TENAX THERAPEUTICS, INC. - Quarter Report: 2008 July (Form 10-Q)

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-Q

For the quarterly period ended July 31, 2008

For the transition period from              to             

Commission File Number: 002-31909

OXYGEN BIOTHERAPEUTICS, INC.

(Exact name of registrant as specified in its charter)

3189 Airway Avenue, Building C, Costa Mesa, California 92626

(Address of Principal Executive Office)

714-427-6363

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 (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 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 the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

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

YES  ¨    NO  x

The number of shares outstanding of each of the issuer’s classes of common stock as of September 12, 2008: 156,515,324 shares of common stock, par value $0.0001.

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FORM 10-Q

OXYGEN BIOTHERAPEUTICS, INC.

INDEX

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Part I-Financial Information

OXYGEN BIOTHERAPEUTICS, INC.

(FORMERLY SYNTHETIC BLOOD INTERNATIONAL, INC.)

(A Development Stage Company)

CONSOLIDATED CONDENSED BALANCE SHEETS

See accompanying notes to consolidated condensed financial statements.

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OXYGEN BIOTHERAPEUTICS, INC.

(FORMERLY SYNTHETIC BLOOD INTERNATIONAL, INC.)

(A Development Stage Company)

CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS

See accompanying notes to consolidated condensed financial statements.

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OXYGEN BIOTHERAPEUTICS, INC.

(FORMERLY SYNTHETIC BLOOD INTERNATIONAL, INC.)

(A Development Stage Company)

CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS

See accompanying notes to consolidated condensed financial statements.

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OXYGEN BIOTHERAPEUTICS, INC.

(FORMERLY SYNTHETIC BLOOD INTERNATIONAL, INC.)

(A Development Stage Company)

CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS - CONTINUED

See accompanying notes to consolidated condensed financial statements.

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OXYGEN BIOTHERAPEUTICS, INC.

(FORMERLY SYNTHETIC BLOOD INTERNATIONAL, INC.)

(A Development Stage Company)

CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS - CONTINUED

Non-cash financing activities during the three months ended July 31, 2008:

Non-cash financing activities during the three months ended July 31, 2007:

See accompanying notes to consolidated condensed financial statements.

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OXYGEN BIOTHERAPEUTICS, INC.

(A Development Stage Company)

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

(UNAUDITED)

1. BASIS OF PRESENTATION

Oxygen Biotherapeutics (the Company) was originally formed as a New Jersey corporation in 1967 under the name Rudmer, David & Associates, Inc., and subsequently changed its name to Synthetic Blood International, Inc. On June 17, 2008, the stockholders of Synthetic Blood International approved the Agreement and Plan of Merger dated April 28, 2008, between Synthetic Blood International and Oxygen Biotherapeutics, Inc., a Delaware corporation.

The accompanying unaudited consolidated condensed financial statements contain all adjustments (consisting only of normal recurring adjustments) which, in the opinion of management, are necessary to present fairly the financial position of the Company as of July 31, 2008, and the results of its operations for the three months ended July 31, 2008 and 2007, and for the period from May 26, 1967 (inception) to July 31, 2008, and its cash flows for the three months ended July 31, 2008 and 2007, and for the period from May 26, 1967 (inception) to July 31, 2008. Certain information and footnote disclosures normally included in financial statements have been condensed or omitted pursuant to rules and regulations of the U.S. Securities and Exchange Commission (the “Commission”). The Company believes that the disclosures in the financial statements are adequate to make the information presented not misleading. However, the financial statements included herein should be read in conjunction with the financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended April 30, 2008 filed with the Commission on August 13, 2008.

The accompanying consolidated condensed financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. As shown in the accompanying financial statements, the Company is in the development stage and, at July 31, 2008, has an accumulated deficit of $41,989,577, continues to sustain operating losses on a monthly basis, and expects to incur operating losses for the foreseeable future. The Company requires substantial additional funds to complete clinical trials and pursue regulatory approvals. Although management believes that the Company has necessary working capital to fund operations in fiscal year 2008-2009, management is actively seeking additional sources of equity and/or debt financing; however, there is no assurance that any additional funding will be available.

In view of the matters described above, recoverability of a major portion of the recorded asset amounts shown in the accompanying July 31, 2008 balance sheet is dependent upon continued operations of the Company, which in turn is dependent upon the Company’s ability to meet its financing requirements on a continuing basis, to maintain present financing, and to generate cash from future operations. These factors, among others, raise substantial doubt about the Company’s ability to continue as a going concern. The consolidated financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts or amounts and classification of liabilities that might be necessary should the Company be unable to continue in existence.

2. RECENT ACCOUNTING PRONOUNCMENTS

In May 2008, the FASB issued Statement of Financial Accounting Standards No. 162, “The Hierarchy of Generally Accepted Accounting Principles” (“SFAS 162”). SFAS 162 identifies the sources of accounting principles and the framework for selecting the principles to be used in the preparation of financial statements of nongovernmental entities that are presented in conformity with generally accepted accounting principles in the United States. SFAS 162 will become effective 60 days following Securities and Exchange Commission (“SEC”) approval of the Public Company Accounting Oversight Board (PCAOB) amendments to AU Section 411, “The Meaning of Present Fairly in Conformity With Generally Accepted Accounting Principles.” The Company does not anticipate the adoption of SFAS 162 to have a material impact on its results of operations, financial position, or cash flows.

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OXYGEN BIOTHERAPEUTICS, INC.

(A Development Stage Company)

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

(UNAUDITED)

2. RECENT ACCOUNTING PRONOUNCMENTS (CONTINUED)

In June 2008, the FASB issued Staff Position No. EITF 03-6-1, “Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities” (“FSP EITF 03-6-1”). FSP EITF 03-6-1 addresses whether instruments granted in share-based payment transactions are participating securities prior to vesting, and therefore, need to be included in the earnings allocation in calculating earnings per share under the two-class method described in FASB Statement of Financial Accounting Standards No. 128, “Earnings Per Share.” FSP EITF 03-6-1 requires companies to treat unvested share-based payment awards that have non-forfeitable rights to dividend or dividend equivalents as a separate class of securities in calculating earnings per shared. FSP EITF 03-6-1 is effective for fiscal years beginning after December 15, 2008. FSP EITF 03-6-1 is effective for the Company in the quarter ending July 31, 2009. The Company is currently assessing the impact of FSP EITF 03-6-1, but does not expect that such adoption will have a material effect on its results of operations, financial position, or cash flows.

3. STOCK-BASED COMPENSATION

The fair value of the Company’s stock options is determined using a Black-Scholes option pricing model, consistent with the provisions of SFAS No. 123R (“Share-Based Payment”) and Securities and Exchange Commission Staff Accounting Bulletin No. 107 (“SAB 107”). The fair value of stock options granted is recognized as compensation expense over the requisite service period. Compensation expense for all share-based payment awards is recognized using the straight-line single-option method. Effective May 1, 2006, the Company adopted SFAS No 123R, using a modified prospective application. Prior to May 1, 2006, the Company measured employee and board member compensation cost under the intrinsic method provided by Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB No. 25”) whereby compensation expense is recognized for the excess, if any, of the fair value of the Company’s common stock over the option price on the date the option is granted.

The Company uses the historical stock price volatility to value stock options within the Black-Scholes option pricing model. The expected term of stock options represents the period of time options are expected to be outstanding and is based on observed historical exercise patterns for the Company, which management believes are indicative of future exercise behavior. For the risk free interest rate, the Company uses the observed interest rates appropriate for the term that the options are expected to be outstanding.

The Company’s net loss for the three months ended July 31, 2008 and 2007 includes approximately $68,000 and $11,000 of non-cash stock-based compensation costs. As of July 31, 2008, there was approximately $71,000 of total unrecognized compensation cost related to non-vested share-based compensation arrangements.

The fair value of each option grant during the three months ended July 31, 2008 was estimated at the grant date using the Black-Scholes option pricing model using the following assumptions: an average risk-free interest rate of 3.95%; average volatility of 105.34%; zero dividend yield for all years; expected life of 10 years; and an estimated forfeiture rate of 14.8%. There were no option grants during the three months ended July 31, 2007.

4. LICENSING RIGHTS

In May 2008, the Company entered into a license agreement with Virginia Commonwealth University (“Licensor”) whereby Oxygen Biotherapeutics obtained a worldwide, exclusive license to valid claims under three of the Licensor’s patent applications that relate to methods for non-pulmonary delivery of oxygen to tissue and the products based on those valid claims used or useful for therapeutic and diagnostic applications in humans and animals. The license includes the right to sub-license to third parties. The term of the agreement is the life of the patents covered by the patent applications, except that we can terminate the agreement at any time on not less than 90 days advance notice.

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OXYGEN BIOTHERAPEUTICS, INC.

(A Development Stage Company)

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

(UNAUDITED)

4. LICENSING RIGHTS (CONTINUED)

The Company has an obligation to diligently pursue product development and pursue, at its expense, prosecution of the patent applications covered by the agreement. The Company paid an initial fee of $50,000 in cash and paid an additional $16,228 to the Licensor as reimbursement of costs paid by the Licensor on patent applications and related work. The Company also issued to the licensor a warrant for the purchase of 500,000 shares of common stock at an exercise price of $0.42 per share that expires May 22, 2013. These warrants were valued at $353,500.

The $50,000 initial fee is fully credited towards future royalty or sublicensing revenue payments to the Licensor. This fee has been accounted for as a deposit and is included in other assets at July 31, 2008.

The $16,228 reimbursement costs and the $353,500 value of the 500,000 warrants discussed above were capitalized as licensing rights and are being amortized over a period of ten years. Accumulated amortization on the licensing rights at July 31, 2008 totaled $8,720.

The Company agreed to pay to the Licensor a royalty on net sales of licensed products as follows:

The Company also agrees to pay to the Licensor a percentage of sublicensing revenue received from sub-licensees or other third parties in regards to the licensed patents, equal to 33% of any such third party payments, which may be reduced to 25% if the Company completes pre-clinical studies on a licensed product, reduced further to 20% if the Company completes Phase I clinical studies, reduced further to 17% if the Company completes Phase II clinical studies, and reduced further to 10% if the Company completes Phase III clinical studies on a licensed product.

The Company agreed to pay a $20,000 annual maintenance fee to the Licensor, starting in May 2009 and payable in each following May as long as the agreement is in force. The maintenance fee payments will be fully credited towards future royalty or sublicensing revenue payments to the Licensor.

The Company agreed to pay a $50,000 annual minimum royalty to the Licensor, starting in May 2009 and payable in each following May as long as the agreement is in force. The minimum royalty fee payments will be fully credited towards future royalty or sublicensing revenue payments to the Licensor.

Lastly, the agreement provides that the Company will make the following minimum milestone payments to the Licensor, with respect to the first licensed product to achieve each milestone. However, if new licensed products are separately patentable, the same milestone payments shall apply to them.

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OXYGEN BIOTHERAPEUTICS, INC.

(A Development Stage Company)

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

(UNAUDITED)

5. STOCKHOLDERS’ EQUITY

During the three months ended July 31, 2008:

On June 17, 2008, the stockholders of the Company approved the amendment of the Company’s 1999 Stock Plan to increase the number of shares of common stock available for awards under the plan from 4,000,000 to 12,000,000, increase the maximum number of shares covered by awards granted under the plan to an eligible participant from 4,000,000 shares to 5,000,000 shares, and make additional technical changes to update the plan. Persons eligible to receive grants under the Plan consist of all of the Company’s employees (including executive officers and employee directors), non-employee directors, and consultants and advisors who perform services for the Company.

The following table summarizes the Company’s stock warrant information during the quarter ended July 31, 2008:

As of July 31, 2008, potentially issuable shares of common stock included 7,925,000 options, 121,334,919 warrants, and 80,528,972 conversion shares. Diluted earnings per share for the quarter ended July 31, 2008 was calculated assuming exercise of the above options and warrants and conversion of all of the outstanding convertible debt as of the beginning of the quarter. Upon conversion of the debt to common stock it is assumed that the Company would recognize $23,837,474 in additional interest expense for the write off of the related debt discounts and debt issuance costs, less $857,367 in discount and issuance cost amortization expense that would be eliminated in the conversion.

6. RELATED PARTY TRANSACTIONS

During the three months ended July 31, 2008, the Company paid $39,245 in severance payments to Robert Nicora, a former President and Chief Executive Officer of the Company.

As of July 31, 2008 the Company had approximately $63,994 payable to current and former directors of the Company.

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OXYGEN BIOTHERAPEUTICS, INC.

(A Development Stage Company)

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

(UNAUDITED)

7. INCOME TAXES

In June 2006, the FASB issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes, an Interpretation of FASB Statement No. 109.” Interpretation No. 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The evaluation of a tax position in accordance with Interpretation No. 48 involves determining whether it is more likely than not that a tax position will be sustained upon examination, based upon the technical merits of the position. A tax position that meets the more-likely-than-not recognition threshold is measured to determine the amount of benefit to recognize in the financial statements. If a tax position does not meet the more-likely-than-not recognition threshold, the financial statements do not recognize a benefit for that position.

As required, the Company adopted Interpretation No. 48 during the quarter ended July 31, 2007. The adoption did not result in a material impact to the Company’s results of operations or its financial condition.

The Company is subject to taxation in the U.S. and a small number of state jurisdictions. The material jurisdictions subject to potential examination by taxing authorities include the U.S. and California.

From time to time, the Company may be assessed interest or penalties by its tax jurisdictions, although any such assessments historically have been minimal and immaterial to the Company’s financial results. In the event the Company has received an assessment for interest and/or penalties, it has been classified in the financial statements as general and administrative expense.

The utilization of net operating loss carryforwards will likely be limited based on past and future issuances of common and preferred stock due to the ownership change provisions of Internal Revenue Code Section 382.

8. COMMITMENTS AND CONTINGENCIES

Employment Agreements — Effective March 25, 2008, Dr. Chris J. Stern, the Company’s Chairman of the Board, was appointed to the office of Chief Executive Officer and will retain his position as Chairman. At the time Mr. Stern was elected to the Board in November 2007 and appointed Chairman, the Company agreed to pay to Mr. Stern’s consulting firm a monthly fee of $15,000 for consulting services that Mr. Stern provides to the Company. Furthermore, the Company agreed (i) to issue to Mr. Stern, as of the date of his election to the Board, options to purchase 1,000,000 common shares at an exercise price of $0.245 per share that expire three years from the grant date, and (ii) if, in the two years following the date of the agreement, the Company enters into a license agreement or is sold, the Company will issue to Mr. Stern at the closing of the transaction, options to purchase an additional 4,000,000 common shares at an exercise price of $0.245 per share that expire three years from the grant date. As a result of Mr. Stern’s appointment as Chief Executive Officer, the Board has agreed to pay Mr. Stern’s consulting company an additional $5,000 per month by way of consulting fees and also to pay the consulting company $2,500 per month for additional secretarial and administration expenses. Furthermore, the Board has also agreed (i) to issue to Mr. Stern an aggregate of 14,000 shares of the Company’s common stock on the 1st of every month, commencing with April 1, 2008, for so long as Mr. Stern serves on the Board, and (ii) to issue and pay to Mr. Stern, upon his termination as a board member by the Company for whatever reason, with or without cause, an aggregate of 100,000 shares of the Company’s common stock and the sum of $200,000, payable upon such termination.

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OXYGEN BIOTHERAPEUTICS, INC.

(A Development Stage Company)

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

(UNAUDITED)

8. COMMITMENTS AND CONTINGENCIES (CONTINUED)

On February 1, 2000 the Board of Directors approved a two-year employment contract with Richard Kiral, as Vice President of Product Development. Mr. Kiral’s current base annual salary is $167,000 for the year ending April 2008 and includes an automobile allowance, medical and dental coverage, participation in the Executive Bonus Plan, $200,000 life insurance payable by the corporation and payable to a beneficiary named by the insured, and options granted for 75,000 shares annually. The contract will renew automatically annually unless terminated by either party. Mr. Kiral’s employment agreement provides that he is to receive a minimum severance payment equal to 9 months of his annual salary period in the event of a change in control as defined. Effective March 25, 2008, the Board appointed Dr. Richard M. Kiral to serve as President and Chief Operating Officer of the Company. Pursuant to an agreement executed on March 26, 2008, Dr. Kiral’s employment agreement with the Company has been amended to provide for payment of a sum equal to Dr. Kiral’s annual base salary and performance bonus upon

Dr. Kiral’s termination without cause, as that term is defined in the employment agreement. Furthermore, the Board has increased Dr. Kiral’s monthly compensation by $6,000 and has agreed to (i) to issue to Dr. Kiral an aggregate of 20,000 options to purchase shares of the Company’s common stock, at a price to be determined, on the 1st of every month, commencing with April 1, 2008, for so long as Dr. Kiral serves on the Board, and (ii) to issue and pay to Dr. Kiral, upon his termination as a board member by the Company for whatever reason, with or without cause, an aggregate of 100,000 shares of the Company’s common stock and the sum of $200,000, payable upon such termination.

Effective November 20, 2007, Robert W. Nicora, the Company’s President, Chief Executive Officer and Chief Financial Officer resigned from all officer positions and from his directorship. In accordance with his employment agreement, Mr. Nicora is entitled to receive a total amount of $378,233 which includes accrued salaries, repayment of advances and severance payments. A total of $39,245 was paid on this obligation during the current quarter, and the remaining balance due to Mr. Nicora as of July 31, 2008 was $48,994.

Consulting Agreement—On May 5, 2008 the Company entered into a consulting agreement with Fiona International SA for the provision of consulting services concerning licensing of the Company’s Oxycyte product and other corporate matters. The agreement was effective through August 4, 2008, and involved the following remuneration: (a) Cash payments during the current quarter totaling $87,500; (b) the issuance of 3,032,000 five year common stock purchase warrants with an exercise price of $0.247 during the current quarter; (c) and the issuance of 411,250 shares of common stock on August 1, 2008. At July 31, 2008, the Company’s obligation on this agreement totaled $205,770, and is included in current liabilities.

Other Agreements—The Company has entered into agreements with its two of its Board members and a consultant whereby it will grant 3-year options for a total of 900,000 shares at an exercise of price of $0.30 per share in the event the Company enters into a license agreement, undergoes a change of control, or is sold.

Registration Requirement—Warrants totaling 49,410,844 and convertible notes with a face amount of $20,256,472 and conversion shares totaling 82,010,008 issued during the year ended April 30, 2008 are subject to a requirement that the Company file a registration statement with the SEC to register the underlying shares, and that it be declared effective on or before January 9, 2009. In the event that the Company does not have an effective registration statement as of that date, or if at some future date the registration ceases to be effective, then the Company is obligated to pay liquidated damages to each holder in the amount of 1% of the aggregate market value of the stock, as measured on January 9, 2009 or at the date the registration statement ceases to be effective. As an additional provision for non-registration of the shares, the holders would also receive the option of a cashless exercise of their warrant or conversion shares.

The agreement underlying the issue of the above warrants (“Warrant Agreement”) asserts that, prior to September 30, 2008, the Company is required to take action to submit to the shareholders of the Company a proposal to amend the Company’s articles of incorporation to increase the number of authorized shares of common stock by such amount as is necessary to reserve for issuance the maximum aggregate number of warrant shares then issued or potentially issuable in the future upon exercise of the Warrant Agreement. As a result of the June 30, 2008 merger (further described in Note 9), this action was completed and the number of authorized common shares was increased from 200 million common shares, par value $0.01, to 400 million common shares, par value $0.0001.

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OXYGEN BIOTHERAPEUTICS, INC.

(A Development Stage Company)

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

(UNAUDITED)

9. MERGER

On June 17, 2008, the stockholders of Synthetic Blood International, Inc. approved the Agreement and Plan of Merger dated April 28, 2008 (“Plan of Merger”), between Synthetic Blood International and Oxygen Biotherapeutics, Inc., a Delaware corporation. Oxygen Biotherapeutics was formed on April 17, 2008, by Synthetic Blood International to participate in the merger for the purpose of changing the state of domicile of Synthetic Blood International from New Jersey to Delaware. Certificates of Merger were filed with the states of New Jersey and Delaware, and the merger was effective June 30, 2008. Under the Plan of Merger, Synthetic Blood International has been merged with and into Oxygen Biotherapeutics, which is the surviving corporation. As a result of the merger: (a) Each share of Synthetic Blood International common stock outstanding on June 30, 2008, has been converted to one share of Oxygen Biotherapeutics common stock; (b) The name of the corporation is changed to Oxygen Biotherapeutics, Inc.; (c) The number of authorized common shares changed from 200,000,000 common shares, par value $0.01, to 400,000,000, par value $0.001; (d) The Certificate of Incorporation and Bylaws of Oxygen Biotherapeutics are now the charter documents for the corporation; and (e) The General Corporation Law of the State of Delaware now applies to the corporation, rather than the New Jersey Business Corporation Act.

10. SUBSEQUENT EVENTS

From August 1, 2008 through September 12, 2008, the Company received an additional $77,910 in cash and issued 318,000 shares for the exercise of common stock warrants.

From August 1, 2008 through September 12, 2008, the Company issued 28,000 shares of its common stock as compensation to its Chief Executive Officer, valued at $19,600. During the same period the Company also issued 411,250 shares in exchange for consulting services valued at $296,100, and 89,968 shares in exchange for the conversion of notes with a face amount of $22,222.

On September 11, 2008, the Company entered into a consulting agreement with Robert F. Diegelmann, Ph.D., Professor of Biochemistry, Anatomy and Emergency Medicine at Virginia Commonwealth University Medical Center. Dr. Diegelmann has agreed to conduct research, advance development, and assist with permitting for the Company’s topical wound-healing therapy based on the Company’s perfluorocarbon based oxygen carrier technology. The agreement is for a term of three years, and the Company has agreed to pay Dr. Diegelmann $9,000 per month for his services. The agreement also provides for additional incentive compensation. Upon successful registration of a 510K application for the first product, the agreement provides that the Company will issue to Dr. Diegelmann options to purchase 100,000 common shares under the Company’s stock plan. In addition, the Company agreed to pay Dr. Diegelmann a success fee equal to one percent of net revenue from the Company’s direct product sales. If the Company sells or licenses the product rights to a third party, the Company agrees to pay Dr. Diegelmann a transaction fee based on the aggregate consideration the Company receives, equal to five percent of the first $1,000,000, four percent of the next $1,000,000, three percent of the next $1,000,000, two percent of the next $1,000,000 and one percent for each $1,000,000 of consideration above $4,000,000 up to a maximum of $250,000.

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Since 1990, Oxygen Biotherapeutics has pursued the development of medical products based on perfluorocarbon technology. These products include Oxycyte™, a synthetic oxygen carrier substance, and Fluorovent™, an oxygen exchange fluid for facilitating the treatment of lung conditions. Since 1993 Oxygen Biotherapeutics has also pursued development of a glucose biosensor implant.

The nature of our business is to spend years in development and testing of pharmaceutical and medical device products, take products through a lengthy and expensive process of regulatory review by the FDA, and, if successful in showing the product is efficacious and obtaining FDA approval, commercialize the product. During the periods of development and regulatory review we have no product to sell and no revenue. Nevertheless, we incur substantial costs pursuing this process, which require cash that comes from outside sources. We rely on outside financing to fund our operations, and will for the foreseeable future. That means we must continue to show progress with our products and be able to locate investors willing to commit their funds to a speculative venture that will ultimately be successful only if we can actually bring a product to market and gain a meaningful level of market acceptance and penetration. Because of these factors a larger number of biotechnology products under development fail, and there is no assurance that the products we have under development will not suffer the same fate.

We received approval of the Investigational New Drug application we filed with the FDA on Oxycyte and began Phase I clinical tests in October 2003. We completed the clinical tests in December 2003. The results of the Phase I tests were in line with our safety and efficacy expectations for the performance of Oxycyte. We started Phase II testing in 2004.

Five clinical sites have received local Institutional Review Board (IRB) approval to participate in the first Phase II trial with Oxycyte in hip surgery patients. In this first Phase II trial we were evaluating both efficacy and safety in the prevention of tissue hypoxia (the effects of reduced oxygen levels) in hip surgery patients who experience mild to moderate blood loss during surgery. While blood transfusions are typically not given during such procedures, blood loss may result in postoperative complications caused by tissue hypoxia. We closed this study in 2006 due to a lack of enrollment and completed this study and reported our findings in April 2008.

A Phase II-A trial in severe brain injury patients was started in 2006 and has been completed with good results. The Phase II-B trial protocol was filed in April 2008 and is currently under review of the FDA. A revised Phase II protocol for a study in patients with sickle cell pain crisis is ready to be filed with the FDA, as soon as the severe brain injury Phase II-B trial has been approved. Our future plans include testing Oxycyte in stroke, myocardial infarction, malignant tumors, trauma, coronary bypass surgery and decompression sickness. We expect Phase II studies will continue over at least the next two years, after which Phase III studies may be able to commence depending on results of Phase II trials, the development of acceptable protocols for Phase III trials, and the availability of financial and other resources to purse the Phase II trials.

Fluorovent and our glucose biosensor implant are both in the animal testing stage. We do not believe we will be able to file any applications with the FDA for human testing on these products for at least another year. So while we will try to advance development of these products as best we can, our primary focus will be on advancing Oxycyte through the FDA review process in order to bring a product to market as soon as possible.

RESULTS OF OPERATIONS

Three months ended July 31, 2008 and 2007

Research and Development expenses for the three months ended July 31, 2008 were $308,288, compared to $151,492 for the same period in the prior year. Due to the financing we obtained during the third and fourth quarters of fiscal 2008, we were able to resume funding of our Phase II clinical trials and increase our laboratory supplies and related expenses. Phase II expenses totaled $49,071 for the quarter ended July 31, 2008, compared to $800 for the quarter ended July 31, 2007. Laboratory supplies totaled $34,553 during the quarter ended July 31, 2008, compared to $917 during the quarter ended July 31, 2007. Consulting fees for our clinical studies totaled $20,570 during the quarter ended July 31, 2008, compared to $0 during the quarter ended January 31, 2007. Additionally, we incurred $19,700 in contract manufacturing costs for Oxycyte and $14,755 of equipment rental costs in the current quarter that we did not incur in the quarter ended July 31, 2007. Because of the nature of our ongoing research and development activities and depending on our cash flow levels, accounting periods may reflect significant changes in expenses resulting from the timing of research related to our developmental products.

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General and Administrative expenses for the three months ended July 31, 2008 were $2,818,581, compared to $213,486 for the same period in the prior year. During the current quarter we incurred $2,168,202 of consulting fees that we did not incur during the same period in the prior year. Of this $2,168,202 total, $1,874,932 was non-cash expense through the issuance of common stock purchase warrants. Our contract management costs increased by $149,799 in the current quarter, and this change is primarily due to our current Chief Executive Officer being compensated as an independent contractor, and an increase in consulting fees paid to two of our non-officer directors. Other significant changes in our administrative expenses during the quarter ended July 31, 2008 included a $56,694 increase in our noncash compensation relating to the issue of compensatory stock options, a $51,161 increase in our administrative payroll, an $83,117 increase in our investor relations, a $41,020 increase in our accounting expenses and a $27,653 increase in our legal expenses over the amounts incurred during the quarter ended July 31, 2007.

The net loss for the three months ended July 31, 2008 was $4,248,215 compared to a net loss of $1,027,227 for the same period in the prior year. Total operating expenses increased $2,761,891 during the quarter ended July 31, 2008 over the comparable period in 2007. In addition to the items noted above, interest expense increased $499,537. This increase during the current quarter was due to the $319,135 of interest expense we incurred in the current quarter on a debt conversion. We also incurred additional interest costs associated with our notes payable and related amortization of associated debt discounts as a result of our $6.3 million financing and the exchange of our short-term notes for 5 year convertible notes during the third and fourth quarters of fiscal 2008. Additionally, other income increased $40,440 in the quarter ended July 31, 2008 compared to the same period ended January 31, 2007 due to additional interest that we earned on our cash and cash equivalents.

LIQUIDITY AND CAPITAL RESOURCES

Oxygen Biotherapeutics has financed its operations since September 1990 through the issuance of debt and equity securities and loans from stockholders. As of July 31, 2008, we had $6,140,495 of total current assets and working capital of $5,562,571. Our practice is to invest excess cash, where available, in short-term money market investment instruments.

During the third quarter of fiscal year 2008, the Company exchanged its outstanding short term loans for five-year convertible notes with a face amount of $6,204,767. The notes are unsecured, convertible into shares of common stock at $0.247 per share, and were issued with a 55% original issue discount totaling $3,412,622. In addition, the Company issued five-year warrants to purchase 12,560,257 shares of common stock at $0.247 per share to investors. Additional discounts of $1,739,499 and $1,052,646 were recorded for the relative fair values of the warrants and beneficial conversion feature, respectively. Pursuant to this exchange transaction, the Company recorded a debt extinguishment loss of $250,097.

During the third and fourth quarters of fiscal year 2008, the Company received a total of $6,335,000 in cash from the sale of convertible notes, with a total face amount of $14,077,778. The notes are convertible at any time prior to maturity into a total of 56,995,053 shares of common stock, or $0.247 per share. In connection with the issuance of these obligations, the Company recorded a 55% original issue discount of $7,742,778, and additional discounts of $4,864,998 related to the relative fair value of the 28,497,501 five-year warrants to purchase common stock at $0.247 per share that were issued in the transaction, and $1,470,002 for the relative fair value of the embedded beneficial conversion feature. The Company also incurred total costs of $5,510,562 for capital raising services on these transactions. The costs of the capital raising services include a $369,215 cash fee, plus $768,337 for the fair value of 2,088,272 restricted shares of common stock, plus $4,373,010 for the fair value of warrants to purchase 21,853,086 common shares at prices ranging from $0.20 to $0.28.

During the quarter ended July 31, 2008, net cash provided by financing activities was $2,115,061, which included $2,147,714 proceeds from the exercise of warrants, less $32,653 in repayments on a short term note. Of the $2,147,714 proceeds received from warrant exercises, we have an obligation to return $140,000 due to a pricing error in the exercise. This obligation is included in our current liabilities at July 31, 2008. Net cash of $874,169 was used to fund operating activities and $33,699 was used for investing activities, which included $14,079 in lab equipment expenditures, $16,228 for the purchase of licensing rights on three patents, and $3,392 of other capitalized patents costs. Consequently, our cash and cash equivalents increased from $1,207,193 at April 30, 2008 to $6,087,826 at July 31, 2008. We do not have any lines of credit or other borrowing arrangements with lenders.

We are in the pre-clinical and clinical trial stages in the development of our products. Under an Investigational New Drug application filed with the FDA, we completed Phase I clinical studies on Oxycyte in December 2003. The results of the Phase I study were in line with our expectations for the performance of Oxycyte. We submitted a report to the FDA along with a Phase II protocol, received FDA approval, and started Phase II testing in the fourth quarter of 2004, which is expected to continue through 2009 for Phase II-b studies in severe traumatic brain injury. Even if we are successful with our Phase II study, we must then conduct a Phase III clinical study and, if that is

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successful, file with the FDA and obtain approval of a Biologics License Application to begin commercial distribution, all of which will take more time and funding to complete. Our other products, Fluorovent and the glucose biosensor, must undergo further development and testing prior to submission to the FDA for approval to initiate clinical trials, which also requires additional funding. Management is actively pursuing private and institutional financing, as well as strategic alliances and/or joint venture agreements to obtain the necessary additional financing and reduce the cost burden related to the development and commercialization of our products. We expect our primary focus will be on funding the continued testing of Oxycyte, since this product is the furthest along in the regulatory review process. Our ability to continue to pursue testing and development of our products beyond 2009 depends on achieving license income, or obtaining outside financial resources. There is no assurance that needed license agreement, or financing will occur or that we will succeed in obtaining the necessary resources.

We are entirely dependent on outside financing to continue our operations. We will not generate operating revenue unless and until one of our products is approved for commercial sale and sales activity begins. We will require substantial additional funds to complete clinical trials, pursue regulatory approval for our products, establish commercial scale manufacturing capabilities, and establish marketing, sales, and administrative capabilities. Expenditures for these purposes will result in substantial losses for at least the next several years. The expense and the time required to realize any product revenues or profitability are highly uncertain. We cannot ensure that we will be able to achieve product revenues or profitability on a sustained basis, or at all. The foregoing factors highlight that the Company must achieve license agreements, or additional financing by end of 2009.

We do have the working capital necessary to fund our operations in fiscal year 2009. By end of 2009, we will need additional financing to cover administrative expenses and on-going expenses of testing Oxycyte. Management is actively seeking additional sources of equity and/or debt financing; however there is no assurance that any additional funding will be available in time. Should we be unable to obtain additional financing to meet mid-term needs, we may be forced to cease operations. Our ability to continue as a going concern depends on success of these activities.

CRITICAL ACCOUNTING POLICIES

We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our financial statements:

Stock-Based Compensation – We account for stock-based compensation as prescribed by of SFAS No. 123R, which requires stock options and warrants issued to employees and nonemployees to be valued using the fair value method. Under the fair value based method, compensation cost is recorded based on the value of the award at the grant date and is recognized over the service period.

The fair value of each option and warrant grant was estimated at the grant date using the Black-Scholes option-pricing model. The Black–Scholes option valuation model was developed for use in estimating the fair value of traded options and warrants that have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions, including the expected stock price volatility and expected term.

Convertible Notes – If the conversion feature of conventional convertible debt provides for a rate of conversion that is below market value, this feature is characterized as a beneficial conversion feature (“BCF”). A BCF is recorded by the Company as a debt discount pursuant to EITF Issue No. 98-5 (“EITF 98-05”), Accounting for Convertible Securities with Beneficial Conversion Features or Contingency Adjustable Conversion Ratio, and EITF Issue No. 00-27, Application of EITF Issue No. 98-5 to Certain Convertible Instruments. In those circumstances, the convertible debt will be recorded net of the discount related to the BCF. The Company amortizes the discount to interest expense over the life of the debt using the effective interest method.

Registration Payment Arrangements – In connection with prior private placements of our common stock and warrants to purchase shares of our common stock, we entered into agreements that committed us to timely register the shares of common stock purchased as well as the shares underlying the issued warrants. Those registration agreements specified potential cash penalties if we did not timely register the related shares with the SEC.

In accordance with EITF 00-19, “Accounting for Derivative Financial Instruments Indexed To, and Potentially Settled In a Company’s Own Stock,” when the potential cash penalties were included in registration payment arrangements, the estimated fair value of the warrants would be recorded as a liability, with an offsetting reduction to additional paid-in capital received from the private placement. The fair value of the warrants would be estimated using the Black-Scholes option pricing model.

Under EITF 00-19, the estimated fair value of the warrants would be re-measured at each reporting date and on the date of effectiveness of the related registration statement, with the increase in fair value recorded as other expense in

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our Statement of Operations. As of the date of effectiveness of the registration statement, the warrant liability would be reclassified to additional paid-in capital, evidencing the non-impact of these adjustments on our financial position and business operations.

In December 2006, the FASB issued FASB Staff Position, or FSP, EITF No. 00-19-2, “Accounting for Registration Payment Arrangements.” This FSP specifies that companies that enter into agreements to register securities will be required to recognize a liability if a payment to investors for failing to fulfill the agreement is probable and can be reasonably estimated. This accounting differs from the guidance in EITF 00-19, which required a liability to be recognized and measured at fair value, regardless of probability.

EITF 00-19-2 is effective immediately for registration payment arrangements and the financial instruments subject to those arrangements that we enter into or modify after the date of issuance of this FSP. For our registration payment arrangements and financial instruments subject to those arrangements that were entered prior to the issuance of this FSP, the guidance was effective beginning January 1, 2007.

Long-Lived Assets – Our intangible assets consist of patents related to our various technologies. These assets are amortized on a straight-line method over their estimated useful life, which ranges from eight to ten years. We review these intangible assets for impairment in accordance with SFAS No.144, Accounting for the Impairment or Disposal of Long-Lived Assets (“SFAS 144”).

FORWARD LOOKING STATEMENTS

Except for the historical information contained herein, the discussion and information presented in this report contain forward-looking statements that involve risks and uncertainties. Oxygen Biotherapeutics’ actual results could differ materially from those presented in the forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those discussed in this section and those discussed in the Oxygen Biotherapeutics’ Annual Report on Form 10-K for the year ended April 30, 2008 and subsequent filings made with the Securities and Exchange Commission.

Although Oxygen Biotherapeutics believes that the expectations reflected in the forward-looking statements are reasonable, Oxygen Biotherapeutics cannot guarantee future results, levels of performance or achievements. Moreover, neither Oxygen Biotherapeutics nor any other person assumes responsibility for the accuracy and completeness of the forward-looking statements. Oxygen Biotherapeutics is under no obligation to update any of the forward-looking statements after the filing of this report to conform such statements to actual results or changes in expectations.

This Report includes the certifications of our Chief Executive Officer and Chief Financial Officer required by Rule 13a-14 of the Securities Exchange Act of 1934 (the “Exchange Act”). See Exhibits 31.1 and 31.2. This Item 4T includes information concerning the controls and control evaluations referred to in those certifications.

Evaluation of Disclosure Controls and Procedures

Disclosure controls and procedures, as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”), are designed to ensure that information required to be disclosed in reports filed or submitted under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in rules and forms adopted by the Securities and Exchange Commission (“SEC”), and that such information is accumulated and communicated to management, including the Chief Executive Officer and the Chief Financial Officer, to allow timely decisions regarding required disclosures.

In connection with the preparation of this report, Oxygen Biotherapeutics’ management, under the supervision and with the participation of the Chief Executive Officer and Chief Financial Officer, assessed the effectiveness of the design and operation of our disclosure controls and procedures as of July 31, 2008. Because of the material weaknesses in our internal control over financial reporting described below, our Chief Executive Officer and Chief Financial Officer conclude that our disclosure controls and procedures were not effective as of July 31, 2008.

Material Weaknesses

In our annual report on Form 10-K for the year ended April 30, 2008, we reported that our disclosure controls and procedures were not effective as of April 30, 2008, because of material weaknesses in our internal control over financial reporting. A “material weakness” is defined under SEC rules as a deficiency, or a combination of deficiencies, in internal control over financial reporting such that there is a reasonable possibility that a material

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misstatement of a company’s annual or interim financial statements will not be prevented or detected on a timely basis by the Company’s internal controls. As a result of management’s review and evaluations that were completed after the end of fiscal year 2008 related to the preparation of management’s report on internal controls over financial reporting required for this annual report on Form 10-K, management concluded that we had material weaknesses in our control environment and financial reporting process consisting of the following:

Changes in Internal Controls

There were no changes in Oxygen Biotherapeutics’ internal control over financial reporting during the three-month period ended July 31, 2008, that materially affected, or are reasonably likely to materially affect, its internal control over financial reporting.

Management’s conclusions regarding material weaknesses disclosed in our Form 10-K for the year ended April 30, 2008, were reached at the end of the first quarter of fiscal year 2009. Following the end of the first quarter, our management has pursued, and will continue to pursue, implementation of corrective measures to address the material weaknesses described above. These measures, outlined below, are intended both to address the identified material weaknesses and to enhance our overall financial control environment.

We believe the remediation measures described above will, if we can effectively implement the measures, remediate the material weaknesses we have identified and strengthen our internal control over financial reporting. We are committed to continuing to improve our internal control processes and will continue to diligently and vigorously review our financial reporting controls and procedures. As we continue to evaluate and work to improve our internal control over financial reporting, we may determine to take additional measures to address control deficiencies or determine to modify, or in appropriate circumstances not to complete, certain of the remediation measures described above.

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Part II-Other Information

Oxygen Biotherapeutics is not presently involved in any legal proceedings and was not involved in any such proceedings during the quarter ended July 31, 2008.

The Private Securities Litigation Reform Act of 1995 provides a safe harbor for forward-looking statements made by Oxygen Biotherapeutics, except where such statements are made in connection with an initial public offering. All statements, other than statements of historical fact, which address activities, actions, goals, prospects, or new developments that we expect or anticipate will or may occur in the future, including such things as expansion and growth of our operations and other such matters are forward-looking statements. Any one or a combination of factors could materially affect our operations and financial condition. These factors include progress in our product development and testing activities, obtaining financing for operations, development of new technologies and other competitive pressures, legal and regulatory initiatives affecting our products, and conditions in the capital markets. Forward-looking statements made by us are based on knowledge of our business and the environment in which we operate as of the date of this report. Because of the factors discussed in the 2008 Annual Report on Form 10-K and in subsequent reports on Form 10-Q, actual results may differ from those in the forward-looking statements.

In July 2008, Oxygen Biotherapeutics issued 1,375,530 shares of common stock to John Johnstone upon the conversion of a previously outstanding convertible note in the principal amount of $339,756. In August 2008, Oxygen Biotherapeutics issued 89,968 shares of common stock to Joan Mahan upon the conversion of a previously outstanding convertible note in the principal amount of $22,222. The securities were issued in reliance on the exemption from registration set forth in Section 3(a)(9) of the Securities Act of 1933.

Oxygen Biotherapeutics issued 14,000 common shares at the beginning of each month from May through September 2008 (a total 70,000 shares of common stock) to Chris J. Stern, its Chief Executive Officer, valued at $53,900, pursuant to the terms of the compensation arrangement for Mr. Stern. The securities were issued in reliance on the exemption from registration set forth in Section 4(2) of the Securities Act of 1933.

Oxygen Biotherapeutics issued to Richard Kiral, its Chief Operating Officer, options to purchase 20,000 shares at the beginning of each month from May through September 2008 pursuant to the terms of the compensation arrangement for Mr. Kiral, as follows:

The securities issued to Mr. Kiral were issued in reliance on the exemption from registration set forth in Section 4(2) of the Securities Act of 1933.

In July and September, 2008, Steven Abbadessa exercised two warrants to purchase a total of 663,000 shares of common stock for $163,125. The securities were issued in reliance on the exemption from registration set forth in Section 4(2) of the Securities Act of 1933.

Under a consulting agreement with Fiona International SA discussed below under “Item 5. Other Information,” we issued to Fiona as compensation for services 411,250 shares of our restricted common stock, warrants to purchase 1,385,000 common shares at an exercise price of $0.247 per share that expire May 5, 2013, and warrants to purchase 1,647,000 common shares at an exercise price of $0.247 per share that expire July 1, 2013. The securities issued

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were valued at a total of $1,874,932, and were issued in reliance on the exemptions from registration set forth in Section 4(2) of the Securities Act of 1933 and/or Regulation S adopted thereunder.

In May 2008, we issued to Virginia Commonwealth University a warrant for the purchase of 500,000 shares of our restricted common stock at an exercise price of $0.42 per share that expires May 22, 2013. The warrant was issued as partial consideration for a license granted to us by Virginia Commonwealth University discussed below under “Item 5. Other Information,” and was issued in reliance on the exemption from registration set forth in Section 4(2) of the Securities Act of 1933.

None

A special meeting of stockholders was held June 17, 2008. At the special meeting, the stockholders voted on (1) the Agreement and Plan of Merger dated April 28, 2008, pursuant to which the Company would change its state of incorporation from New Jersey to Delaware and the name of the Company to Oxygen Biotherapeutics, Inc., and (2) the proposal to amend our 1999 Stock Plan to increase the number of shares of common stock available for awards under the plan from 4,000,000 to 12,000,000, increase the maximum number of shares covered by awards granted under the plan to an eligible participant from 4,000,000 shares to 5,000,000 shares, add provisions intended to facilitate compliance with changes in tax law, and make additional technical changes to update the plan. The stockholders approved the Agreement and Plan of Merger by a vote of 71,672,849 for, 1,956,027 against and 346,329 abstain. The stockholders approved the amendments to our 1999 Stock Plan by a vote of 64,378,513 for, 142,500 against and 30,600 abstain.

License Agreement

In May 2008, Oxygen Biotherapeutics entered into a license agreement with Virginia Commonwealth University (“Licensor”) whereby Oxygen Biotherapeutics obtained a worldwide, exclusive license to valid claims under three of the Licensor’s patent applications that relate to methods for non-pulmonary delivery of oxygen to tissue and the products based on those valid claims used or useful for therapeutic and diagnostic applications in humans and animals. The license includes the right to sub-license to third parties. The term of the agreement is the life of the patents covered by the patent applications, except that we can terminate the agreement at any time on not less than 90 days advance notice.

We have an obligation to diligently pursue product development and pursue, at our expense, prosecution of the patent applications covered by the agreement. We paid an initial fee of $50,000 in cash and paid an additional $16,288 to the Licensor as reimbursement of costs paid by the Licensor on patent applications and related work. We also issued to the licensor a warrant for the purchase of 500,000 shares of our restricted common stock at an exercise price of $0.42 per share that expires May 22, 2013.

We agreed to pay to the Licensor a running royalty on net sales of licensed products as follows:

We also agrees to pay to the Licensor a percentage of sublicensing revenue received from sub-licensees or other third parties in regards to the licensed patents, equal to 33% of any such third party payments, which may be reduced to 25% if we complete pre-clinical studies on a licensed product, reduced further to 20% if we complete Phase I clinical studies, reduced further to 17% if we complete Phase II clinical studies, and reduced further to 10% if we complete Phase III clinical studies on a licensed product.

We agreed to pay a $20,000 annual maintenance fee to the Licensor, starting in May 2009 and payable in each following May as long as the agreement is in force. The maintenance fee payments will be fully credited towards future royalty or sublicensing revenue payments to the Licensor.

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We agreed to pay a $50,000 annual minimum royalty to the Licensor, starting in May 2009 and payable in each following May as long as the agreement is in force. The minimum royalty fee payments will be fully credited towards future royalty or sublicensing revenue payments to the Licensor.

Lastly, the agreement provides that we will make the following minimum milestone payments to the Licensor, with respect to the first licensed product to achieve each milestone. However, if new licensed products are separately patentable, the same milestone payments shall apply to them.

Consulting Agreement- Fiona

On May 5, 2008, we entered into a consulting agreement with Fiona International SA, an offshore Panamanian company. Under the agreement Fiona agreed to provide consulting services for a term of three months with respect to licensing our products to third parties and other corporate and administrative matters. Under the agreement we paid to Fiona $87,500 in cash, issued to Fiona 411,250 shares of our restricted common stock, issued to Fiona warrants to purchase 1,385,000 common shares at an exercise price of $0.247 per share that expire May 5, 2013, and issued to Fiona warrants to purchase 1,647,000 common shares at an exercise price of $0.247 per share that expire July 1, 2013.

Consulting Agreement- Diegelmann

On September 11, 2008, Oxygen Biotherapeutics entered into a consulting agreement with Robert F. Diegelmann, Ph.D., Professor of Biochemistry, Anatomy and Emergency Medicine at Virginia Commonwealth University Medical Center. Dr. Diegelmann has agreed to conduct research, advance development, and assist with permitting for our topical wound-healing therapy based on our perfluorocarbon based oxygen carrier technology. The agreement is for a term of three years, and Oxygen Biotherapeutics has agreed to pay Dr. Diegelmann $9,000 per month for his services. The agreement also provides for additional incentive compensation. Upon successful registration of a 510K application for the first product, the agreement provides we will issue to Dr. Diegelmann an option to purchase 100,000 common shares under our stock plan. In addition, we agreed to pay Dr. Diegelmann a success fee equal to one percent of net revenue from our direct product sales. If we sell or license the product rights to a third party we agreed to pay Dr. Diegelmann a transaction fee based on the aggregate consideration we receive equal to five percent of the first $1,000,000, four percent of the next $1,000,000, three percent of the next $1,000,000, two percent of the next $1,000,000 and one percent for each $1,000,000 of consideration above $4,000,000 up to a maximum of $250,000.

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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.

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