UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

 

FORM 10-QSB

 

(Mark One)

 

For the transition period from              to             

 

Commission file number 333-103083

XENOMICS, INC.

(Name of small business issuer in its charter)

 

 

420 Lexington Avenue, Suite 1701, New York, New York 10170

(Address of principal executive offices) (Zip Code)

(212) 297-0808

(Registrant’s telephone number)

(Former Name, Former Address and Former Fiscal Year, if changed since last report)

 

Check whether the issuer: (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act 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 past 90 days.

x Yes o No

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

o Yes x No

As of June 19, 2006, the registrant had 19,207,832 shares of common stock, par value $0.0001, outstanding.

XENOMICS, INC.

(A Development Stage Company)

Index to Condensed Consolidated Financial Statements

 

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INTRODUCTORY NOTE

This Report on Form 10-QSB for Xenomics, Inc. (the “Company”) may contain forward-looking statements. You can identify these statements by forward-looking words such as “may,” “will,” “expect,” “intend,” “anticipate,” believe,” “estimate” and “continue” or similar words. Forward-looking statements include information concerning possible or assumed future business success or financial results. You should read statements that contain these words carefully because they discuss future expectations and plans, which contain projections of future results of operations or financial condition or state other forward-looking information. We believe that it is important to communicate future expectations to investors. However, there may be events in the future that we are not able to accurately predict or control. Accordingly, we do not undertake any obligation to update any forward-looking statements for any reason, even if new information becomes available or other events occur in the future.

The forward-looking statements included herein are based on current expectations that involve a number of risks and uncertainties set forth under “Risk Factors” in our Annual Report on Form 10-KSB for the year ended January 31, 2006 and other periodic reports filed with the SEC. Accordingly, to the extent that this Quarterly Report contains forward-looking statements regarding the financial condition, operating results, business prospects or any other aspect of the Company, please be advised that the Company’s actual financial condition, operating results and business performance may differ materially from that projected or estimated by the Company in forward-looking statements.

 

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PART I — FINANCIAL INFORMATION

Item 1. Condensed Consolidated Financial Statements

Xenomics, Inc. and Subsidiary
(A Development Stage Company)
Condensed Consolidated Balance Sheets

 

The accompanying notes are an integral part of these financial statements

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Xenomics, Inc. and Subsidiary
(A Development Stage Company)
Condensed Consolidated Statements of Operations
(Unaudited)

 

		Three Months Ended April 30						For the period August 4, 1999 (Inception) to
		2006			2005			April 30, 2006
Revenues		$	0		$	0		$	0
Operating expenses:
Research and development:
Non-cash charge (benefit) for stock-based compensation		34,278			(132,249		)	2,075,411
Other		813,830			296,646			4,982,238
Total		848,108			164,397			7,057,649
General and administrative
Non-cash charge for stock-based compensation		521,381			24,311			6,176,584
Other		571,788			575,283			3,769,276
Total		1,093,169			599,594			9,945,860
Total operating expenses		1,941,277			763,991			17,003,509
Operating loss		(1,941,277		)	(763,991		)	(17,003,509		)
Other (income) expense:
Other income		24,969			12,124			174,161
Other expense		(30,343		)	0			(165,325		)
Change in fair value of derivative financial instrument		39,670			0			201,126
Total other expense		34,296			12,124			209,962
Net loss		(1,906,981		)	(751,867		)	(16,793,547		)
Items attributed to preferred stock:
Preferred stock dividend		(27,710		)	0			(88,451		)
Accretion on Series A preferred stock		0			0			(322,209		)
Net loss attributable to common shareholders		(1,934,691		)	(751,867		)	(17,204,207		)
Weighted average shares of common stock outstanding:
Basic and diluted		18,788,629			17,716,394
Net loss per common share:
Basic and diluted		$(0.10		)	$	(0.04	)

 

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

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Xenomics, Inc. and Subsidiary
(A Development Stage Company)
Condensed Consolidated Statements of Shareholders’ Equity (Deficiency)
(Unaudited)

 

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

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Xenomics, Inc. and Subsidiary
(A Development Stage Company)
Condensed Consolidated Statements of Shareholders’ Equity (Deficiency) - Continued
(Unaudited)

 

 

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

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Xenomics, Inc. and Subsidiary
(A Development Stage Company)
Condensed Consolidated Statement of Cash Flows
(Unaudited)

		Three Months Ended						For the period August 4, 1999
		April 30						(Inception) to April 30,
		2006			2005			2006
Operating activities:
Net loss		$	(1,906,981	)	$	(751,867	)	$	(16,793,547	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation		8,181			4,533			46,193
Stock based compensation expense		555,659			(107,938		)	8,251,995
Founders compensation contributed to equity		0			0			1,655,029
Increase (decrease) in fair value of derivative financial instrument		(39,670		)	0			(201,126		)
Changes in operating assets and liabilities:
(Increase) decrease in receivables		(12,322		)	0			(12,322		)
(Increase) decrease in prepaid expenses		44,756			(9,141		)	(31,941		)
(Increase) decrease in deposits		0			2,565			(55,698		)
(Increase) decrease in other assets		2,000			0			0
Increase (decrease) in accounts payable and accrued expenses		10,901			(25,651		)	245,582
Net cash used in operating activities		(1,337,476		)	(887,499		)	(6,895,835		)
Investing activities:
Purchase of property and equipment		0			(29,575		)	(159,545		)
Net cash provided by investing activities		0			(29,575		)	(159,545		)
Financing activities:
Proceeds from sale of common stock net of expenses		0			3,154,399			8,428,937
Payment of acquisition costs on common stock		0			(477,000		)	(779,098		)
Proceeds from sale of preferred stock net of expenses		0			0			2,771,000
Payment of acquisition costs on preferred stock		0			0			(277,102		)
Redemption of common stock		0			0			(500,000		)
Payment of preferred stock dividends		(27,710		)	0			(88,451		)
Net cash provided by financing activities		(27,710		)	2,677,399			9,555,286
Net change in cash		(1,365,186		)	1,760,325			2,499,906
Cash - Beginning of period		3,865,092			3,226,965			0
Cash - End of period		$	2,499,906		$	4,987,290		$	2,499,906
Supplemental disclosure of non-cash investing and financing activities:
Cash paid for taxes		$	0		$	0		$	0
Cash paid for interest		$	0		$	0		$	0

 

The accompanying notes are an integral part of these financial statements

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XENOMICS, INC.
(A Development Stage Company)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
April 30, 2006
(UNAUDITED)

1. BUSINESS OVERVIEW:

Xenomics, Inc. (“Xenomics” or the “Company”) is considered to be in the development stage. Since inception on August 4, 1999, Xenomics’ efforts have been principally devoted to research and development, securing and protecting its patents and raising capital. From inception through April 30, 2006, Xenomics has sustained cumulative net losses of $16,793,547. Xenomics’ losses have resulted primarily from expenditures incurred in connection with salaries and facilities cost associated with research and development activities, application and filing for regulatory approval of its proposed products, patent filing and maintenance expenses, outside accounting and legal services and regulatory, scientific and financial consulting fees as well as stock-based compensation expense. From inception through April 30, 2006, Xenomics has not generated any revenue from operations, expects to incur additional losses to perform further research and development activities and does not currently have any commercial molecular diagnostic products approved by the Food and Drug Administration, and does not expect to have such for several years, if at all.

Xenomics’s product development efforts are thus in their early stages and Xenomics cannot make estimates of the costs or the time it will take to complete. The risk of completion of any program is high because of the many uncertainties involved in bringing new drugs to market including the long duration of clinical testing, the specific performance of proposed products under stringent clinical testing protocols, the extended regulatory approval and review cycles and the nature and timing of costs and competing technologies being developed by organizations with significantly greater resources.

2. BASIS OF PRESENTATION/GOING CONCERN:

The condensed consolidated interim financial information as of April 30, 2006 and for the three-month period ended April 30, 2006 and 2005 and for the cumulative period from August 4, 1999 to April 30, 2006, has been prepared without audit, pursuant to the rules and regulations of Securities and Exchange Commission (the “SEC”). Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations, although we believe that the disclosures made are adequate to provide for fair presentation. These Condensed Consolidated Financial Statements should be read in conjunction with the Consolidated Financial Statements and the notes threto, included in the Company’s Annual Report on Form 10-KSB for the fiscal year ended January 31, 2006, previously filled with the SEC.

 

In the opinion of management, all adjustments (which include normal recurring adjustments) necessary to present a fair statement of financial position as of April 30, 2006, and results of operations, cash flows and shareholders’ equity (deficiency) for the three months ended April 30, 2006 and 2005 and for the cumulative period from August 4, 1999 to April 30, 2006, as applicable, have been made. The results of operations for the thre months ended April 30, 2006 are not necessarily indicative of the operating results for the full fiscal year or any future periods.

Going Concern Uncertainty

As shown in the accompanying consolidated financial statements, Xenomics has suffered operating losses and negative cash flow from operations since inception and has an accumulated deficit of $17,204,207. Primarily as a result of private placements of common stock in 2005 and 2006 and proceeds received upon the issuance of preferred stock, Xenomics realized net

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proceeds of approximately $10,000,000. As of April 30, 2006, Xenomics has a capital surplus of $2,101,678 and a cash balance of $2,499,906. Xenomics expects that its existing capital resources will not be sufficient to fund its operations for the next twelve months. Consequently, it will be required to raise additional capital to complete the development and commercialization of its current product candidates. Xenomics’ auditors stated in their report on the Consolidated Financial Statements for the year ended January 31, 2006, that these conditions raise substantial doubt about the Company’s ability to continue as a going concern.

To date, Xenomics’ sources of cash have been primarily limited to the sale of its equity securities. Xenomics cannot be certain that additional funding will be available on acceptable terms, or at all. Any debt financing, if available, may involve restrictive covenants that impact the Company’s ability to conduct business. If Xenomics is unable to raise additional capital when required or on acceptable terms, it may have to significantly delay, scale back or discontinue the development and/or commercialization of one or more of its product candidates. Xenomics can give no assurances that any additional capital that it is able to obtain will be sufficient to meet its needs. Based on the resources available to Xenomics at April 30, 2006, Xenomics will need additional financing to sustain its operations through 2006 and it will need additional financing thereafter. These matters raise substantial doubt about Xenomics’ ability to continue as a going concern.

3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

USE OF ESTIMATES - The preparation of financial statements in conformity with GAAP requires management to make 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.

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NET LOSS PER SHARE - Basic and diluted net loss per share is presented in conformity with SFAS No. 128, “Earnings per Share,” for all periods presented. In accordance with SFAS No. 128, basic and diluted net loss per common share was determined by dividing net loss applicable to common stockholders by the weighted-average common shares outstanding during the period. Diluted weighted-average shares are the same as basic weighted-average shares since, due to net losses, the inclusion of issuable shares pursuant to the conversion of preferred stock and the exercise of stock options and warrants would have been antidilutive.

As of April 30, 2006, Xenomics had 731,814 shares of common stock issuable upon conversion of the 157,340 shares of Series A convertible preferred stock outstanding. In addition Xenomics had 2,503,501 and 2,011,418 common stock warrants outstanding which were 100% vested as of April 30, 2006 and 2005, respectively. Stock options outstanding totaled 7,135,000 and 5,495,000 as of April 30, 2006 and 2005, respectively. All share and per share amounts have been retroactively restated to reflect the 111 for 1 stock split which was effective July 26, 2004.

4. STOCK BASED COMPENSATION

In December 2004, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standard (“SFAS”) No. 123 (Revised 2004), Share-Based Payments (“SFAS 123R”). SFAS 123R requires a public entity to measure the cost of employee services received in exchange for the award of equity instruments based on the fair value of the award at

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the date of grant. The expense is to be recognized over the period during which an employee is required to provide services in exchange for the award. SFAS 123R is effective as of the beginning of the first interim or annual reporting period that begins after December 15, 2005 and accordingly Xenomics adopted this standard on February 1, 2006.

For all awards granted prior to February 1, 2006, the unrecognized portion of stock based compensation will be recognized as an expense on a straight line basis over the remaining requisite service period, ranging from nine to thirty six months. Xenomics has chosen the modified prospective method for transitioning to the new standard and accordingly the financial results for prior periods have not been restated. The adoption of SFAS 123R increased net loss for the three months ended April 30, 2006 by approximately $538,000 for stock based compensation cost related to employee stock options. The remaining unrecognized compensation cost related to non-vested share-based compensation arrangements for all employee stock options outstanding at April 30, 2006, as measured at the date of grant, was approximately $3,086,000.

Effective with the adoption of SFAS 123R stock-based compensation expense related to Xenomics’s share-based compensation arrangements attributable to employees is being recorded as a component of general and administrative expense and research and development expense in accordance with the guidance of Staff Accounting Bulletin 107 , Topic 14, paragraph F . Classification of Compensation Expense Associated with Share-Based Payment Arrangements (“SAB 107”). Prior period financial statement accounts have been reclassified to conform to this presentation. Stock-based compensation expense related to employee and non-employee stock options recognized in the operating results for the three months ended April 30, 2006, April 30, 2005 and for the period from August 4, 1999 (inception) through April 30, 2006 is as follows:

		Three Months			Three Months			Inception
		Ended			Ended			Through
		April 30,			April 30,			April 30,
		2006			2005			2006
Stock-based compensation expense related to employees		$	538,656		$	161,459		$	1,430,187
Stock-based compensation expense (benefit) not related to employees		17,003			(269,397		)	6,821,808
Total		$	555,659		$	(107,938	)	$	8,251,995

 

The estimated fair value of each employee option award granted was determined in accordance with SFAS 123R on the date of grant using the Black-Scholes option valuation model with the following weighted-average assumptions for option granted during the three months ended April 30, 2006 and 2005:

		Employee options granted during the three months ended April 30,
		2006		2005
Risk free interest rate		4.5	%	4.25	%
Dividend yield		0.0	%	0.0	%
Volatility		80	%	80	%
Expected Life		3 to 7 years		7 years

 

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The risk-free interest rate assumption is based upon observed interest rates appropriate for the expected term of Xenomics’ employee stock options. The expected volatility is based on the historical volatility of Xenomics’ stock. The Company has not paid any dividends on common stock since its inception and does not anticipate paying dividends on its common stock in the foreseeable future. The computation of the expected option term is based on expectations regarding future exercises of options which generally vest over 3 years and have a 10 year life.

 

SFAS 123R requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. Based on historical Company experience Xenomics estimated future unvested option forfeitures at 6% as of February 1, 2006 and incorporated this rate in estimated fair value of employee option grants.

Xenomics’ determination of fair value is affected by Xenomics’ stock price as well as the assumptions discussed above that require judgment. The weighted-average fair value of all options granted during the three months ended April 30, 2006, estimated as of the grant date using the Black-Scholes option valuation model, was $1.16 per share. A summary of the changes in options outstanding during the three months ended April 30, 2006 is as follows:

		Number of		Weighted Average
		Shares		Price Per Share
Outstanding at February 1, 2006		6,655,000		$	1.68
Granted		500,000		1.88
Exercised		—
Terminated		20,000		1.68
Outstanding at April 30, 2006		7,135,000		$	1.70
Options exercisable at April 30, 2006		4,606,667		$	1.41

 

The weighted average remaining term of all options outstanding decreased from 8.7 years at January 31, 2006 to 8.5 years at April 30, 2006.

SFAS 123R requires that cash flows resulting from tax deductions in excess of the cumulative compensation cost recognized for options exercised (excess tax benefits) be classified as cash inflows from financing activities and cash outflows from operating activities. Due to Xenomics’ accumulated deficit position, no tax benefits have been recognized in the cash flow statement.

Prior to February 1, 2006, Xenomics had adopted Statement of Financial Accounting Standard (“SFAS”) No. 123, “Accounting for Stock-Based Compensation.” As provided for by SFAS 123, Xenomics had elected to continue to account for its stock-based compensation programs according to the provisions of Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees (“APB 25”).” Accordingly, compensation expense had been recognized to the extent of employee or director services rendered based on the intrinsic value of stock options granted under the plan.

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The balance of deferred unamortized stock based compensation as of January 31, 2006 of $1,045,971, prior to adoption of SFAS 123R, has been eliminated against the appropriate equity accounts as prescribed by paragraph seventy-four of SFAS 123R during the quarter ended April 30, 2006.

Had compensation cost for stock options granted to employees and directors prior to February 1, 2006 been determined based upon the fair value at the grant date for awards, consistent with the methodology prescribed under SFAS 123, Xenomics’ net loss for the three months ended April 30, 2005 would have been as follows:

		Three months ended
		April 30,
		2005
Net loss, as reported		$	(751,867	)
Add: Stock-based employee compensation expense recorded under APB No. 25 intrinsic value method		161,458
Deduct: Stock-based employee compensation expense determined under fair value based method		(324,742		)
Pro forma net loss		$	(915,151	)
Net loss per share:
Basic and diluted -as reported		$	(0.04	)
Basic and diluted -pro forma		$	(0.05	)

 

5. STOCKHOLDERS’ EQUITY:

All share and per share amounts have been restated to reflect the 111 for 1 stock split which was effected July 26, 2004 as discussed in Note 1.

On July 2, 2004 the Company completed a private placement of 2,645,210 shares of our common stock for aggregate proceeds of $2,512,950, or $0.95 per share. The sale was made to 17 accredited investors directly by us without any general solicitation or broker and thus no finder’s fees were paid. The Company filed a Form D with the Securities and Exchange Commission (“SEC”) and the offering is claimed to be exempt from registration pursuant to Rule 506 of Regulation D under the Securities Act of 1933, as amended.

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Pursuant to a services agreement with Trilogy Capital Partners (Trilogy), Xenomics issued warrants to Trilogy to purchase 1,000,000 shares of Common Stock of Xenomics at an exercise price of $2.95 per share (the “Warrants”). The exercise price was determined to be consistent with the price of the warrants being offered to purchasers as part of an investment unit in the then operative private placement memorandum. The Warrants issued to Trilogy are exercisable upon issuance and expire on December 13, 2007. In connection with the issuance of these warrants, Xenomics agreed to file a registration statement with the Securities and Exchange Commission (SEC) registering for resale the shares of Common Stock underlying the Warrants. That registration statement was declared effective by the SEC on March 17, 2006. The fair value of the Warrants using the Black-Scholes methodology is $2,630,440 which was immediately expensed. The following assumptions were used to determine fair value: (i) stock price $4.20 per share (ii) no dividend (iii) risk free interest rate 4.5% (iv) volatility of 80%.

On January 28, 2005, the Company closed the first traunche of a private placement selling 1,368,154 shares of common stock and 367,681 warrants to certain investors (the “Investors”). The securities were sold as a unit (the “Units”) at a price of $1.95 per Unit for aggregate proceeds of $2,667,900. Each Unit consisted of one share of common stock and a warrant to purchase one quarter share of common stock. The warrants are immediately exercisable at $2.95 per share and are exercisable at any time within five years from the date of issuance. The fair value of these Investor warrants using a market price of $4.20 per share on the date of issuance was $1,198,373. The Company also issued an aggregate 123,659 warrants to purchase common stock to various selling agents, which are immediately exercisable at $2.15 per share and will expire five years after issuance. The selling agent warrants had a fair value of $403,038 on the date of issuance and this amount was recorded as a cost of raising capital.

On February 5, 2005 the Company completed the first traunche of the private placement described above selling an additional 102,564 shares of its common stock to the Investors at a price of $1.95 per share for aggregate proceeds of $200,000. In addition, the Company paid an aggregate $179,600 in cash and issued 24,461 shares of common stock to certain selling agents, in lieu of cash, which had a fair value of $47,699 capitalized at $1.95 per share.

In connection with the offer and sale of securities to the Investors the Company also entered into a Registration Rights Agreement, dated as of January 28, 2005, with the Investors pursuant to which the Company agreed to file, within 120 days after the closing, a registration statement covering the resale of the shares of common stock sold to the Investors and the shares of common stock issuable upon exercise of the Warrants issued to the Investors. In the event a registration statement covering such shares of Common Stock is not filed with the SEC by the 120th day after the final closing of the Offering (May 28, 2005), the Company shall pay to the investors, at the Company’s option in cash or common stock, an amount equal to 0.1125% of the gross proceeds raised in the Offering for each 30 day period that the registration statement is not filed with the SEC. On August 1, 2005 the Company filed a Form SB-2 registration statement with the Securities and Exchange Commission and the resulting liquidated damages in the amount of $16,304 was paid to the Investors. Pursuant to this January 28, 2005 Registration Rights Agreement there are no additional liquidated damages for failure to have the registration

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statement declared effective by a specified date, or for failure to maintain its effectiveness for any specified period of time.

On April 7, 2005, the Company closed the second and final traunche of the private placement of 1,515,384 shares of common stock and 378,846 warrants to certain additional Investors. The securities were sold as a unit (the “Units”) at a price of $1.95 per Unit for aggregate proceeds of $2,954,999. Each Unit consisted of one share of common stock and a warrant to purchase one quarter share of common stock. The warrants are immediately exercisable at $2.95 per share and are exercisable at any time within five years from the date of issuance. The fair value of these Investor warrants using a market price of $2.61 per share on the date of issuance date was $694,335. The Company paid an aggregate $298,000 and issued an aggregate 121,231 warrants to purchase common stock to Axiom Capital Management who acted as the selling agent. The warrants are immediately exercisable at $2.15 per share, will expire five years after issuance. The warrants had a fair value of $222,188 on the date of issuance and this amount was recorded as a cost of raising capital. These April 7, 2005 Investors became parties to the same Registration Rights Agreement as the January 28, 2005 Investors

On July 13, 2005, the Company closed a private placement of 277,100 shares of Series A Convertible Preferred Stock (the “Series A Preferred Stock”) and 386,651 warrants to certain investors for aggregate gross proceeds of $2,771,000 pursuant to a Securities Purchase Agreement dated as of July 13, 2005. The warrants sold to the Investors are immediately exercisable at $3.25 per share and are exercisable at any time within five years from the date of issuance. These investor warrants had a fair value of $567,085 on the date of issuance using a market price of $2.40 on that date. In addition the Company paid an aggregate $277,102 and issued an aggregate 105,432 warrants to purchase common stock to certain selling agents. The warrants issued to the selling agents are immediately exercisable at $2.50 per share and will expire five years after issuance. The selling agent warrants had a fair value of $167,397 on the date of issuance and this amount was recorded as a cost of raising capital.

The material terms of the Series A Preferred Stock consist of:

Dividends.   Holders of the Series A Convertible Preferred Stock shall be entitled to receive cumulative dividends at the rate per share of 4% per annum, payable quarterly on March 31, June 30, September 30 and December 31, beginning with September 30, 2005. Dividends shall be payable, at the Company’s sole election, in cash or shares of common stock.

Voting Rights.   Shares of the Series A Convertible Preferred Stock shall have no voting rights. However, so long as any shares of Series A Convertible Preferred Stock are outstanding, the Company shall not, without the affirmative vote of the holders of the shares of Series A Convertible Preferred Stock then outstanding, (a) adversely change the powers, preferences or rights given to the Series A Convertible Preferred Stock, (b) authorize or create any class of stock senior or equal to the Series A Convertible Preferred Stock, (c) amend its articles of incorporation or other charter documents, so as to affect adversely any rights of the holders of Series A Convertible Preferred Stock or (d) increase the authorized number of shares of Series A Convertible Preferred Stock.

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Liquidation.   Upon any liquidation, dissolution or winding-up of the Company, the holders of the Series A Convertible Preferred Stock shall be entitled to receive an amount equal to the Stated Value per share, which is $10 per share plus any accrued and unpaid dividends.

Conversion Rights.   Each share of Series A Convertible Preferred Stock shall be convertible into that number of shares of common stock determined by dividing the Stated Value, currently $10 per share, by the conversion price, currently $2.15 per share. The conversion price is subject to adjustment for dilutive issuances.

Beginning July 13, 2006, if the price of the common stock equals $4.30 per share for 20 consecutive trading days, and an average of 50,000 shares of common stock per day shall have been traded during the 20 trading days, the Company shall have the right to deliver a notice to the holders of the Series A Convertible Preferred Stock, to convert any portion of the shares of Series A Convertible Preferred Stock into shares of Common Stock at the conversion price.

During the quarter ended April 30, 2006 119,760 Series A Preferred shares were converted to 557,022 shares of common stock.

As per EITF 00-19, “Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, Company Stock” the Company calculated the value of the warrants issued in connection with this transaction to be $567,085. This amount was recorded as a reduction to the proceeds allocated to Preferred Stock and a corresponding liability was established. This liability has been classified as non-current since the exercise price of these warrants exceeds the market value of the related common shares. These warrants have been marked-to-market and the liability has been adjusted with a corresponding charge or benefit recorded in the statement of operations. During the three months ended April 30, 2006, and for the period from August 4, 1999 (Inception) through April 30, 2006, the Company recorded benefits of $39,670 and $201,126, respectively.

As per EITF 00-27 “Application of Issue 98-5 to Certain Convertible Instruments” the Company evaluated the preferred stock transaction and accordingly found that there was an associated beneficial conversion feature. The cash purchase and existing conversion were found to contain a beneficial conversion feature totaling $322,209 and the preferred stock was further discounted by this amount. The beneficial conversion amount was then accreted back to the preferred stock in accordance with the conversion provision which allowed for 100% to be converted immediately. The total amount accreted back to the preferred and charged to Deficit Accumulated during Development Stage was $322,209 as of April 30, 2006.

In connection with the offer and sale of the Series A Preferred Stock securities the Company also entered into a Registration Rights Agreement pursuant to which the Company agreed to have a registration statement covering the resale of the common stock attributable to conversion of Series A Preferred Stock and the shares of common stock issuable upon exercise of the preferred warrants, declared effective by the SEC. By October 25, 2005. In the event a registration statement covering such shares of common stock was not declared effective by October 25, 2005, the Company was required to pay a penalty to the investors, at the Company’s option in cash or common stock, an amount equal to 1% of the gross proceeds raised in the Offering for each 30 day period that the registration statement is not declared effective by the SEC. The registration statement filed on August 1, 2005 was not declared effective until March 17, 2006 and a penalty of $134,982 was paid to the investors through April 30, 2006.

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