Edgar Filing: ARBIOS SYSTEMS INC

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

________________________________

FORM 10-Q

(MARK ONE)

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

For the quarterly period ended September 30, 2008

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

For the transition period from ___________ to __________

Commission file number: 000-32603

ARBIOS SYSTEMS, INC.

(Exact name of registrant as specified in its charter)

Delaware	91-1955323
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)

200 E. Del Mar Blvd., Suite 320, Pasadena, CA	91105
(Address of principal executive offices)	(Zip Code)

(626) 356-3105

(Registrant's telephone number, including area code)

1050 Winter Street, #1000

Waltham, MA 02451

(Former name or former address, 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 is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large Accelerated filer o

Accelerated filer o

Non-accelerated filer o

(do not check if a smaller reporting company)

Smaller reporting company x

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

On September 30, 2008, there were 25,792,747 shares of common stock, $.001 par value per share, issued and outstanding.

ARBIOS SYSTEMS, INC.

FORM 10-Q

TABLE OF CONTENTS

		PAGE NO.
PART I. FINANCIAL INFORMATION

Item 1.	Financial Statements:

	Condensed Balance Sheets as of September 30, 2008 (unaudited) and December 31, 2007 (audited)	4

	Condensed Statements of Operations for the three and nine months ended September 30, 2008 and 2007 and from August 23, 2000 (inception) through September 30, 2008 (all unaudited)	5

	Condensed Statements of Cash Flows for the nine months ended September 30, 2008 and 2007 and from August 23, 2000 (inception) through September 30, 2008 (all unaudited)	6

	Condensed Statement of Stockholders’ Equity (Deficit) from August 23, 2000 (inception) through September 30, 2008 (unaudited)	7
	Notes to Condensed Financial Statements	12
Item 2.	Management's Discussion and Analysis of Financial Condition and Results Of Operations	17

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	21

Item 4T.	Controls and Procedures	21

PART II. OTHER INFORMATION

Item 1.	Legal Proceedings	22

Item 1A.	Risk Factors	22

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	23

Item 3.	Defaults Upon Senior Securities	23

Item 4.	Submission of Matters to a Vote of Security Holders	23

Item 5.	Other Information	23

Item 6.	Exhibits	23

SIGNATURES		24

PART I - FINANCIAL INFORMATION

ITEM 1. Condensed Financial Statements

ARBIOS SYSTEMS, INC.

(A development stage company)

CONDENSED BALANCE SHEETS

	September 30, 2008			December 31,
	(Unaudited)			2007
ASSETS

Current assets
Cash and cash equivalents	$	477,756		$	2,735,944
Prepaid expenses		2,087			37,546
Total current assets		479,843			2,773,490

Net property and equipment		22,240			45,450
Assets held for sale		116,931			132,293
Deferred financing costs		-			16,757
Other assets		1,550			70,236

Total assets	$	620,564		$	3,038,226

LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities
Accounts payable	$	320,578		$	434,727
Accrued expenses		386,250			483,617
Total current liabilities		706,828			918,344

Long term contract obligations		150,000			250,000
Total liabilities		856,828			1,168,344

Stockholders' equity (deficit)
Preferred stock, $.001 par value; 5,000,000 shares authorized:
none issued and outstanding		-			-

Common stock, $.001 par value; 100,000,000 shares authorized; 25,792,747 and 25,578,461 shares issued and outstanding at September 30, 2008 and December 31, 2007, respectively		25,792			25,578
Additional paid-in capital		21,600,117			21,159,276
Deficit accumulated during the development stage		(21,862,173	)		(19,314,972	)
Total stockholders' equity (deficit)		(236,264	)		1,869,882

Total liabilities and stockholders' equity (deficit)	$	620,564		$	3,038,226

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

ARBIOS SYSTEMS, INC.

(A development stage company)

CONDENSED STATEMENTS OF OPERATIONS

(Unaudited)

	For the three months ended September 30,						For the nine months ended September 30,						August 23, 2000 (inception)
	2008			2007			2008			2007			through September 30, 2008

Revenues	$	-		$	-		$	-		$	-		$	320,966

Operating expenses:
General and administrative		147,103			1,025,108			1,358,718			2,651,264			13,100,855
Research and development		164,350			422,743			1,220,747			1,982,747			9,333,555
Total operating expenses		311,453			1,447,851			2,579,465			4,634,011			22,434,410

Loss before other income (expense)		(311,453	)		(1,447,851	)		(2,579,465	)		(4,634,011	)		(22,113,444	)

Other income (expense):
Interest income		3,786			53,445			32,264			128,064			495,409
Interest expense		-			-			-			-			(244,138	)
Total other income (expense)		3,786			53,445			32,264			128,064			251,271


Net loss	$	(307,667	)	$	(1,394,406	)	$	(2,547,201	)	$	(4,505,947	)	$	(21,862,173	)

Net loss per share:
Basic and diluted	$	(0.01	)	$	(0.05	)	$	(0.10	)	$	(0.20	)

Weighted-average shares:
Basic and diluted		25,792,747			25,446,803			25,712,950			22,021,676

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

ARBIOS SYSTEMS, INC.

(A Development Stage Company)

CONDENSED STATEMENTS OF CASH FLOWS

(Unaudited)

	For the nine months ended September 30,						August 23, 2000 (inception)
	2008			2007			through September 30, 2008
Cash flows from operating activities:
Net loss	$	(2,547,201	)	$	(4,505,947	)	$	(21,862,173	)

Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
Amortization of debt discount		-			-			244,795
Depreciation and amortization		32,190			37,506			334,454
Patent rights impairment		-			-			91,694
Issuance of common stock, options and warrants for compensation		441,055			585,376			4,054,502
Issuance of warrants for patent acquistion		-			74,570			74,570
Settlement of accrued expense		-			-			54,401
Deferred compensation costs		-			-			319,553
Loss on disposition of fixed assets		2,207			2,766			4,973
Changes in operating assets and liabilities:
Prepaid expenses		35,459			96,388			(2,089	)
Deferred financing costs		16,757			-			-
Other assets		68,686			(13,187	)		(1,550	)
Accounts payable		(114,149	)		75,102			320,578
Accrued expenses		(97,367	)		549,141			292,748
Other liabilities		-			-			64,695
Contractual obligation		(100,000	)		250,000			150,000
Net cash used in operating activities		(2,262,363	)		(2,848,285	)		(15,858,849	)

Cash flows from investing activities:
Dispositions (Additions) of property and equipment		4,175			(2,500	)		(145,292	)
Purchase of short term investments		-			-			(21,866,787	)
Maturities of short term investments		-			-			21,866,787
Net cash provided by (used in) investing activities		4,175			(2,500	)		(145,292	)

Cash flows from financing activities:
Proceeds from issuance of convertible debt		-			-			400,000
Proceeds from common stock option/warrant exercise		-			2,700			67,900
Net proceeds from issuance of common stock and warrants		-			4,483,831			15,797,080
Net proceeds from issuance of preferred stock		-			-			238,732
Payments on capital lease obligation, net		-			-			(21,815	)
Net cash provided by financing activities		-			4,486,531			16,481,897
Net increase (decrease) in cash		(2,258,188	)		1,635,746			477,756

Cash at beginning of period	$	2,735,944		$	2,054,280		$	-

Cash at end of period	$	477,756		$	3,690,026		$	477,756

Supplemental disclosures of non-cash financing activity
Issuance of securities for obligation related to finder's fees	$	-		$	-		$	47,500

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

ARBIOS SYSTEMS, INC.

(A Development Stage Company)

CONDENSED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)

PERIOD FROM AUGUST 23, 2000 (INCEPTION) THROUGH SEPTEMBER 30, 2008

														Deficit
														Accumulated
									Additional					During the
	Preferred Stock				Common Stock				Paid-In		Deferred			Development
	Shares		Amount		Shares		Amount		Capital		Costs			Stage			Total


Balance, August 23, 2000 (inception) restated for effect of reverse merger with Historical Autographs U.S.A. Inc.		-	$	-		-	$	-	$	-	$	-		$	-		$	-

Stock issuance in exchange for cash						5,000,000		50		4,950								5,000

Net loss															(9,454	)		(9,454	)

Balance, December 31, 2000, as restated		-		-		5,000,000		50		4,950		-			(9,454	)		(4,454	)

Issuance of junior preferred stock for cash of $250,000 and in exchange for $400,000 in patent rights, research and development costs, and employee loanout costs less issuance expenses of $11,268, June 29, 2001		681,818		7						958,278		(343,553	)					614,732

Issuance of common stock in exchange for patent rights and deferred research and development costs						362,669		4		547,284								547,288

Services receivable												(550,000	)					(550,000	)

Deferred employee loan-out costs receivable earned												82,888						82,888

Net loss															(237,574	)		(237,574	)

Balance, December 31, 2001		681,818		7		5,362,669		54		1,510,512		(810,665	)		(247,028	)		452,880

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

ARBIOS SYSTEMS, INC.

(A Development Stage Company)

CONDENSED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)

PERIOD FROM AUGUST 23, 2000 (INCEPTION) THROUGH SEPTEMBER 30, 2008

															Deficit
															Accumulated
									Additional						During the
	Preferred Stock				Common Stock				Paid-In			Deferred			Development
	Shares		Amount		Shares		Amount		Capital			Costs			Stage			Total

Amendment of December 31, 2001 agreement for the issuance of common stock agreement in exchange for research and development services										(495,599	)		550,000						54,401

Deferred employee loan out costs receivable earned													171,776						171,776

Issuance of common stock for compensation						70,000		1		10,499									10,500

Issuance of common stock for cash						999,111		9		149,857									149,866

Net loss																(494,780	)		(494,780	)

Balance, December 31, 2002		681,818		7		6,431,780		64		1,175,269			(88,889	)		(741,808	)		344,643

Issuance of common stock for cash less issuance expense of $2,956						417,000		417		246,827									247,244

Issuance of common stock in private placement for cash less issuance expense of $519,230						4,000,000		4,000		3,476,770									3,480,770

Issuance of common stock for convertible debenture less issuance expense of $49,500						400,000		400		350,100									350,500

Shares issued in connection with acquisition of Historical Autographs U.S.A., Inc. on October 30, 2003						1,220,000		8,263		(8,263	)								-

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

ARBIOS SYSTEMS, INC.

(A Development Stage Company)

CONDENSED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)

PERIOD FROM AUGUST 23, 2000 (INCEPTION) THROUGH SEPTEMBER 30, 2008

															Deficit
															Accumulated
											Additional				During the
	Preferred Stock						Common Stock				Paid-In		Deferred		Development
	Shares			Amount			Shares		Amount		Capital		Costs		Stage			Total

Value of warrants and beneficial conversion feature of bridge loan												244,795							244,795

Deferred employee loan-out costs receivable earned														88,889					88,889

Preferred Stock converted to Common Stock		(681,818	)		(7	)		681,818		7

Net loss																(885,693	)		(885,693	)

Balance, December 31, 2003		-			-			13,150,598		13,151		5,485,498		-		(1,627,501	)		3,871,148

Issuance of common stock options and warrants for compensation												972,430							972,430

Exercise of common stock options								18,000		18		2,682							2,700

Issuance of securities for payable								47,499		47		47,451							47,498

Net loss																(3,327,827	)		(3,327,827	)

Balance, December 31, 2004		-			-			13,216,097		13,216		6,508,061		-		(4,955,328	)		1,565,949

Issuance of common stock in private placement for cash less issuance expense of $384,312								2,991,812		2,992		6,224,601							6,227,593

Issuance of common stock options and warrants for compensation												557,080							557,080

Exercise of common stock options								25,000		25		62,475							62,500

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

ARBIOS SYSTEMS, INC.

(A Development Stage Company)

CONDENSED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)

PERIOD FROM AUGUST 23, 2000 (INCEPTION) THROUGH SEPTEMBER 30, 2008

														Accumulated During
	Preferred Stock				Common Stock				Additional Paid-In			Deferred		the Development
	Shares		Amount		Shares		Amount		Capital			Costs		Development Stage			Total
Net loss															(3,823,903	)		(3,823,903	)

Balance, December 31, 2005		-		-		16,232,909		16,233		13,352,217			-		(8,779,231	)		4,589,219

Issuance of common stock in private placement for cash less issuance expense of $95,013						1,227,272		1,227		1,253,760								1,254,987

Issuance of common stock options and warrants for compensation										703,839								703,839

Stock warrant term extension						-				482,964								482,964

Warrant liability										(1,284,841	)							(1,284,841	)

Net loss															(4,461,904	)		(4,461,904	)

Balance, December 31, 2006		-		-		17,460,181		17,460		14,507,939			-		(13,241,135	)		1,284,264

Cumulative effect of change in accounting principle: Adjust retained earnings at January 1, 2007 for change in accounting principle															(521,187	)		(521,187	)
Reclassification of warrants										1,284,841								1,284,841

Issuance of common stock and warrants in private placement for cash less issuance expense of $377,169						7,478,462		7,479		4,476,352								4,483,831

Exercise of common stock warrants						18,000		18		2,682								2,700

Stock option based compensation expense										438,263								438,263

Stock warrant term extension						-				59,025								59,025

Restricted stock based compensation expense						621,818		621		315,604								316,225

Issuance of warrants for patent acquistion										74,570								74,570

Net loss															(5,552,650	)		(5,552,650	)

Balance, December 31, 2007		-		-		25,578,461		25,578		21,159,276			-		(19,314,972	)		1,869,882

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

ARBIOS SYSTEMS, INC.

(A Development Stage Company)

CONDENSED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)

PERIOD FROM AUGUST 23, 2000 (INCEPTION) THROUGH SEPTEMBER 30, 2008

(Unaudited)

													Accumulated
									Additional				During the
	Preferred Stock				Common Stock				Paid-In		Deferred		Development
	Shares		Amount		Shares		Amount		Capital		Costs		Stage			Total


Issuance of common stock for compensation						214,286		214		59,786							60,000

Stock option based compensation expense										97,866							97,866

Stock warrant term extension						-				175,256							175,256

Restricted stock based compensation expense						-		-		107,933							107,933

Net loss														(2,547,201	)		(2,547,201	)

Balance, September 30, 2008 (unaudited)		-		-		25,792,747	$	25,792	$	21,600,117		-	$	(21,862,173	)	$	(236,264	)

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

Arbios Systems, Inc.

(A Development Stage Company)

Notes to Condensed Financial Statements (Unaudited)

Nine Months Ended September 30, 2008

(1) Basis of Presentation

Arbios Systems, Inc., a Delaware corporation (the “Company”), seeks to develop, manufacture and market liver assist devices to meet the urgent need for therapy of liver failure.

On October 30, 2003, Historical Autographs U.S.A., Inc. and Arbios Technologies, Inc. (“ATI”) consummated a reverse merger, in which ATI became the wholly owned subsidiary of Historical Autographs U.S.A., Inc. Concurrently with the merger, Historical Autographs U.S.A., Inc. changed its name to Arbios Systems, Inc. and is herein referred to as “Arbios Systems”. The stockholders of ATI transferred ownership of one hundred percent of all the issued and outstanding shares of their capital stock of ATI in exchange for 11,930,598 newly issued shares, or approximately 91%, of the common stock, $.001 par value, of Arbios Systems. At that time, the former management of Arbios Systems resigned and was replaced by the same persons who served as officers and directors of ATI. Inasmuch as the former owners of ATI controlled the combined entity after the merger, the combination was accounted for as a purchase by ATI as acquirer, for accounting purposes in accordance with Statement of Financial Accounting Standards, (“SFAS”) No. 141: “Business Combinations” using reverse merger accounting, and no adjustments to the carrying values of the assets or liabilities of the acquired entity were required. Proforma operating results, as if the acquisition had taken place at the beginning of the period, have not been presented as the operations of the acquiree were negligible. The financial position and results of operations of Arbios Systems is included in the statements of the Company from the date of acquisition.

On July 25, 2005, Arbios Systems completed its reincorporation as a Delaware corporation by merging with and into Arbios Systems, Inc., a Delaware corporation (“Arbios”). The foregoing merger was approved by the Company’s stockholders at the annual meeting of stockholders held on July 7, 2005. In order to consolidate the functions and operations of Arbios and ATI, on July 26, 2005, ATI merged into Arbios. As a result, Arbios now owns all of the assets of ATI and all of the operations of the two companies have been consolidated into Arbios. Unless the context indicates otherwise, references herein to the “Company” during periods prior to July 26, 2005 include Arbios Systems, a Nevada corporation, and ATI.

The unaudited condensed financial statements and notes are presented as permitted by Form 10-Q. These unaudited condensed financial statements have been prepared by the Company pursuant to the rules and regulations of the 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 omitted pursuant to such SEC rules and regulations. In the opinion of the management of the Company, the accompanying unaudited condensed financial statements include all adjustments, including those that are normal and recurring considered necessary to present fairly the financial position of the Company as of September 30, 2008, and the results of operations for the periods presented. These unaudited condensed financial statements should be read in conjunction with the Company's audited financial statements and the accompanying notes included in the Company's Annual Report on Form 10-KSB for the year ended December 31, 2007 as filed with the SEC. The Company expects that its operating results will fluctuate for the foreseeable future. Therefore, period-to-period comparisons should not be relied upon as predictive of the results in future periods. The results of operations for the nine months ended September 30, 2008 are not necessarily indicative of the results to be expected for any subsequent periods or for the entire 2008 fiscal year.

(2) Going Concern

The Company’s financial statements have been prepared in accordance with generally accepted accounting principles in the United States of America, which contemplate continuation of the Company on a going concern basis, and which contemplate the realization of assets and the satisfaction of liabilities in the normal course of business. The Company has incurred a net operating loss of $2,547,201 for the nine months ended September 30, 2008 and an accumulated deficit of $21,862,173 at September 30, 2008. In October 2008 we sold our HepatAssist bioartificial liver device to HepaLife Technologies, Inc. As part of the sale, we received $250,000 in cash, which provides us with additional working capital to continue to seek licensing, merger, or financing opportunities for our remaining SEPET technology into the first quarter of 2009. However, the Company’s lack of adequate cash reserves to fund such activities to the end of the first quarter of 2009 and beyond raises substantial doubt about the Company’s ability to continue as a going concern.

The Company reduced its staffing levels by 2 employees and 1 consultant in the first quarter of 2008 to reduce its administrative expenses. On August 5, 2008, the Company announced that it was suspending its operations to focus its efforts on obtaining financing or consummating a strategic transaction. In connection with the suspension of its operations, the Company on July 31, 2008 terminated the employment of Shawn Cain, Interim President and Chief Executive Officer, Scott Hayashi, Interim Chief Financial Officer, Jacek Rozga, MD, Ph.D., Chief Scientific Officer, and Susan Papalia, Vice President of Clinical Affairs (Mr. Cain and Mr. Hayashi continue to provide services to the Company as part-time consultants.) Upon the termination of their employment, each of the foregoing officers executed the Company’s standard severance/termination agreement, and each of these officers received a severance payment in the following amount: Shawn Cain ($46,250, representing three month’s salary), Scott Hayashi ($20,833, representing two month’s salary), Jacek Rozga ($33,333, representing two month’s salary), and Susan Papalia ($28,333, representing two month’s salary).

If the Company is unsuccessful in its efforts to raise additional funds through the sale of additional equity securities or a strategic transaction, the Company will not have the ability to continue as a going concern into the first quarter of 2009. If the Company is unable to obtain financing, it will wind down operations and actively seek the sale of the assets, licensing of its SEPET^TM technology, or exploring a potential merger with another company. While the Company hopes to pursue development of its product candidate, any significant continued development is contingent upon significant additional funding or a strategic partnership. The amount and timing of future capital requirements will depend on numerous factors, including the number and characteristics of product candidates that the Company pursues, the conduct of clinical studies, the status and timelines of regulatory submissions, the costs associated with protecting patents and other proprietary rights, the ability to complete strategic collaborations and the availability of third-party funding, if any. The Company may also seek additional funding through corporate collaborations and other financing vehicles. If funds are obtained through arrangements with collaborative partners or others, the Company may be required to relinquish rights to its technologies or product candidates.

No assurance can be given that the Company will be successful in raising additional capital or will complete a strategic transaction. Furthermore, there can be no assurance, assuming the Company successfully raises additional equity or closes a strategic transaction, that the Company will achieve profitability or positive cash flow. If the Company is unable to raise additional capital or close a strategic transaction for the Company bythe first quarter of 2009, the Company will not be able to meet its obligations and will have to cease all operations. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.

(3) Recent Accounting Pronouncements

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements,” or SFAS 157. SFAS 157 establishes a single authoritative definition of fair value, sets out a framework for measuring fair value, and requires additional disclosures about fair-value measurements. SFAS 157 applies only to fair value measurements that are already required or permitted by other accounting standards (except for measurements of share-based payments) and is expected to increase the consistency of those measurements. Accordingly, SFAS 157 does not require any new fair value measurements. However, for some entities, the application of SFAS 157 will change current practice. SFAS 157 is effective for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. The adoption of FAS 157 did not have a material impact on the financial position or results of operations.

In February 2007, the FASB issued FASB Statement No.159: “The Fair Value Option for Financial Assets and Financial Liabilities – including an amendment of FASB Statement No. 115” (“FAS 159”). This statement permits entities to choose to measure many financial instruments and certain other items at fair value and is expected to expand the use of fair value measurement. FASB 159 is effective for fiscal years beginning after November 15, 2007. The Company has adopted FAS 159 and the adoption did not have a material impact on the financial position or results of operations.

On June 27, 2007, the FASB reached a final consensus on EITF Issue No. 07-03: “Accounting for Advance Payments for Goods or Services to Be Used in Future Research and Development Activities” (“EITF 07-03”). Currently, under FASB Statement No. 2: “Accounting for Research and Development Costs,” nonrefundable advance payments for future research and development activities for materials, equipment, facilities and purchased intangible assets that have no alternative future use are expensed as incurred. EITF 07-03 addresses whether such non-refundable advance payments for goods or services that have no alternative future use and that will be used or rendered for research and development activities should be expensed when the advance payments are made or when the research and development activities have been performed. The consensus reached by the FASB requires companies involved in research and development activities to capitalize such non-refundable advance payments for goods and services pursuant to an executory contractual arrangement because the right to receive those services in the future represents a probable future economic benefit. Those advance payments will be capitalized until the goods have been delivered or the related services have been performed. Entities will be required to evaluate whether they expect the goods or services to be rendered. If an entity does not expect the goods to be delivered or services to be rendered, the capitalized advance payment will be charged to expense. The consensus on EITF 07-03 is effective for financial statements issued for fiscal years beginning after December 15, 2007, and interim periods within those fiscal years. Earlier application is not permitted. Entities are required to recognize the effects of applying the guidance in EITF 07-03 prospectively for new contracts entered into after the effective date. In accordance with EITF 07-03, the Company does evaluate its research and development contracts and payments within the guidance of EITF 07-03 and either expenses or capitalizes such payments based upon the contract terms.

In March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities” The new standard is intended to improve financial reporting about derivative instruments and hedging activities by requiring enhanced disclosures to enable users of the financial statements to better understand the effects on an entity’s financial position, financial performance, and cash flows. It is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008, with early application encouraged. The Company is evaluating the impact of adopting SFAS 161 on our financial statements.

(4) Stock-Based Compensation:

On January 1, 2008, in accordance with the established Board of Director’s compensation program, the Company granted 90,000 options to purchase common stock to Board members with an exercise price of $0.69 per share, the closing market price of the Company’s common stock on the date of grant, valued at approximately $47,229, which vest on a monthly pro-rata basis over one year. The fair value of the options was determined using the Black Scholes option pricing model utilizing the following assumptions: risk free interest rate 2.98%, stock price volatility 0.84, expected life 7 years, dividend yield 0%.

On January 28, 2008, the Company granted 70,000 options to purchase common stock to employees with an exercise price of $0.60 per share, the closing market price of the Company’s common stock on the date of grant, valued at approximately $32,000, which vest upon the achievement of a performance milestone by December 31, 2008. The fair value of the options was determined using the Black Scholes option pricing model utilizing the following assumptions: risk free interest rate 2.98%, stock price volatility 0.84, expected life 7 years, dividend yield 0%. As of June 30, 2008, and through the current reporting period, the Company has determined that it is not probable that the performance objective will be met, and in accordance with SFAS 123R, the incremental vesting charges incurred through March 31, 2008 of approximately $5,800 was reversed during the second quarter of 2008.

On January 28, 2008, the Company issued 25,000 shares of restricted stock with restrictions that are removed upon achievement of a performance milestone by December 31, 2008, to an advisor and current member of the Board of Directors as compensation for services at a price of $0.01 per share. The approximate $15,000 value of these restricted shares, based on the closing price of the Company’s common stock on the date of issuance, was expensed with a corresponding increase in additional paid in capital. The Company estimated that as of June 30, 2008, and through the current reporting period, it is not probable that the performance objective will be met, and in accordance with SFAS 123R, the incremental vesting charges incurred through March 31, 2008 of $15,000 was reversed during the second quarter of 2008.

On March 25, 2008, the Company issued 250,000 options to purchase common stock with an exercise price of $0.30 per share, the closing market price of the Company’s common stock on the date of grant, to employees as a retention incentive and to compensate employees for a salary deferral that began on April 1, 2008, which options were valued at approximately $57,000 and vested as long as the employee remained with the Company until a financing was achieved. These options are considered performance based options. The Company estimated that as of June 30, 2008 it was not probable that the performance objective would be met, and in accordance with SFAS 123R, the incremental vesting charges incurred through March 31, 2008 of approximately $4,000 were reversed during the second quarter of 2008. The fair value of the options was determined using the Black Scholes option pricing model utilizing the following assumptions: risk free interest rate 2.48%, stock price volatility 0.84, expected life 7 years, dividend yield 0%.

On April 29, 2008, the Company entered into an agreement with a fund raising firm and issued 214,286 shares of common stock at a price of $0.28 per share as compensation plus other agreed upon terms. The value of the shares, based on the closing price of the Company’s common stock on the date of grant, was recorded as a deferred financing expense of $60,000 with a corresponding increase in additional paid in capital. An additional $30,000 cash retainer was also recorded as a deferred financing cost for legal and other expenses. These costs were subsequently expensed as of June 30, 2008 due to the termination of the agreement.

On July 18, 2008, the Company issued 50,000 options to purchase common stock with an exercise price of $0.05 per share, the closing market price of the Company’s common stock on the date of grant, to a consultant per the provisions of a previously negotiated scientific consulting agreement as compensation. The value of the option grant is $2,087. The stock option vested 100% immediately on the date of grant and the termination clause was extended from 90 days to 180 days to compensate for ongoing consulting services from the consultant.

During the three months ended September 30, 2008 and 2007, the Company recognized equity based compensation expense for stock options of $22,000 and $156,000, respectively, which was recognized in the Statement of Operations. During the nine months ended September 30, 2008 and 2007, the Company recognized equity based compensation expense for stock options of $98,000 and $346,000, respectively, which was recognized in the Statement of Operations. As of September 30, 2008, the total compensation costs related to non-vested awards not yet recognized is $11,000 which will be recognized over the next three months. As of September 30, 2008, there were 2,906,677 options to purchase common stock outstanding under the Company’s 2005 Stock Option Plan.

(5) Warrant Extension

On February 15, 2008, the Company amended outstanding warrants to purchase an aggregate of 900,000 shares of common stock of the Company, which have an exercise price of $1.00 per share (the “Warrants”). The Warrants were originally issued in 2003 in connection with certain financing transactions and were scheduled to expire on February 15, 2008. The amendment extends the expiration date of the Warrants until February 15, 2010. The value of the extension of the warrants was calculated using the Black Scholes pricing model and resulted in a charge of approximately $176,000, which was recorded in the statement of operations during the first quarter of 2008.

In addition, the Warrants contain a call provision whereby the Company can require the holders of the Warrants to exercise them if the Company’s common stock trades at a level of at least $3.25 per share for 20 consecutive trading days (the “Call Provision”). In addition to amending the expiration date of the Warrants as described in the preceding paragraph, the Company amended the Call Provision by lowering the trading price at which the Call Provision may be triggered from $3.25 per share to $2.25 per share.

(6) Subsequent Event

October 3, 2008, the