TENAX THERAPEUTICS, INC. - Quarter Report: 2009 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, 2009

For the transition period from              to             

Commission File Number: 002-31909

OXYGEN BIOTHERAPEUTICS, INC.

(Exact name of registrant as specified in its charter)

2530 Meridian Parkway, Suite 3084, Durham, North Carolina 27713

(Address of Principal Executive Office)

919-806-4414

(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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data file required to be submitted and posted pursuant to rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or such shorter period that the registrant was required to submit and post such files).    YES  ¨    NO  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated 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 15, 2009: 293,767,389 shares of common stock, par value $0.0001.

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Part I-Financial Information

OXYGEN BIOTHERAPEUTICS, INC.

(FORMERLY SYNTHETIC BLOOD INTERNATIONAL, INC.)

(A Development Stage Company)

CONSOLIDATED CONDENSED BALANCE SHEETS

The accompanying notes are an integral part of these Consolidated Financial Statements.

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OXYGEN BIOTHERAPEUTICS, INC.

(FORMERLY SYNTHETIC BLOOD INTERNATIONAL, INC.)

(A Development Stage Company)

CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS

The accompanying notes are an integral part of these Consolidated Financial Statements.

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OXYGEN BIOTHERAPEUTICS, INC.

(FORMERLY SYNTHETIC BLOOD INTERNATIONAL, INC.)

(A Development Stage Company)

CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS

The accompanying notes are an integral part of these Consolidated 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, 2009:

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

The accompanying notes are an integral part of these Consolidated 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, 2009, and the results of its operations for the three months ended July 31, 2009 and 2008, and for the period from May 26, 1967 (inception) to July 31, 2009, and its cash flows for the three months ended July 31, 2009 and 2008, and for the period from May 26, 1967 (inception) to July 31, 2009. 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, 2009 filed with the Commission on August 12, 2009.

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, 2009, has an accumulated deficit of $73,485,667. Through July 31, 2009, the Company has sustained operating losses on a monthly basis, and expects to incur operating losses through the remainder of fiscal year 2010. The Company requires substantial funds to complete clinical trials and pursue regulatory approvals. Due to the initial closing of the Securities Purchase Agreement with Vatea Fund in July and achieving the initial milestone in August (as further discussed in note 5), management believes that the Company has necessary working capital to fund operations through the first quarter of fiscal year 2011.

In view of the matters described above, recoverability of a major portion of the recorded asset amounts shown in the accompanying July 31, 2009 balance sheet is dependent upon continued operations of the Company, which in turn is dependent upon the Company’s ability to generate cash from future operations. This factor raises 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 December 2007, FASB issued SFAS No. 141 (revised 2007), “Business Combinations,” (SFAS 141R) effective for fiscal years beginning after December 15, 2008. The new standard is based on a fair value model and requires an acquirer to measure all assets acquired and liabilities assumed at their respective fair values at the date of acquisition. This includes measuring non controlling (minority) interests at fair value. SFAS 141R establishes principles and requirements for recognizing and measuring goodwill arising from a business combination, and any gain from a bargain purchase. SFAS 141R establishes new disclosure standards and significantly alters the accounting for contingent consideration, pre-acquisition contingencies, in-process research and development and restructuring costs. It requires expensing of acquisition-related costs as incurred. Transactions consummated after the effective date of SFAS 141R apply the new standard prospectively. Existing guidance in SFAS 141 applies to business combinations consummated prior to the effective date of SFAS 141R. The Company’s adoption of SFAS 141R did not have a material impact on its results of operations, financial position, or cash flows.

In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements,” (SFAS 160) which amends Accounting Research Bulletin No. 51 and provides accounting and reporting standards for noncontrolling (minority) interests in a subsidiary and deconsolidation of a subsidiary. SFAS 160 requires noncontrolling interests to be presented separately within equity in the consolidated statement of financial position. Consolidated net income attributable to the parent and noncontrolling interests are to be separately presented on the face of the statement of operations. A change in ownership that does not affect control of a subsidiary is to be accounted for as an equity transaction. A change in ownership that affects control results in recognition of a gain or loss and remeasurement at fair value of any remaining noncontrolling interest. Because SFAS 160 requires that a noncontrolling interest continue to be attributed its share of losses, a noncontrolling interest could have a negative carrying balance. SFAS 160 is effective for fiscal years beginning after December 15, 2008. In the year of adoption, presentation and disclosure requirements will apply retrospectively to all periods presented. The Company’s adoption of SFAS 160 did not materially affect its consolidated financial statements or results of operations.

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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’s adoption of SFAS 162 did not have a material impact on its results of operations, financial position, or cash flows.

In June 2008, the FASB issued EITF 07-05, “Determining whether an instrument (or Embedded Feature) is indexed to an Entity’s Own Stock”, (“EITF 07-05”). EITF 07-05 provides guidance on determining what types of instruments or embedded features in an instrument held by a reporting entity can be considered indexed to its own stock for the purpose of evaluating the first criteria of the scope exception in paragraph 11(a) of FAS 133. EITF 07-05 is effective for financial statements issued for fiscal years beginning after December 15, 2008 and early application is not permitted. The Company adopted EITF 07-05 on May 1, 2009. Adopting EITF 07-05 did not have a material impact on its results of operations, financial position, or cash flows.

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 share. FSP EITF 03-6-1 is effective for fiscal years beginning after December 15, 2008. The Company adopted EITF 03-6-1-05 on May 1, 2009. Adopting EITF 03-6-1 did not have a material impact on its results of operations, financial position, or cash flows.

In October 2008, the FASB issued Staff Position No EITF. 08-9, “Milestones Method of Revenue Recognition” (“EITF 08-9”). EITF 08-9 addresses the accounting when entities enter into revenue arrangements with multiple payment streams for a single deliverable or a single unit of accounting. The FASB staff could not reach agreement on transition of EITF 08-9. The Company does not anticipate the adoption of Staff Position No EITF 08-9 to have a material impact on its results of operations, financial position, or cash flows.

3. STOCK-BASED COMPENSATION AND WARRANTS

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, 2009 and 2008 includes approximately $119,423 and $68,000, respectively, of non-cash stock-based compensation costs. As of July 31, 2009, there was approximately $165,114 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, 2009 was estimated at the grant date using the Black-Scholes option pricing model using the following assumptions: an average risk-free interest rate of 1.76%; average volatility of 105.68%; zero dividend yield for all years; expected life of 3 to 10 years; and an estimated forfeiture rate of 11.5%.

The following table summarizes the Company’s stock option information during the quarter ended July 31, 2009:

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In May 2009, the Company, as part of a consulting agreement with an unrelated third party to provide services in connection with the company’s Share Purchase Agreement, agreed to extend the term of 2,266,666 outstanding warrants that were set to expire on May 31, 2009. The term for these warrants was extended through January 31, 2011. The Company recorded $256,181 in compensation expense for the difference in the computed fair values of the modified warrants and the original warrants at the modification date.

In July 2009, the holders of 89,719,187 outstanding warrants accepted an exchange agreement (the “Agreement”). The terms of the Agreement allowed the Company to settle the warrants by paying the holder cash ($0.04/warrant share) and issuing Common Stock (1/2 share/warrant share). In accordance with the Agreement, the Company also had, at its sole discretion, the option to exchange all, a portion of, or none of the holders’ warrants. The original warrants had strike prices ranging from $0.245 - $0.247; a 5-year term; and were issued between April 2006 and October 2008. All of these warrants were valued using the Black-Sholes-Merton Option Pricing Model and were recorded in stockholders’ equity in accordance with EITF 96-18 and EITF 00-19 when they were originally issued.

On July 20, 2009, the Company exchanged 70,912,999 warrants in accordance with the terms of the Agreement. The remaining 18,806,188 warrants were reissued to the original holders with the original terms. The 70,912,999 warrants were returned to the Company and cancelled in exchange for $2,836,520 and 35,456,500 shares of restricted common stock.

The following table summarizes the Company’s stock warrant information during the quarter ended July 31, 2009:

As of July 31, 2009, potentially issuable shares of common stock included 13,716,668 options, 50,098,920 warrants, and 261,985 conversion shares. Diluted earnings per share for the quarter ended July 31, 2009 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 $30,510 in additional interest expense for the write off of the related debt discounts, less $1,540 in discount amortization expense that would be eliminated in the conversion.

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 unless by the Company elects to terminate the agreement prior to patent expiration.

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 $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 the legal life of the underlying patents. As of July 31, 2009, the Company has capitalized an additional $136,223 in legal costs incurred to maintain the underlying patents. Accumulated amortization on the licensing rights at July 31, 2009 totaled $18,775.

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 deferred cost of sale and is included in other assets at July 31, 2009.

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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. In May 2009, the Company recorded the $20,000 fee as a deferred cost of sale and the payment is reported in other assets at July 31, 2009.

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. In May 2009, the Company recorded the $50,000 royalty as a deferred cost of sale and the payment is reported in other assets at July 31, 2009.

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.

As of July 31, 2009, the Company has not met any of the stated milestones.

5. STOCKHOLDERS’ EQUITY

During the three months ended July 31, 2009:

On June 8, 2009, the Company entered into a securities purchase agreement with Vatea Fund, Segregated Portfolio, an investment fund formed under the laws of the Cayman Islands (the “Financing Transaction”). Under the terms of the agreement, Vatea Fund purchased on July 10, 2009, 20 million shares of the Company’s restricted common stock at a price of $0.25 per share, or a total of $5 million. Furthermore, the agreement establishes milestones for the achievement of product development and regulatory targets and other objectives, after which Vatea Fund is required to purchase up to 60 million additional shares of common stock at a price of $0.25 per share.

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Target dates are the estimated dates by which the corresponding milestone will be accomplished. If a milestone is not achieved by its corresponding target date, then the date is automatically extended for three months. Thereafter, if a milestone is not achieved by its extended target date, the Company and Vatea Fund shall negotiate in goodfaith agreement on a new target date for the milestone, but if no agreement is reached within 30 days Vatea Fund has no obligation to purchase any shares with respect to that milestone should it subsequently be achieved. The obligation of Vatea Fund to purchase any additional shares upon achieving milestones ends for any milestones not achieved by September 30, 2011.

Including the initial investment in July 2009, and assuming all milestones are achieved in a timely manner, the securities purchase agreement provides for a maximum of 80 million shares being sold for $20 million. The number of shares issued is subject to adjustment for stock dividends, stock splits, reverse stock splits, and similar transactions.

After Vatea Fund purchases 40 million shares for $10 million, including the initial sale of shares in July 2009, the Company agreed to elect to the board of directors a person nominated by Vatea Fund.

Vatea Fund was introduced to the Company through the efforts of two consultants in Europe. For its services, the Company paid one of the consultants

6. RELATED PARTY TRANSACTIONS

During the three months ended July 31, 2009, the Company issued 3,132 shares of common stock for the conversion of a convertible note with a gross carrying value of $774, at a conversion price of $0.247 per share to Robert Nicora, a former President and Chief Executive Officer of the Company. The unamortized discount attributable to the conversion of $626 was recognized as interest expense upon conversion.

As of July 31, 2009 the convertible note has a gross carrying value of $10,819 with discounts totaling $8,724. The net carrying value of the convertible note payable to Mr. Nicora, former President and Chief Executive Officer of the Company is $2,095. In accordance with the convertible note agreement, the Company will continue to make monthly installment payments through January 2013.

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.

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8. COMMITMENTS AND CONTINGENCIES

Registration Requirement - As of July 31, 2009, 670,000 outstanding warrants 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 remedy for non-registration of the shares, the holders would also receive the option of a cashless exercise of their warrant or conversion shares.

9. SUBSEQUENT EVENTS

In August 2009, the Company amended the Security Purchase Agreement (“SPA,” or “the Agreement”) with the Vatea Fund (“the Fund”). The amendment provided an alternate milestone schedule by which the Fund would purchase additional shares of the Company’s common stock.

In August 2009, the Company received formal approval from Swissmedic to begin Phase II clinical trials of Oxycyte in Switzerland. The Swissmedic approval triggered the first milestone payment in the amended SPA described above. On September 4, 2009, the Company called the milestone on the alternate milestone schedule. In accordance with the Agreement, the Fund is required to purchase an additional 24,000,000 shares of common stock at $0.25 per share, or $6,000,000, on or before December 10, 2009.

In August 2009, the Company issued 50,000 options to Michael Jebsen, Chief Financial Officer, in accordance with his employment agreement.

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Oxygen Biotherapeutics (“the Company,” “we,” “our”) is engaged in the business of developing biotechnology products with a focus on oxygen delivery to tissue. We are currently developing Oxycyte™, a product we believe is a safe and effective oxygen carrier for use in surgical and similar medical situations. We have developed a family of perfluorocarbon based oxygen carriers for use in personal care, topical wound healing, and other topical indications. In addition, we also have under development Fluorovent™, an oxygen exchange fluid for facilitating the treatment of lung conditions, and entered into license agreements with unrelated third parties for our rights to a biosensor implant product that uses an enzyme process for measuring the glucose level in subcutaneous fluid.

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. We incur substantial costs pursuing this process, which requires financing from outside sources. 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 may ultimately be successful only if we can 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 our Investigational New Drug application for Oxycyte filed with the U.S. Food and Drug Administration (FDA) and began Phase I clinical studies in October 2003, which were completed in December 2003. We submitted a report on the results, which were in line with our expectations, to the FDA along with a Phase II protocol in 2004. Phase II-A clinical studies began in the fourth quarter 2004, and were completed in 2006. A further Phase II study protocol was filed with the FDA in the spring of 2008, but put on clinical hold due to safety concerns raised by the regulatory agency. Management decided to take a radically different approach to trials from the past and filed a revised protocol as a dose-escalation study with the regulatory authorities in Switzerland and Israel. The protocol has received Ethic Commission approval in Switzerland and Israel, and Swissmedic approved the protocol in August 2009. The new study will begin in September 2009. We expect to commit a substantial portion of our financial and business resources over the next three years to testing Oxycyte and advancing this product to regulatory approval for use in one or more medical applications.

In July 2009 the Company filed a 510K medical device application for its wound gel Wundecyte™ with the U.S. Food and Drug Administration (FDA). If granted, we will be able to market its topical gel to treat wounds and abrasions over the counter. If not granted, we will have to pursue the standard device approval route. Since trials may be needed to substantiate claims in either case, and to accelerate approvals of many other potential topical indications, the Company has initiated the required clinical trials for the wound gel. There is no assurance that the topical indications we have under development will prove their claims and be successful commercial products.

In September 2009 the Company started production of its first commercial topical cosmetic product Dermacyte™. The market launch for the gel is scheduled to begin in the fourth quarter of calendar year 2009, first on the website http://www.buydermacyte.com, and later through commercial distributors. Marketing cosmetic products is a very speculative venture and reaching consumers through web-based marketing is dependent on many factors the company has no control of. There is no guarantee the Company will enter into a license agreement with a major cosmetic brand or distributor.

RESULTS OF OPERATIONS

Three months ended July 31, 2009 and 2008

Research and Development expenses for the three months ended July 31, 2009 were $545,255, compared to $308,288 for the same period in the prior year. The Company incurred significant costs related to the development of Dermacyte that were not incurred in the first quarter of fiscal year 2009. In addition to the costs incurred to develop Dermacyte, the Company also continued to pursue clinical trials for Oxycyte. During the quarter ended July 31, 2009, laboratory supplies increased $58,077, consulting costs increased $60,423, and Phase II costs related to Oxycyte development increased $8,633 compared to the quarter ended July 31, 2008. Because of the nature of our ongoing research and development activities, accounting periods may reflect significant changes in expenses resulting from the timing of research related to our developmental products.

General and Administrative expenses for the three months ended July 31, 2009 were $1,745,280, compared to $2,818,581 for the same period in the prior year. During the quarter ended July 31, 2008, the Company incurred $2,168,202 of consulting fees that we did not incur during the same period in the current year. Our contract management costs increased by approximately $760,155 in the current quarter, and this change is primarily due to noncash share based compensation incurred in conjunction with the issue of 20 million shares of stock to the Vatea Fund. Additional costs incurred for contract management include payments to our nonemployee directors and consultants engaged to facilitate the closing of the Securities Purchase Agreement. Salaries and benefits increased $322,880 due to the increase in headcount over the same period in the prior year and our current Chief Executive Officer being compensated as an employee as opposed to an independent contractor. Other significant changes in our administrative expenses during the quarter ended July 31, 2009 included a $51,423 increase in our noncash compensation relating to the issue of compensatory stock options, an $8,000 increase in rent due to moving our corporate headquarters to North Carolina.

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The net loss for the three months ended July 31, 2009 was $2,396,678 compared to a net loss of $4,248,215 for the same period in the prior year. Total operating expenses decreased approximately $1.1 million during the quarter ended July 31, 2009 over the comparable period in 2008. In addition to the items noted above, interest expense decreased approximately $1.0 million due to the recognition of interest costs associated with our notes payable and related amortization of associated debt discounts as a result of the conversion of the majority of convertible notes during the third and fourth quarters of fiscal 2009.

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, 2009, we had $2,773,253 of total current assets and working capital of $2,212,438. Our practice is to invest excess cash, where available, in short-term money market investment instruments.

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. 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 and completed in 2006. A further Phase II study protocol was filed with the FDA in the spring of 2008, but put on clinical hold due to safety concerns raised by the regulatory agency. Management decided to take a radically different approach to trials from the past and filed a revised protocol as a dose-escalation study with the regulatory authorities in Switzerland and Israel. The protocol has received Ethic Commission approval in Switzerland and Israel, and Swissmedic approved the protocol in August 2009. The new study will begin in September 2009. We expect to commit a substantial portion of our financial and business resources over the next three years to testing Oxycyte and advancing this product to regulatory approval for use in one or more medical applications. Our other products must undergo further development and testing prior to submission to the FDA for approval to initiate clinical trials, which also requires additional funding. Our primary focus will be on funding the continued testing of Oxycyte, since this product is the furthest along in the regulatory review process. Management believes that the Securities Purchase Agreement with Vatea Fund (described below) will provide the capital required to advance Oxycyte through regulatory approval.

On June 8, 2009, the Company entered into a securities purchase agreement with Vatea Fund, Segregated Portfolio, an investment fund formed under the laws of the Cayman Islands (the “Financing Transaction”). Under the terms of the agreement, Vatea Fund purchased on July 10, 2009, 20 million shares of our restricted common stock at a price of $0.25 per share, or a total of $5 million. Furthermore, the agreement establishes milestones for the achievement of product development and regulatory targets and other objectives, after which Vatea Fund is required to purchase 60 million additional shares for $15 million. In August 2009 Vatea Fund and the Company agreed on an amended milestone schedule. On September 4, 2009 we notified Vatea Fund that we had accomplished another milestone triggering the next tranche of $6 million in funding and subsequent purchase of 24 million of shares, due to be closed within 20 days, but under the amendment no later than December 10, 2009. Including the initial investment in July 2009, and assuming all other milestones are achieved in a timely manner, the Financing Transaction provides for the purchase of a maximum of 80 million shares being sold for $20 million. The number of shares issued is subject to adjustment for stock dividends, stock splits, reverse stock splits, and similar transactions.

In June 2009, the Company commenced a limited offering to persons holding approximately 120.4 outstanding warrants to exchange the warrants for cash and restricted common stock . On July 20, 2009, we closed the transaction and cancelled, 52.1 million common stock purchase warrants with an exercise price of $0.247 per share and an additional 18.8 million warrants with an exercise price of $0.245 per share, a total of 70.9 million warrants. In exchange for the cancelled warrants the Company issued to the holders 35,456,500 shares of restricted common stock and paid to them $2,836,520 in cash.

Because of the agreement with the Vatea Fund, and subject to the $6 million receivable from the milestone achieved, we believe we will have the working capital necessary to fund our operations through the first quarter of fiscal year 2011.

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.

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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 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 legal life. We review these intangible assets for impairment monthly 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.

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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, 2009. 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, 2009.

Material Weaknesses

In our annual report on Form 10-K for the year ended April 30, 2009, we reported that our disclosure controls and procedures were not effective as of April 30, 2009, 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 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 the Company’s internal control over financial reporting during the three-month period ended July 31, 2009, 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, 2009, were reached at the end of the first quarter of fiscal year 2010. In August 2009, the Company hired a new Chief Financial Officer to implement corrective measures to remediate 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.

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We believe the measures described above will 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 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 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, 2009.

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 2009 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 the first quarter of fiscal 2010, the Company issued 34,922 common shares to Chris J. Stern, its Chief Executive Officer, valued at $8,365, pursuant to the terms of his compensation agreement.

In the first quarter of fiscal 2010, the Company issued to Richard Kiral, its President and Chief Operating Officer, options to purchase 60,000 shares of common stock pursuant to the terms of his compensation arrangement. The terms of the options issued to Dr. Kiral are summarized as follows:

In addition, the Company issued to its employees options to purchase 85,000 shares of common stock with a weighted average exercise price of $0.263 and a ten-year term. The Company also issued options to purchase 700,000 shares of common stock to two of its non-employee directors. These options were issued with a weighted-average exercise price of $0.229 and a three-year term.

All of the securities described above were issued in reliance on the exemption from registration set forth in Section 4(2) of the Securities Act of 1933.

None.

None.

None.

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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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