convertible Bridge Notes on July 17, 2007.

In accordance with EITF 00-19, the options were reclassified as of July 17, 2007 from additional paid-in capital to warrant liabilities on the balance sheet, at the fair value of $2,271,879. The value was calculated using the Black-Scholes valuation model with the following assumptions: risk free rate of return of 5.02%; volatility of 219.89%; dividend yield of 0%; and expected term of 3.67 years.

EITF 00-19, paragraph 9 was then applied, which states that all contracts classified as liabilities should be measured at fair value at each balance sheet date, with changes in fair value reported in earnings and disclosed in the financial statements as long as the contracts remain classified as liabilities.

The Company began the analysis for the restatement by applying FASB 133, paragraph 6 to ascertain if the options remained derivatives as of March 31, 2008. All of the criteria in the original analysis were met, and the options were determined to be within the scope and definition of a derivative. EITF 00-19, paragraph 8 was applied which states that if share settlement is not controlled by the company, the contract is required to be classified as a liability. Paragraph 9, which states that contracts classified as liabilities should be measured at fair value at each balance sheet date, with changes in fair value reported in earnings and disclosed in the financial statements as long as the contracts remain classified as liabilities, was also applied.

The fair value of the options was determined to be $457,114 as of March 31, 2008 and was calculated using the Black-Scholes valuation model with the following assumptions: risk free rate of return of 1.56%; volatility of 72.53%; dividend yield of 0%; and expected term of 3 years.

The decrease in the fair value of the options was $766,474 for the three months ended March 31, 2008, and recorded by decreasing the warrant liability on the balance sheet.

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The decrease in the fair value of the options was $1,469,800 for the six months ended March 31, 2008, and recorded by decreasing the warrant liability on the balance sheet.

Statement of Operations

EITF 00-19, paragraph 9 was applied which requires all contracts classified as liabilities to be measured at fair value, with changes in fair value reported in earnings as long as the contracts remain classified as liabilities.

The change in the fair value of the options for the three months ended March 31, 2008 was $766,474 and included in decrease in warrant liability in the other income (expense) section of the statement of operations.

The change in the fair value of the options for the six months ended March 31, 2008 was $1,469,800 and included in decrease in warrant liability in the other income (expense) section of the statement of operations.

Statement of Cash Flows

The change in the statement of cash flows for the six months ended March 31, 2008 was the result of the change in the fair value of the options of $1,469,800.

Advisory Board Compensation

On October 1, 2004, the Company formed an advisory board consisting of four members. Each member was to receive $5,000 monthly from October 1, 2004 to February 22, 2007 for a total of $576,000, convertible by the advisory board members into 11,520,000 shares of Common Stock at a rate of $0.05 per share. On December 13, 2007 the advisory board members agreed to forfeit the ability to convert their compensation into shares of Common Stock in exchange for warrants exercisable at $0.25 per share. The Company determined that the accrued expense, embedded beneficial conversion feature, embedded beneficial conversion feature discount, and related amortization expense were not recorded at the date of issuance, or prior to the restatement of the financial statements as of March 31, 2008, no payments have been made to any advisory board members, there has been no conversion by any Advisory Board members of the accrued liability into shares of Common Stock, and no warrant has been exercised.

Balance Sheet

The Company began the analysis for the restatement by applying paragraph 6 of Financial Accounting Standard Board (FASB) Statement No. 133, Accounting for Derivative Instruments and Hedging Activities,   to ascertain if the embedded beneficial conversion features were derivatives at the date of issuance. The embedded beneficial conversion features had one or more underlings and one or more notional amounts; required no initial investment; and required or permitted net settlement. Therefore, the embedded beneficial conversion features were determined to be within the scope and definition of a derivative at the date of issuance. Next, FASB 133, paragraph 12 was applied to determine if the embedded beneficial conversion features should be separated from the accrued expense. The Company determined that the economic characteristics of the embedded beneficial conversion features are not clearly and closely related to the accrued expense; the embedded beneficial conversion features and accrued expense are not remeasured at fair value at each balance sheet date; and a separate contract with the same terms would be a derivative pursuant to FASB 133, paragraphs 6-11. Therefore, the embedded beneficial conversion features were separated from the accrued expense to determine the classification and valuation. EITF 00-19, paragraphs 7 and 8 were applied to determine the classification. Paragraph 7 states that contracts which require net-cash settlement are liabilities, and paragraph 8 states that contracts which give the counterparty (advisory board members) a choice of net-cash settlement or settlement in shares are liabilities. Therefore, the embedded conversion features were determined to be liabilities. EITF 00-19, paragraph 9 was applied to determine the value. Paragraph 9 of EITF 00-19 states all contracts classified as liabilities should be measured at fair value at each balance sheet date, with changes in fair value reported in earnings and disclosed in the financial statements as long as the contracts remain classified as liabilities.

The fair value of the monthly embedded beneficial conversion features was determined to be $576,000 as of September 30, 2007, and was calculated using the Black-Scholes valuation model with the following assumptions: risk free rate of return of 4.05%; volatility of 126.94%; dividend yield of 0%; and expected term of 2.08 to 4.42 years.

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On December 13, 2007 the advisory board members agreed to forfeit the ability to convert their compensation into shares of common stock in exchange for warrants. As a result, the beneficial conversion feature of $576,000 and the unamortized beneficial conversion feature discount of $195,560 were written off for a net of $380,440.

The beneficial conversion features discount amortization was $15,104 for the three and six months ended March 31, 2008, which increased accrued expenses.

Statement of Operations

EITF 00-19, paragraph 9 was applied which requires all contracts classified as liabilities to be measured at fair value, with changes in fair value reported in earnings as long as the contracts remain classified as liabilities.

There was no increase in the fair value of the beneficial conversion features for the three or six months ended March 31, 2008.

The beneficial conversion feature discount amortization was determined to be $15,104 and has been included in general and administrative expenses in the operating expenses section of the statement of operations for the three and six months ended March 31, 2008.

The beneficial conversion feature of $576,000 and the beneficial conversion feature discount of $195,560 were written off for a net of $380,440 and has been included in the other income (expense) section of the statement of income (operations) for the three and six months ended March 31, 2008.

Statement of Cash Flows

Changes in the statement of cash flows were the result of the amortization of the beneficial conversion features discount of $15,104, and the net write off of beneficial conversion feature and beneficial conversion feature discount of $380,440 on the statement of operations.

Warrants Related to 2004 Stock Purchase Agreement

Under the terms of a 2004 Stock Purchase Agreement, the Company issued warrants to purchase 1,463,336 shares of Common Stock at an exercise price of $0.03 which expire from February 9, 2007 to August 25, 2007. The Company determined that the warrants and related expense were not recorded at the date of issuance or prior to the restatement and there has been no exercise of the warrants into shares of Common Stock.

Balance Sheet

The Company began the analysis by applying FASB 133, paragraph 6 to determine if the warrants were within the scope and definition of a derivative at the date of issuance. The warrants: had one or more underlings, and one or more notional amounts; required no initial investment; and required or permitted net settlement. Therefore, the warrants were determined to be derivatives at the date of issuance. EITF 00-19, paragraphs 7 and 8 were then applied to determine classification. These paragraphs state that contracts which require settlement in shares are equity instruments. EITF 00-19, paragraph 9 was applied to determine the value of the options. Paragraph 9 of EITF 00-19 states that contracts which require the company to deliver shares as part of a physical settlement or net-share settlement should be initially measured at fair value.

The fair value of the warrants was determined to be $24,366 at the date of issuance which was calculated using the Black-Scholes valuation model with the following assumptions: risk free rate of return ranging from 1.21% to 2.14%; volatility ranging from 141.91% to 170.27%; dividend yield of 0%; and expected term of 5 years. The warrants were considered an expense prior to October 1, 2006. Therefore, $24,366 was recorded to additional paid-in capital and deficit accumulated during development stage.

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EITF 00-19, paragraph 19 was applied next. Paragraph 19 states that if a company is required to obtain shareholder approval to increase the company’s authorized shares in order to net-share or physically settle a contract, share settlement is not controlled by the company and the contract is required to be classified as a liability. EITF 00-19, paragraph 10 was then applied. This paragraph states that if classification changes as the result of an event, the contract should be reclassified as of the date of the event at fair value. The event responsible for the change in classification was the issuance of the $1,025,000 Convertible Bridge Notes on July 17, 2007.

In accordance with EITF 00-19, the warrants were reclassified as of July 17, 2007 from additional paid-in capital to warrant liabilities on the balance sheet at the fair value of $70,029, which was calculated using the Black-Scholes valuation model with the following assumptions: risk free rate of return of 5.02%; volatility of 219.89%; dividend yield of 0%; and expected term of .08 years.

EITF 00-19, paragraph 9 was also applied in the analysis. Paragraph 9 states that all contracts classified as liabilities must be measured at fair value at each balance sheet date, with changes in fair value reported in earnings and disclosed in the financial statements as long as the contracts remain classified as liabilities.

The fair value of the warrants was $0 as of September 30, 2007, due to their expiration.

The decrease in the fair value of the warrants was $70,029 for the year ended September 30, 2007, which was recorded to warrant liability and accumulated deficit during development stage as of March 31, 2008.

Statement of Operations

There was no change in the fair value of the warrants for the three months ended March 31, 2008, due to their expiration.

Statement of Cash Flows

There was no change in the statement of cash flows for the three months ended March 31, 2008.

Beneficial Conversion Features

As of March 31, 2008, the Company had Convertible Bridge Notes outstanding totaling $1,811,000 which were issued between October 17, 2006 and July 17, 2007. The bridge notes included an embedded beneficial conversion feature that allowed the holders of the convertible notes to convert their notes into shares of Common Stock at rates between $0.01 and $0.22. The bridge notes mature between June 17, 2008 and December 31, 2008. The bridge notes accrue interest at rates between 8% and 10%, and any accrued but unpaid interest is also convertible by the holder of the bridge notes into shares of Common Stock at the same rate.

Balance Sheet

The Company began the analysis for the restatement as of and for the six months ended March 31, 2008 by applying FASB 133, paragraph 6 to ascertain if the embedded beneficial conversion features remained derivatives subsequent to the date of issuance. All of the criteria in the original analysis were met, and the embedded beneficial conversion features issued were determined to be within the scope and definition of a derivative. FASB 133, paragraph 12 was applied to determine if the embedded beneficial conversion features should be separated from the convertible bridge notes. All of the criteria in the original analysis were met, and the embedded beneficial conversion features were separated from the convertible bridge notes. EITF 00-19, paragraphs 7 and 8 were applied to determine the classification. Paragraph 7 states that contracts which require net-cash settlement are liabilities, and paragraph 8 states that contracts which give the counterparty (holders of the convertible notes) a choice of net-cash settlement or settlement in shares are liabilities. Therefore the embedded conversion features were determined to be liabilities. The change in the determination of the classification from equity to a liability was based on the rights of the holders of the convertible notes to convert the notes into shares of Common Stock. Therefore, share settlement is not controlled by the Company. EITF 00-19, paragraph 9 was applied to determine the value of the embedded beneficial conversion features. Paragraph 9 states that all contracts classified as liabilities must be measured at fair value at each balance sheet date, with changes in fair value reported in earnings and disclosed in the financial statements as long as the contracts remain classified as liabilities.

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The fair value of the monthly embedded beneficial conversion features was determined to be $874,882 as of March 31, 2008, which was calculated using the Black-Scholes valuation model with the following assumptions: risk free rate of return of 1.56%; volatility of 72.53%; dividend yield of 0%; and expected term of .08 to .33 years.

The decrease in the fair value of the beneficial conversion features was determined to be $347,850 for the three months ended March 31, 2008, and was recorded in beneficial conversion features liability on the balance sheet.

The decrease in the fair value of the beneficial conversion features was determined to be $555,929 for the six months ended March 31, 2008, and was recorded in beneficial conversion features liability on the balance sheet.

The amortization of the beneficial conversion features discount was $285,610 for the three months ended March 31, 2008, which increased convertible notes.

The amortization of the beneficial conversion features discount was $573,646 for the six months ended March 31, 2008, which increased convertible notes.

Statement of Operations

The beneficial conversion features were analyzed in accordance with EITF 00-19, paragraph 9 which requires all contracts classified as liabilities to be measured at fair value, with changes in fair value reported in earnings as long as the contracts remain classified as liabilities.

The decrease in the fair value of the beneficial conversion features was determined to be $347,850 for the three months ended March 31, 2008, and was recorded in increase (decrease) in beneficial conversion features liability, in the other income (expense) section of the statement of operations.

The decrease in the fair value of the beneficial conversion features was determined to be $555,929 for the six months ended March 31, 2008, and was recorded in increase (decrease) in beneficial conversion features liability, in the other income (expense) section of the statement of operations.

The amortization of the beneficial conversion features discount was $285,610 for the three months ended March 31, 2008, and was recorded in interest expense in the other income (expense) section of the statement of operations.

The amortization of the beneficial conversion features discount was $573,646 for the six months ended March 31, 2008, and was recorded in interest expense in the other income (expense) section of the statement of operations.

Statement of Cash Flows

Changes in the statement of cash flows for the three months ended March 31, 2008 were the result of the decrease in the fair value of the beneficial conversion features liability of $347,850 and the amortization of the beneficial conversion features discounts of $285,610 on the statement of operations.

Changes in the statement of cash flows for the six months ended March 31, 2008 were the result of the decrease in the fair value of the beneficial conversion features liability of $555,929 and the amortization of the beneficial conversion features discounts of $573,646 on the statement of operations.

Warrants related to $1,025,000 of Convertible Bridge Notes

On July 17, 2007 the Company completed an offering of $1,025,000 of convertible notes to a group of institutional and accredited investors which included warrants to purchase 2,795,454 shares of Common Stock (2,329,546 shares of Common Stock to holders of the convertible bridge notes, 465,908 shares of Common Stock as a placement fee) at an exercise price of $0.50 per share. An amendment to the convertible notes dated March 13, 2008 reduced the exercise price to $0.30 per share.

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Balance Sheet

The Company began the analysis for the restatement of the financial statements as of and for the six months ended March 31, 2008 by applying FASB 133, paragraph 6 to ascertain if the warrants issued remained derivatives as of March 31, 2008. All of the criteria in the original analysis were met, and the warrants issued were determined to be within the scope and definition of a derivative. EITF 00-19, paragraph 19 was applied next to determine classification. Paragraph 19 states that if a company is required to obtain shareholder approval to increase the company’s authorized shares in order to net-share or physically settle a contract, share settlement is not controlled by the company, and the contract is required to be classified as a liability. EITF 00-19, paragraph 9 was applied to determine the value of the warrants. Paragraph 9 states that all contracts classified as liabilities must be measured at fair value at each balance sheet date, with changes in fair value reported in earnings and disclosed in the financial statements as long as the contracts remain classified as liabilities.

The fair value of the warrants was determined to be $135,950 as of March 31, 2008, and was calculated using the Black-Scholes valuation model with the following assumptions: risk free rate of return of 1.56%; volatility of 72.53%; dividend yield of 0%; and expected term of 4.17 to 4.25 years.

The decrease in the fair value of the warrants was determined to be $185,827 for the three months ended March 31, 2008, and recorded by decreasing warrant liabilities on the balance sheet by $185,827 ($143,242 related to the holders of the convertible bridge notes, and $42,585 related to the placement fee) .

The decrease in the fair value of the warrants was determined to be $363,982 for the six months ended March 31, 2008, and recorded by decreasing warrant liabilities on the balance sheet by $363,982 ($268,470 related to the holders of the convertible bridge notes, and $95,512 related to the placement fee) .

The amortization of the warrant discount was $213,353 for the six months ended March 31, 2008, which increased convertible notes.

Statement of Operations

EITF 00-19, paragraph 9 was applied which requires all contracts classified as liabilities to be measured at fair value, with changes in fair value reported in earnings as long as the contracts remain classified as liabilities.

The decrease in the fair value of the warrants was determined to be $185,827 for the three months ended March 31, 2008, and recorded in decrease in warrants in the other income (expense) section of the statement of operations.

The decrease in the fair value of the warrants was determined to be $363,982 for the six months ended March 31, 2008, and recorded in decrease in warrants in the other income (expense) section of the statement of operations.

The increase in the amortization of the warrant discount of $30,065 is included in interest expense in the other income (expense) section of the statement of operations.

Statement of Cash Flows

Changes in the statement of cash flows for the six months ended March 31, 2008 were the result of the decrease in the amount of $363,982 in the fair value of the warrants at the date of issuance on the statement of operations, and the increase in the amortization of the warrant discount of $30,065 on the balance sheet.

Warrant Issued to Consultant

On December 19, 2007, the Company entered into a one year Consulting Agreement with Mark Maron pursuant to which Mr. Maron was appointed as Special Adviser to the Company. As compensation for his services, the Company granted Mr. Maron a five year warrant to purchase up to 8,539,312 shares of the Company’s Common Stock at an exercise price of $0.25 per share. As per the terms of the warrant agreement, the right to purchase 340,000 shares of Common Stock is not exercisable until the notes dated June 6, 2007 (Convertible Notes 2 as discussed in Note 6 to our financial statements) are eligible for conversion into shares of Common Stock.  The warrant was not issued from the 2001 Executive Officers Stock Option Plan.

58

Balance Sheet

The Company followed the guidance of FASB 133, paragraph 6, to determine if the warrant was within the scope and definition of a derivative at the date of issuance. The warrant had one or more underlings and one or more notional amounts, required no initial investment and required or permitted net settlement. Therefore, the warrant was determined to be a derivative at the date of issuance. In order to determine how to classify the warrant, the Company followed the guidance of EITF 00-19, paragraphs 7 and 8, which state that contracts   that require net-cash settlement (including a requirement to net cash settle the contract if an event occurs and if that event is outside the control of the company) are liability instruments. In order to determine the value of the warrant, the Company followed the guidance of EITF 00-19, paragraph 9, which states that contracts which require the company to deliver shares as part of a physical settlement or net-share settlement should be initially measured at fair value.

The fair value of the warrant was determined to be $1,448,321 at the date of issuance and was calculated using the Black-Scholes valuation model with the following assumptions: risk free interest rate of 3.26%; expected volatility of 98.01%; dividend yields of 0%; and expected term of 5 years.

The Company then applied EITF 00-19, paragraph 9, which states that all contracts classified as liabilities are to be measured at fair value at each balance sheet date, with changes in fair value reported in earnings and disclosed in the financial statements as long as the contracts remain classified as liabilities.

The Company analyzed the warrant by applying FASB 133, paragraph 6 to ascertain if the warrant remained a derivative as of December 31, 2007. All of the criteria in the original analysis were met, and the warrant issued was determined to be within the scope and definition of a derivative. EITF 00-19, paragraph 8 was applied which states that if share settlement is not controlled by the company, the contract is required to be classified as a liability. Paragraph 9 was also applied, which states that contracts classified as liabilities should be measured at fair value at each balance sheet date, with changes in fair value reported in earnings and disclosed in the financial statements as long as the contracts remain classified as liabilities.

The fair value of the warrant was determined to be $543,267 as of March 31, 2008, and was calculated using the Black-Scholes valuation model with the following assumptions: risk free rate of return of 1.56%; volatility of 72.53%; dividend yield of 0%; and expected term of 4.67 years.

The decrease in the fair value of the warrant was $972,165 for the three months ended March 31, 2008, and was recorded by decreasing the warrant liability on the balance sheet.

The decrease in the fair value of the warrant was $905,054 for the six months ended March 31, 2008, and was recorded by decreasing the warrant liability on the balance sheet.

Statement of Operations

The decrease in the fair value of the warrant was $972,165 for the three months ended March 31, 2008, and was recorded by decreasing the warrant liability on the balance sheet.

The decrease in the fair value of the warrant was $905,054 for the six months ended March 31, 2008, and was recorded by decreasing the warrant liability on the balance sheet.

Statement of Cash Flows

The change in the statement of cash flows for the six months ended March 31, 2008 was the result of the change in the fair value of the warrant of $905,054.

59

Option Issued to Chief Executive Officer

On December 19, 2007, the Company entered into a one year Employment Agreement with Richard H. Papalian pursuant to which Mr. Papalian had been appointed as the Company’s Chief Executive Officer. As compensation for his services, the Company granted to Mr. Papalian a five year option to purchase up to 8,539,312 shares of the Company’s Common Stock at an exercise price of $0.25 per share. As per the terms of the stock option agreement, the right to purchase 340,000 shares of Common Stock is not exercisable until the notes dated June 6, 2007 (Convertible Notes 2 as discussed in Note 6 to our financial statements) are eligible for conversion into shares of Common Stock. These options were not issued from the 2001 Executive Officers Stock Option Plan.   On the grant date, the Company applied FASB 133, paragraph 6 to determine if the option was within the scope and definition of a derivative. The option had one or more underlings and one or more notional amounts, required no initial investment, and required or permitted net settlement. Therefore, the option was determined to be a derivative. In order to determine how to classify the option, the Company followed the guidance of EITF 00-19, paragraphs 7 and 8, which state that contracts   that require net-cash settlement (including a requirement to net cash settle the contract if an event occurs and if that event is outside the control of the company) are liability instruments. In order to determine the value of the option, the Company applied EITF 00-19, paragraph 9, which states that contracts that require the company to deliver shares as part of a physical settlement or net-share settlement should be initially measured at fair value.

Balance Sheet

The fair value of the option was determined to be $1,448,321 at the date of issuance, and was calculated using the Black-Scholes valuation model with the following assumptions: risk free rate of return of 3.26%; volatility of 98.01%; dividend yield of 0%; and expected term of 5 years.

The Company then applied EITF 00-19, paragraph 9, which states that all contracts classified as liabilities are to be measured at fair value at each balance sheet date, with changes in fair value reported in earnings and disclosed in the financial statements as long as the contracts remain classified as liabilities.

The Company analyzed the option as of March 31, 2008 by applying FASB 133, paragraph 6 to ascertain if the option remained a derivative as of March 31, 2008. All of the criteria in the original analysis were met, and the option was determined to be within the scope and definition of a derivative. EITF 00-19, paragraph 8 was applied which states that if share settlement is not controlled by a company, the contract is required to be classified as a liability. Paragraph 9, which states that contracts classified as liabilities should be measured at fair value at each balance sheet date, with changes in fair value reported in earnings and disclosed in the financial statements as long as the contracts remain classified as liabilities, was also applied.

The fair value of the option was determined to be $543,267 as of March 31, 2008, and was calculated using the Black-Scholes valuation model with the following assumptions: risk free rate of return of 1.56%; volatility of 72.53%; dividend yield of 0%; and expected term of 4.67 years.

The decrease in the fair value of the option was $972,165 for the three months ended March 31, 2008, and was recorded by decreasing the warrant liability on the balance sheet.

The decrease in the fair value of the option was $905,054 for the six months ended March 31, 2008, and was recorded by decreasing the warrant liability on the balance sheet.

Statement of Operations

The decrease in the fair value of the option was $972,165 for the three months ended March 31, 2008, and was recorded by decreasing the warrant liability on the balance sheet.

The decrease in the fair value of the option was $905,054 for the six months ended March 31, 2008, and was recorded by decreasing the warrant liability on the balance sheet.

Statement of Cash Flows

The change in the statement of cash flows for the six months ended March 31, 2008 was the result of the change in the fair value of the option of $905,054.

Option Issued to Director

On December 13, 2007, the Company’s Board of Directors approved the issuance to a director of a five year option to purchase a total of 1,000,000 shares of the Company’s common stock at an exercise price of $0.25 per share.

60

Balance Sheet

The Company followed the guidance of FASB 133, paragraph 6, to determine if the option was within the scope and definition of a derivative at the date of issuance. The option had one or more underlings and one or more notional amounts, required no initial investment and required or permitted net settlement. Therefore, the option was determined to be a derivative at the date of issuance. In order to determine how to classify the option, the Company followed the guidance of EITF 00-19, paragraphs 7 and 8, which state that contracts   that require net-cash settlement (including a requirement to net cash settle the contract if an event occurs and if that event is outside the control of the company) are liability instruments. In order to determine the value of the option, the Company followed the guidance of EITF 00-19, paragraph 9, which states that contracts which require the company to deliver shares as part of a physical settlement or net-share settlement should be initially measured at fair value.

The fair value of the option was determined to be $171,520 at the date of issuance and was calculated using the Black-Scholes valuation model with the following assumptions: risk free interest rate of 3.22%; expected volatility of 99.86%; dividend yield of 0%; and expected term of 5 years.

The Company then applied EITF 00-19, paragraph 9, which states that all contracts classified as liabilities are to be measured at fair value at each balance sheet date, with changes in fair value reported in earnings and disclosed in the financial statements as long as the contracts remain classified as liabilities.

The Company analyzed the option by applying FASB 133, paragraph 6 to ascertain if the option remained a derivative as of March 31, 2008. All of the criteria in the original analysis were met, and the option was determined to be within the scope and definition of a derivative. EITF 00-19, paragraph 8 was applied which states that if share settlement is not controlled by the company, the contract is required to be classified as a liability. Paragraph 9, which states that contracts classified as liabilities should be measured at fair value at each balance sheet date, with changes in fair value reported in earnings and disclosed in the financial statements as long as the contracts remain classified as liabilities, was also applied.

The fair value of the option was determined to be $63,620 as of March 31, 2008, using the Black-Scholes valuation model with the following assumptions: risk free rate of return of 1.56%; volatility of 72.53%; dividend yield of 0%; and expected term of 4.67 years.

The decrease in the fair value of the option was $113,845 for the three months ended March 31, 2008, and recorded by decreasing the warrant liability on the balance sheet.

The decrease in the fair value of the option was $107,900 for the six months ended March 31, 2008, and recorded by decreasing the warrant liability on the balance sheet.

Statement of Operations

The decrease in the fair value of the option was $113,845 for the three months ended March 31, 2008, and recorded by decreasing the warrant liability on the balance sheet.

The decrease in the fair value of the option was $107,900 for the six months ended March 31, 2008, and recorded by decreasing the warrant liability on the balance sheet.

Statement of Cash Flows

The change in the statement of cash flows for the six months ended March 31, 2008 was the result of the change in the fair value of the option of $107,900.

Option Issued to Chief Financial Officer

On December 13, 2007, the Company’s Board of Directors approved the issuance to the Chief Financial Officer of a five year option to purchase a total of 1,000,000 shares of the Company’s common stock at an exercise price of $0.25 per share.

61

Balance Sheet

The Company followed the guidance of FASB 133, paragraph 6, to determine if the option was within the scope and definition of a derivative at the date of issuance. The option had one or more underlings and one or more notional amounts, required no initial investment and required or permitted net settlement. Therefore, the option was determined to be a derivative at the date of issuance. In order to determine how to classify the option, the Company followed the guidance of EITF 00-19, paragraphs 7 and 8, which state that contracts   that require net-cash settlement (including a requirement to net cash settle the contract if an event occurs and if that event is outside the control of the company) are liability instruments. In order to determine the value of the option, the Company followed the guidance of EITF 00-19, paragraph 9, which states that contracts which require the company to deliver shares as part of a physical settlement or net-share settlement should be initially measured at fair value.

The fair value of the option was determined to be $171,520 at the date of issuance and was calculated using the Black-Scholes valuation model with the following assumptions: risk free interest rate of 3.22%; expected volatility of 99.86%; dividend yield of 0%; and expected term of 5 years.

The Company then applied EITF 00-19, paragraph 9, which states that all contracts classified as liabilities are to be measured at fair value at each balance sheet date, with changes in fair value reported in earnings and disclosed in the financial statements as long as the contracts remain classified as liabilities.

The Company analyzed the option by applying FASB 133, paragraph 6 to ascertain if the option remained a derivative as of March 31, 2008. All of the criteria in the original analysis were met, and the option issued was determined to be within the scope and definition of a derivative. EITF 00-19, paragraph 8 was applied which states that if share settlement is not controlled by the company, the contract is required to be classified as a liability. Paragraph 9, which states that contracts classified as liabilities should be measured at fair value at each balance sheet date, with changes in fair value reported in earnings and disclosed in the financial statements as long as the contracts remain classified as liabilities, was also applied.

The fair value of the option was determined to be $63,620 as of March 31, 2008 using the Black-Scholesvaluation model with the following assumptions: risk free rate of return of 1.56%; volatility of 72.53%; dividend yield of 0%; and expected term of 4.67 years.

The decrease in the fair value of the option was $113,845 for the three months ended March 31, 2008, and recorded by decreasing the warrant liability on the balance sheet.

The decrease in the fair value of the option was $107,900 for the six months ended March 31, 2008, and recorded by decreasing the warrant liability on the balance sheet.

Statement of Operations

The decrease in the fair value of the option was $113,845 for the three months ended March 31, 2008, and recorded by decreasing the warrant liability on the balance sheet.

The decrease in the fair value of the option was $107,900 for the six months ended March 31, 2008, and recorded by decreasing the warrant liability on the balance sheet.

Statement of Cash Flows

The change in the statement of cash flows for the six months ended March 31, 2008 was the result of the change in the fair value of the option of $107,900.

Table 1 – 2008

62

																Warrant
													Beneficial Conversion			Related to $1,025,000 of
				2001						Warrants Related to			Features and			Convertible Bridge
	As			Executive Officers			Advisory			2004 Stock			Beneficial Conversion			Notes and			Warrant Issued			Option Issued to Chief						Warrant Issued to Chief			10%			Warrants Related
	Previously Stated			Option Plan			Board Compensation			Purchase Agreement			Features Discount			Warrant Discount			to Consultant			Executive Officer			Warrant Issued to Director			Financial Officer			Subordinated Notes Payable			to $750,000 Stock Issuance			Other			As Restated
Balance Sheet
Cash and cash equivalent	$	102,604																																			$	151		$	102,755
Accounts payable		470,137																																				32,987			503,124
Accrued expenses		1,847,254						576,000																																	2,423,254
Convertible Notes, net		1,306,593												12,913			206,465																								1,525,971
10% subordinated notes payable		332,182																														20,169						38			352,389
Warrant liability		974,632			457,114			549,672									36,522			128,358			128,358			63,620			63,620						156,268						2,558,164
Beneficial conversion feature liability		857,678												17,204																											874,882
Additional paid-in capital		12,815,792			(2,271,879	)		(269,848	)		(45,663	)		473,797			135,406																								10,837,605
Deficit accumulated during development stage		(19,149,208	)		1,814,765			(855,824	)		45,663			(503,914	)		(378,393	)		(128,358	)		(128,358	)		(63,620	)		(63,620	)		(20,169	)		(156,268	)		(32,874	)		(19,620,178	)
Statement of Operations (for the three months ended March 31, 2008)
General and administrative	$	395,890																																$	165,022		$	32,540		$	593,452
Research and development		328,694																																				334			329,028
Interest expense		(492,546	)											16,677			(78,022	)														(20,169	)								(574,060	)
Decrease (increase) in warrant liability		273,778			766,474			983,628									(36,522	)		972,165			972,165			113,845			113,845						8,754						4,168,132
Increase in beneficial conversion feature liability		364,944												(17,204	)																										347,740
Basic and dilutive loss per share		-																																							-
Statement of Operations (for the six months ended March 31, 2008)
General and administrative	$	1,526,663					$	1,557,705											$	1,033,412		$	1,033,412		$	171,520		$	171,520					$	165,022		$	32,540		$	5,691,794
Research and development		565,598																																				334			565,932
Interest expense		(906,150	)											32,816			(167,287	)														(20,169	)								(1,060,790	)
Decrease (increase) in warrant liability		427,991			1,469,800			1,008,033									(12,580	)		905,054			905,054			107,900			107,900						8,754						4,927,906
Increase in beneficial conversion feature liability		637,688												(81,759	)																										555,929
Write-off of beneficial conversion feature								380,440																																	380,440
Basic and dilutive loss per share		-																																							-
Statement of Cash Flows (for the six months ended March 31, 2008)
Net loss	$	(2,077,833	)	$	1,469,800		$	(169,232	)				$	(48,943	)	$	(179,867	)	$	(128,358	)	$	(128,358	)	$	(63,620	)	$	(63,620	)	$	(20,169	)	$	(156,268	)	$	(32,874	)	$	(1,599,342	)
Amortization of beneficial conversion features discount and warrant discount		669,025						10,072						(32,816	)		167,287															20,169						38			833,775
Stock based compensation expense- employee		414,908																		1,033,412						171,520			171,520												1,791,360
Stock based compensation expense- consultant		439,909						1,557,705															1,008,413												165,022						3,171,049
(Decrease) increase in warrant liability		(427,991	)		(1,469,800	)		(1,008,033	)								12,580			(905,054	)		(905,054	)		(107,900	)		(107,900	)					(8,754	)					(4,927,906	)
Increase in beneficial conversion feature liaiblity		(637,688	)											81,759																											(555,929	)
Write-off of beneficial conversion feature								(380,440	)																																(380,440	)
Accounts payable		312,738																																				32,987			345,725
Accrued expenses		159,581						576,000																																	735,581
Cash and cash equivalents		102,604																																				151			102,755

63

Second Restatement for the Three and Six Months Ended March 31, 2009

The Company restated its September 30, 2007 financial statements in response to a comment letter from the Securities and Exchange Commission.  However, the restatement did not properly account for certain derivative transactions, as discussed below, which resulted in the Company restating its September 30, 2007 financial statements for a third time and restating its September 30, 2008 financial statements.  Due to the items discussed below, the Company is restating its March 31, 2009 financial statements.

The Company issued 25 secured convertible promissory notes between October 17, 2006 and February 27, 2007 for total proceeds to the Company of $750,000 (“Convertible Notes 1”). Convertible Notes 1 could be converted into shares of the Company’s common stock at a conversion price of $0.05 per share. Convertible Notes 1 contained a provision that would automatically adjust the conversion price if equity securities or instruments convertible into equity securities were issued at a conversion price less than $0.05.

On June 6, 2007, the Company issued 5 convertible promissory notes for a total of $86,000 (“Convertible Notes 2”).  No warrants were issued in connection with Convertible Notes 2. Convertible Notes 2 mature on December 31, 2008, and are convertible into common stock at $0.01 per share.

As a result of the issuance of Convertible Notes 2, the conversion price for Convertible Notes 1 was adjusted down from $0.05 to $0.01.  The decrease in the conversion price increased the potential dilutive shares from 15,000,000 to 75,000,000, and this subsequently increased the total outstanding and potential dilutive shares over the authorized common share limit of 150,000,000.  Because there were insufficient authorized shares to fulfill all potential conversions, the Company should have classified all potentially dilutive securities as derivative liabilities as of June 6, 2007.  The Company researched its debt and equity instruments and determined that the potentially dilutive securities are as follows:

·   Warrants and Options

·   Beneficial Conversion Features

The Company analyzed the effect of the recalculation on the balance sheet and the statements of operations and cash flows as of March 31, 2009. The analysis and results were as follows:

Warrants and Options Liability

As of March 31, 2009, the Company had 42,849,099 warrants outstanding and 17,384,491 options outstanding that were vested at that date.

Balance Sheet

The Company determined that because there were not sufficient authorized shares available that the embedded conversion feature met the definition of a derivative based on Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities", (SFAS 133) as of June 6, 2007.

At March 31, 2009, the Company determined the fair value of all warrants and options to be $2,763,660 and $1,207,255, respectively, using the Black-Scholesmodel with the following assumptions:

·   risk free rate of return between 0.57% and 1.67%;

·   volatility between 153% and 260%;

·   dividend yield of 0%; and

·   expected term between 1.95 years and 5.24 years.

Statement of Operations

For the three and six months ended March 31, 2009, the Company recorded $837,506 and an additional $1,490,193, respectively, as a gain on change in fair value of warrant and option liability.

64

Statement of Cash Flows

Changes in the statement of cash flows were the result of the decrease in fair value of the warrant and option liability of $1,490,193.

Beneficial Conversion Liability

As of March 31, 2009, the Company had $781,333 in convertible notes that could be converted into 67,006,499 shares. During the period ended March 31, 2009, certain investors converted $11,797 of convertible notes into 294,930 common shares at $0.04 per share; however, the conversion rate should have been $0.01.  At March 31, 2009, the Company owes an additional 12,248,173 shares to the investors related to the $11,797 converted during the period ended March 31, 2009 and the $151,512 converted during the period ended September 30, 2008.  The Company recorded a liability of $979,854, which is recorded in accrued expenses in the accompanying financial statements.  The change in the fair value of the shares will be recorded as a change in fair value of beneficial conversion liability.

Balance Sheet

The Company determined that because there were not sufficient authorized shares available that the embedded conversion feature met the definition of a derivative based on SFAS 133 as of June 6, 2007.

At March 31, 2009, the Company determined the fair value of the embedded conversion options to be $4,740,412 using the Black-Scholesmodel with the following assumptions:

·   risk free rate of return of 0.57%;

·   volatility between of 180%;

·   dividend yield of 0%; and

·   expected term of 0.75 years.

Statement of Operations

For the three and six months ended March 31, 2009, the Company recorded $907,549 and an additional $4,742,622, respectively, as a gain on change in beneficial conversion liability.

Statement of Cash Flows

Changes in the statement of cash flows were the result of the $4,742,622 change in fair value of the beneficial conversion liability.

The following table shows the effect of each of the changes discussed above on the Company’s balance sheet, statement of operation, and statement of cash flows for the three and six months ended March 31, 2009.

65

	As Previously Stated			Beneficial Conversion			Warrants and					As Restated
	March 31, 2009			Options			Options			Reclassifications		March 31, 2009
Balance Sheet
Other assets	$	34,165		$	-		$	-		$	155,000	$	189,165
Accrued expenses		2,734,069			979,854			-			155,000		3,868,923
Warrant and option liability		2,180,429			-			1,790,486			-		3,970,915
Beneficial conversion liability		-			4,740,412			-			-		4,740,412
Additional paid-in capital		13,383,049			-			(1,847,488	)		-		11,535,561
Deficit accumulated during developmental stage		(21,869,332	)		(5,720,266	)		57,002			-		(27,532,596	)
Statement of Operations (for the three months ended March 31, 2009)
Gain (loss) on change in fair value of warrant and option liability	$	(219,981	)	$	-		$	837,506		$	-	$	617,525
Gain on change in fair value of beneficial conversion liability		-			907,549			-			-		907,549
Statement of Operations (for the six months ended March 31, 2009)
Gain on change in fair value of warrant and option liability	$	1,631,387		$	-		$	1,490,193		$	-	$	3,121,580
Gain on change in fair value of beneficial conversion liability		26,000			4,742,622			-			-		4,768,622
Statement of Operations (since inception)
Gain on change in fair value of warrant and option liability	$	6,849,627		$	-		$	516,466		$	-	$	7,366,093
Gain on change in fair value of beneficial conversion liability		1,426,767			29,000,652			-			-		30,427,419
General and administrative expense		21,740,171			3,787,032			83,855			-		25,611,058
Interest expense and financing costs		(2,457,641	)		(30,536,702	)		(897,793	)		-		(33,892,136	)
Statement of Cash Flows (for the six months ended March 31, 2009)
Net income	$	149,324		$	4,742,622		$	1,490,193		$	-	$	6,382,139
Gain on change in fair value of warrant and option liability		(1,631,387	)		-			(1,490,193	)		-		(3,121,580	)
Gain on change in fair value of beneficial conversion liability		(26,000	)		(4,742,622	)		-			-		(4,768,622	)
Statement of Cash Flows (since inception)
Net loss	$	(21,744,332	)	$	(5,323,082	)	$	(465,182	)	$	-	$	(27,532,596	)
Gain on change in fair value of warrant and option liability		(6,849,627	)		-			(516,466	)		-		(7,366,093	)
Gain on change in fair value of beneficial conversion liability		(1,426,768	)		(29,000,652	)		-			-		(30,427,420	)
Non-cash compensation expense		-			3,787,032			83,855			-		3,870,887
Non-cash financing costs		-			30,536,702			897,793			-		31,434,495

66

67

Results of Operations

Three Months Ended March 31, 2009 Compared To Three Months Ended March 31, 2008

Revenues for the three months ended March 31, 2009 and 2008 were zero.  Although we received an order and deposit for two water treatment systems during the 2008 fiscal year, revenue from this order has not been recognized because the units have not been completed and delivered. The Company incurred operating expenses of $499,935 during the three months ended March 31, 2009, a decrease of $464,474 or approximately 48%, as compared to $964,409 for the three months ended March 31, 2008.  General and administrative expenses were $314,055 during the three months ended March 31, 2009, a decrease of $313,169 or approximately 49%, as compared to $627,224 for the three months ended March 31, 2008.  The decrease in general and administrative expenses contributed to the significant decrease in operating expenses. During the three months ended March 31, 2008, warrants having a relative fair value of $165,022 were issued to the purchasers of common stock and classified as general and administrative expenses. Research and development expenses were $178,265 during the three months ended March 31, 2009, a decrease of $150,763 or approximately 46%, as compared to $329,028 for the three months ended March 31, 2008.  The decrease in research and development expenses resulted primarily from the reallocation of personnel for the design of the two water treatment systems ordered during the 2009 fiscal year.

Other income (expense) totaled $1,445,409 during the three months ended March 31, 2009, a decrease of $10,725,641 or approximately 88%, as compared to $12,171,050 for the three months ended March 31, 2008. The Company earned interest income of $277 during the three months ended March 31, 2009, a decrease of $89 or 24%, as compared to $366 during the three months ended March 31, 2008.  The Company incurred interest expense of $63,758 during the three months ended March 31, 2009, a decrease of $490,307 or approximately 88%, as compared to $554,065 for the three months ended March 31, 2008. The significant interest expense we incurred during the three months ended March 31, 2008 was due primarily to the amortization of the beneficial conversion features discount and warrant discount of the convertible debt securities, while during the three months ended March 31, 2009 there was a decrease in outstanding debt principal, which resulted in lower interest expenses. Gain on change in fair value of warrant and option liability was $617,525 for the three months ended March 31, 2009, a decrease of $1,147,813 or approximately 65%, as compared to $1,765,338 during the three months ended March 31, 2008. The gain on change in fair value for the three months ended March 31, 2009 represents the decrease in the fair value of the warrant and option liability. Gain on change in fair value of the beneficial conversion liability was $907,549 for the three months ended March 31, 2009, a decrease of $10,181,028 or approximately 92% as compared to $11,088,577 for the three months ended March 31, 2008. The decrease in the gain on change in beneficial conversion liability was due to the expiration of the expected term of the beneficial conversion feature and decrease in convertible notes that were outstanding as of March 31, 2009 compared to March 31, 2008. During the three months ended March 31, 2009 the Company recorded a loss on settlement of debt in the amount of $16,184 related to the conversion of notes payable and accrued interest into Common Stock. There were no comparable expenses recorded during the three months ended March 31, 2008. During the three months ended March 31, 2008 the Company recorded a loss on lease termination for $129,166 related to the termination of lease. There were no comparable expenses recorded during the three months ended March 31, 2009.

As a result of these items, net income for the three months ended March 31, 2009 was $945,474, a decrease of $10,261,167 or approximately 92% over the net income of $11,206,641 for the three months ended March 31, 2008.

Six Months Ended March 31, 2009 Compared To Six Months Ended March 31, 2008

Revenues for the six months ended March 31, 2009 and 2008 were zero.  Although we received an order and deposit for two water treatment systems during the 2008 fiscal year, revenue from this order has not been recognized because the units have not been completed and delivered. The Company incurred operating expenses of $1,337,224 during the six months ended March 31, 2009, a decrease of $4,936,816 or approximately 79%, as compared to $6,274,040 for the six months ended March 31, 2008.  General and administrative expenses were $964,891 during the six months ended March 31, 2009, a decrease of $4,726,903 or approximately 83%, as compared to $5,691,794 for the six months ended March 31, 2008.  The decrease in general and administrative expenses contributed to the significant decrease in operating expenses. The significant general and administrative expenses incurred during the six months ended March 31, 2008 were primarily due to the issuance of warrants having a fair value of $5,010,748. During the six months ended March 31, 2009, the Company issued warrants having a fair value of $238,244. Research and development expenses were $357,229 during the six months ended March 31, 2009, a decrease of $208,703 or approximately 37%, as compared to $565,932 for the six months ended March 31, 2008.  The decrease in research and development expenses resulted primarily from the reallocation of personnel for the design of the two water treatment systems ordered during the 2009 fiscal year.

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Other income totaled $7,719,363 during the six months ended March 31, 2009, a decrease of $14,339,121 or approximately 65%, as compared to $22,058,484 for the six months ended March 31, 2008. The Company earned interest income of $3,868 during the six months ended March 31, 2009, an increase of $2,589 or 202%, as compared to $1,279 during the six months ended March 31, 2008.  The Company incurred interest expense of $158,523 during the six months ended March 31, 2009, a decrease of $521,827 or approximately 77%, as compared to $680,350 for the six months ended March 31, 2008. The significant interest expense we incurred during the six months ended March 31, 2008 was due primarily to the amortization of the beneficial conversion features discount and warrant discount of the convertible debt securities, while during the six months ended March 31, 2009 there was a decrease in outstanding debt principal, which resulted in lower interest. Gain on change in fair value of warrant and option liability was $3,121,580 for the six months ended March 31, 2009, a decrease of $822,263 or approximately 21%, as compared to $3,943,843 during the six months ended March 31, 2008. The decrease in gain on change in fair value of the warrant and option liability was due to the increase in the trading price of our Common Stock, resulting in a higher Black-Scholesvaluation model valuation calculation of the warrant and option liability. Gain on change in fair value of the beneficial conversion liability was $4,768,622 for the six months ended March 31, 2009, a decrease of $14,154,256 or approximately 75% as compared to $18,922,878 for the six months ended March 31, 2008. The decrease in gain on change in beneficial conversion liability was due to the amortization expiration of the expected term of the beneficial conversion features of our convertible debt. During the six months ended March 31, 2009 the Company recorded a loss on settlement of debt of $16,184 related to the conversion of notes payable and accrued interest into Common Stock. During the three months ended March 31, 2008, the Company recorded a loss on lease termination for $129,166 related to the termination of lease. 

As a result of these items, net income for the six months ended March 31, 2009 was $6,382,139, a decrease of $9,401,405 or approximately 60% over net income of $15,783,544 for the six months ended March 31, 2008.

Liquidity and Capital Resources

The Company had cash and cash equivalents of $25,613 at March 31, 2009. The Company’s source of liquidity has been the sale of its securities and deposits received from orders for two water treatment systems. The Company expects to receive additional orders for water treatment systems, but if it does not receive additional orders or if these orders do not satisfy its capital needs, the Company expects to sell its securities or obtain loans to meet its capital requirements.  On May 13, 2009, the Company entered into a letter of understanding regarding the issuance of a total of $300,000 in principal amount of notes payable of which notes having a principal value of $35,000 will mature on May 22, 2009 and notes having a principal value of $265,000 will mature on August 21, 2009. The notes will include a provision that will permit the holders, upon the occurrence of a default, to convert the outstanding principal and unpaid accrued interest into shares of Common Stock at $0.10 per share.  The securities being offered will not be or have not been registered under the Securities Act of 1933, as amended, and may not be offered or sold in the United States absent registration or an applicable exemption from registration requirements. There can be no assurance that sales of the Company’s securities or the sale of its water treatment systems, if such sales occur, will provide sufficient capital for its operations or that the Company will not encounter unforeseen difficulties that may deplete its capital resources more rapidly than anticipated. As of March 31, 2009, a total of $2,476,389 in principal and accrued interest related to certain promissory notes issued by the Company was due.  The Company has not yet paid the notes and no demand for payment has been made.

Operating Activities

During the six months ended March 31, 2009, the Company used $1,194,429 of cash in operating activities.  Non-cash adjustments included $15,104 for depreciation, $27,094 for amortization of warrant and beneficial conversion feature, and $16,184 for loss on settlement of debt. Cash provided by operating activities included $12,230 in other current assets, $92,508 in accounts payable, $189,486 in accrued liabilities, and $200,000 in customer deposits. Cash used in operating activities included $608,565 for inventory, $150,400 in other assets, $3,121,580 for warrant and option liability, and $4,768,622 for beneficial conversion liability. Stock based compensation to nonemployees was $248,752.

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During the six months ended March 31, 2008, the Company used $896,996 of cash in operating activities. Non-cash adjustments included $16,314 for depreciation, $833,775 for amortization of warrant and beneficial conversion feature, $129,166 for loss on termination of lease, $380,440 for write-off of beneficial conversion features, and $138,375 for accrual of liquidated damages. Cash provided by operating activities included $345,724 in accounts payable, and $174,508 in accrued liabilities. Cash used in operating activities included $33,650 for other current assets, $3,943,843 for warrant and option liability, and $18,922,878 for beneficial conversion liability. Stock based compensation to employees was $1,791,360 and stock based compensation to nonemployees was $3,171,049.

Investing Activities

During the six months ended March 31, 2009, the Company acquired $5,546 of property and equipment. During the six months ended March 31, 2008, the Company acquired $29,164 of property and equipment.

Financing Activities

During the six months ended March 31, 2009, the Company received $5,000 for the purchase of common stock.

During the six months ended March 31, 2008 the Company used $656,404 in financing activities. Cash provided from financing activities for the six months ended March31, 2008 consisted of proceeds of $425,000 from the issuance of 10% subordinated notes payable and $283,000 for the purchase of Common Stock. Cash used in financing activities for the six months ended March 31, 2008 included a payment of $5,000 toward a note payable, payments of $27,336 toward notes payable under an equity line of credit, and payments totaling $19,260 to officers for loans made to us.

On March 31, 2009, the Company had cash and cash equivalents of $25,613. The sole source of liquidity has been borrowings from affiliates and the sales of our securities. While the Company has a commitment for $300,000 in financing through the sale of promissory notes, this amount is not likely to be adequate to finance the Company’s operations through the end of its fiscal year.  Furthermore, there is no certainty that the Company will be able to generate revenues from operations during the fiscal year. As of March 31, 2009, the Company had an accumulated deficit of $27,532,596. We expect that our future operating results will continue to be subject to many of the problems, expenses, delays and risks, which we often cannot control, inherent in the establishment of a developmental business enterprise.

Off-Balance Sheet Arrangements

We have no off-balance sheet arrangements, special purpose entities or financing partnerships.

Capital Expenditures

The Company currently has no commitments for capital expenditures.

Material Trends, Events or Uncertainties

We are not certain how the current economic downturn may affect our business.  Because of the global recession, government agencies and private industry may not have the funds to purchase our water treatment systems.  It may also be more difficult for us to raise capital in the current economic environment. Other than as discussed herein, the Company does not know of any material trends, events or uncertainties that may impact its operations in the future.

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Going Concern Opinion

The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. This basis of accounting contemplates the recovery of the Company’s assets and the satisfaction of its liabilities in the normal course of business. Through March 31, 2009, the Company has incurred cumulative losses of $27,532,596 including net income for the six months ended March 31, 2009 of $6,382,139. As the Company has limited cash flow from operations, its ability to transition from a development stage company to an operating company is entirely dependent upon obtaining adequate financing to pay for its overhead, research and development activities, and acquisition of production equipment. It is unknown when, if ever, the Company will achieve a level of revenues adequate to support its costs and expenses. In order for the Company to meet its basic financial obligations, including rent, salaries, debt service and operations, it plans to undertake additional equity or debt financing. Because of the Company’s history and current debt levels, there is considerable doubt that the Company will be able to obtain financing. The Company’s ability to meet its cash requirements for the next twelve months depends on its ability to obtain such financing. Even if financing is obtained, any such financing will likely involve additional fees and debt service requirements, which may significantly reduce the amount of cash the Company will have for its operations. Accordingly, there is no assurance that the Company will be able to implement its plans.

The Company expects to continue to incur substantial operating losses for the foreseeable future, and it cannot predict the extent of the future losses or when it may become profitable, if ever. It expects to incur increasing sales and marketing, research and development and general and administrative expenses. Also, the Company has a substantial amount of short-term debt, which will need to be repaid or refinanced, unless it is converted into equity. As a result, as it begins to generate revenues from operations, those revenues will need to be significant in order to cover current and anticipated expenses. These factors raise substantial doubt about the Company's ability to continue as a going concern unless it is able to obtain substantial additional financing in the short term and generate significant revenues over the long term. If the Company is unable to obtain financing, it would likely discontinue operations.

As mentioned in Notes 7 and 8, the Company has convertible notes and subordinated notes payable that have matured. The Company is in the process of renegotiating the terms of the notes with the note holders to extend the maturity date. If the Company is unsuccessful in extending the maturity date, the Company may not be able to continue as a going concern.

Part I, Item 3.  Quantitative and Qualitative Disclosures about Market Risk.

As a smaller reporting company, we are not required to provide this disclosure.

Part I, Item 4T.  Controls and Procedures.

(a) Disclosure Controls and Procedures

Regulations under the Securities Exchange Act of 1934 require public companies to maintain “disclosure controls and procedures,” which are defined to mean a company’s controls and other procedures that are designed to ensure that information required to be disclosed in the reports that it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported, within the time periods specified in the Commission’s rules and forms.

We conducted an evaluation, with the participation of our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of the period covered by this report.  Based on that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that as of March 31, 2009, our disclosure controls and procedures were not effective at the reasonable assurance level due to the material weaknesses described below.

A material weakness is a control deficiency (within the meaning of the Public Company Accounting Oversight Board (PCAOB) Auditing Standard No. 2) or combination of control deficiencies that result in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected.  Management has identified the following three material weaknesses in our disclosure controls and procedures:

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1.           We do not have written documentation of our internal control policies and procedures.  Written documentation of key internal controls over financial reporting is a requirement of Section 404 of the Sarbanes-Oxley Act.  Management evaluated the impact of our failure to have written documentation of our internal controls and procedures on our assessment of our disclosure controls and procedures and has concluded that the control deficiency that resulted represented a material weakness.

2.           We do not have sufficient segregation of duties within accounting functions, which is a basic internal control.  Due to our size and nature, segregation of all conflicting duties may not always be possible and may not be economically feasible.  However, to the extent possible, the initiation of transactions, the custody of assets and the recording of transactions should be performed by separate individuals.  Management evaluated the impact of our failure to have segregation of duties on our assessment of our disclosure controls and procedures and has concluded that the control deficiency that resulted represented a material weakness.

3.           We do not have review and supervision procedures for financial reporting functions. The review and supervision function of internal control relates to the accuracy of financial information reported. The failure to review and supervise could allow the reporting of inaccurate or incomplete financial information. Due to our size and nature, review and supervision may not always be possible or economically feasible.  Management evaluated the impact of our significant number of audit adjustments and has concluded that the control deficiency that resulted represented a material weakness.

To address these material weaknesses, management performed additional analyses and other procedures to ensure that the financial statements included herein fairly present, in all material respects, our financial position, results of operations and cash flows for the periods presented.

(b) Changes in internal control over financial reporting

  During the quarter covered by this report, there was no change in our internal control over financial reporting that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

Part II, Item 1.  Legal Proceedings.

Not applicable.

Part II, Item 1A.  Risk Factors.

As a smaller reporting company we are not required to provide this information.

Part II, Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds.

On January 19, 2009, the Company issued 166,666 shares of common stock in exchange for $25,000 in principal owed to holders of our convertible notes. We relied on section 3(9) of the Securities Act of 1933 to issue the securities inasmuch as the notes were exchanged by us with our existing security holders exclusively, and no commission or other remuneration was paid or given directly or indirectly for soliciting the exchange.

On February 17, 2009, the Company issued 200,000 shares of common stock in exchange for $30,000 in principal owed to holders of our convertible notes. We relied on section 3(9) of the Securities Act of 1933 to issue the securities inasmuch as the notes were exchanged by us with our existing security holders exclusively, and no commission or other remuneration was paid or given directly or indirectly for soliciting the exchange.

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On February 24, 2009, the Company issued 1,000,000 shares of common stock in exchange for $150,000 in principal owed to holders of our convertible notes. We relied on section 3(9) of the Securities Act of 1933 to issue the securities inasmuch as the notes were exchanged by us with our existing security holders exclusively, and no commission or other remuneration was paid or given directly or indirectly for soliciting the exchange.

On March 25, 2009, the Company issued 2,129,600 shares of common stock in exchange for $18,000 in principal and $3,301 in accrued interest owed to holders of our convertible notes. We relied on section 3(9) of the Securities Act of 1933 to issue the securities inasmuch as the notes were exchanged by us with our existing security holders exclusively, and no commission or other remuneration was paid or given directly or indirectly for soliciting the exchange.

On March 30, 2009, the Company issued 2,123,025 shares of common stock in exchange for $5,000 cash, $7,000 in principal, $1,816 in accrued interest, $75,000 of liquidated damages, and $28,400 of late fees owed to holders of our convertible notes. We relied on section 3(9) of the Securities Act of 1933 to issue the common stock for principal, interest, liquidated damages and late fees inasmuch as the notes were exchanged by us with our existing security holders exclusively, and no commission or other remuneration was paid or given directly or indirectly for soliciting the exchange.  We relied on section 4(2) of the Securities Act of 1933 to issue the common stock in exchange for cash, as the common stock was issued without any form of general solicitation or general advertising and the acquirers were accredited investors.

On March 30, 2009, we issued options to three individuals to purchase a total of 3,833,650 shares of our Common Stock at $0.15 per share.  The options expire five years from the date of grant.  We relied on section 4(2) of the Securities Act of 1933 to issue the options , as the options were issued without any form of general solicitation or general advertising and the each of the acquirers occupied an insider status relative to us that afforded him effective access to the information registration would otherwise provide.

Part II, Item 3.  Defaults upon Senior Securities.

Between October 2006 and February 2007 we issued Secured Convertible Promissory Notes in the aggregate principal amount of $750,000.  These notes were due to be paid on the earlier of the first anniversary of the date of issuance, an Event of Default (as defined in the note) or on the closing of any equity financing in which we received gross proceeds of at least $2.5 million.  Payment of these notes became due on the first anniversary of the date of issuance.  We have not paid the notes and, as of May 15, 2009, we owed a total of $523,333 in principal and $108,932 in accrued interest.

On June 6, 2007 we issued Convertible Promissory Notes in the aggregate principal amount of $86,000.  These notes became due and payable upon the earlier of (i) the occurrence of an Event of Default or (ii) the Maturity Date unless, prior to such time, the notes were converted into shares of our common stock.  “Maturity Date” is defined in these notes as a business day that is not sooner than December 31, 2008, as the holder of the note may specify in written notice delivered to us not less than 30 days prior to such specified date.  No holder has given us written notice of a Maturity Date, however, we have determined that an Event of Default may have occurred under the provisions of the notes defining an Event of Default.  As of May 15, 2009 we owed a total of $8,000 in principal and $3,261 in accrued interest.

On July 17, 2007 we issued Subordinated Notes Payable in the aggregate principal amount of $1,025,000.  We were required to pay the principal and accrued interest monthly in cash or in shares of our common stock.  We have not paid these notes in accordance with their terms and, as of May 15, 2009, we owed a total of $250,000 in principal and $37,776 in accrued interest.

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In January 2008 we completed an offering of $425,000 in principal amount of Subordinated Debentures to a group of institutional and accredited investors.  The Subordinated Debentures bear interest at the rate of 10% per annum, principal and interest were due to be paid monthly and they matured on December 31, 2008.  We did not repay the Subordinated Debentures in accordance with their terms and, as of May 15, 2009, we owed a total of $425,000 in principal and $58,658 in accrued interest.

Part II, Item 4.  Submission of Matters to a Vote of Security Holders.

During the quarter ended March 31, 2009, no matters were submitted to a vote of security holders.

Part II, Item 5.  Other Information.

On March 30, 2009, we issued 3,833,650 options to purchase Common Stock at $0.15 per share to 2 executive officers and an employee, all of whom were related to each other. The options expire five years from the date of grant. The options were determined to have a fair value of $232,483 using the Black-Scholesvaluation model. Rodney Anderson, our interim Chief Executive Officer, received 1,380,114 options to purchase our Common Stock, Joe Anderson, an employee and Mr. Anderson’s son, received 1,495,124 options to purchase our Common Stock, and Robert Hasson, our interim Chief Financial Officer, received 958,412 options to purchase our Common Stock.

Part II, Item 6.  Exhibits.

Exhibit No.		Description of Exhibit
3.1	Articles of Incorporation (1)
3.2	Bylaws (1)
10.1	Option agreement issued to Rodney Anderson on March 30, 2009*
10.2	Option agreement issued to Joe Anderson on March 30, 2009*
10.3	Option agreement issued to Robert Hasson on March 30, 2009*
31.1	Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002*
31.2	Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002*
32	Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002*

* Filed herewith.

(1) Incorporated by reference from our Current Report on Form 8-K filed with the Securities and Exchange Commission on July 15, 2003 as file number 002-95626-D.

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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.

	SIONIX CORPORATION
January 13, 2010	By:	/s/ David R. Wells
		David R. Wells
		President, Chief Financial Officer, Principal Financial and Accounting Officer