QUANTUM MATERIALS CORP. - 10-Q/A - Management's Discussion and Analysis of Financial Condition and Results of Operations.

(Edgar Glimpses Via Acquire Media NewsEdge) This Form 10-Q contains "forward-looking statements" relating to us which represent our current expectations or beliefs, including statements concerning our operations, performance, financial condition and growth. For this purpose, any statement contained in this report that are not statements of historical fact are forward-looking statements. Without limiting the generality of the foregoing, words such as "may", "anticipation", "intend", "could", "estimate", or "continue" or the negative or other comparable terminology are intended to identify forward-looking statements.

Statements contained herein that are not historical facts are forward-looking statements as that term is defined by the Private Securities Litigation Reform Act of 1995. Although the Company believes that the expectations reflected in such forward-looking statements are reasonable, the forward-looking statements are subject to risks and uncertainties that could cause actual results to differ from those projected. The Company cautions investors that any forward-looking statements made by the Company are not guarantees of future performance and those actual results may differ materially from those in the forward-looking statements. Such risks and uncertainties include, without limitation: well-established competitors who have substantially greater financial resources and longer operating histories, regulatory delays or denials, ability to compete as a start-up company in a highly competitive market, and access to sources of capital.

The following discussion should be read in conjunction with the Company's financial statements and notes thereto included elsewhere in this Form 10-Q and our Form 10-K filed October 11, 2012 for the fiscal year ended June 30, 2012. Except for the historical information contained herein, the discussion in this Form 10-Q contains certain forward looking statements that involve risks and uncertainties, such as statements of the Company's plans, objectives, expectations and intentions. The cautionary statements made in this Form 10-Q should be read as being applicable to all related forward-looking statements wherever they appear herein. The Company's actual results could differ materially from those discussed here.

The financial information furnished herein has not been audited by an independent accountant; however, in the opinion of management, all adjustments (only consisting of normal recurring accruals) necessary for a fair presentation of the results of operations for the period ended December 31, 2012 have been included.

Critical Accounting Policies We prepare our consolidated financial statements in conformity with GAAP, which requires management to make certain estimates and apply judgments. We base our estimates and judgments on historical experience, current trends and other factors that management believes to be important at the time the condensed consolidated financial statements are prepared. On a regular basis, we review our accounting policies and how they are applied and disclosed in our condensed consolidated financial statements.

While we believe that the historical experience, current trends and other factors considered support the preparation of our condensed consolidated financial statements in conformity with GAAP, actual results could differ from our estimates and such differences could be material.

For a full description of our critical accounting policies, please refer to Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" in our 2012 Annual Report on Form 10-K.

Business Overview Quantum Materials Corp. is a start-up solar technology and quantum dot manufacturing firm. We perceive an opportunity to acquire a significant amount of both quantum dot and solar photovoltaic market share by commercializing a low cost quantum dot processing technology and a low cost quantum dot based third generation photovoltaic technology/solar cell, pursuant to an exclusive license agreement with William Marsh Rice University ("Rice University" or "Rice"). Our objective is for Quantum to become the first bulk manufacturer of high quality tetrapod quantum dots and for Solterra to be the first solar cell manufacturer to be able to offer a solar electricity solution that competes on a non-subsidized basis with the price of retail electricity in key markets in North America, Europe, the Middle East and Asia.

Competitors are pursuing different nanotechnological approaches to developing solar cells, but the general idea is the same for all. When light hits an atom in a semiconductor, those photons of light with lots of energy can push an electron out of its nice stable orbital around the atom. The electron is then free to move from atom to atom, like the electrons in a piece of metal when it conducts electricity. Using nano-size bits of semiconductor embedded in a conductive plastic maximizes the chance that an electron can escape the nanoparticle and reach the conductive plastic before it is "trapped" by another atom that has also been stripped of an electron. Once in the plastic, the electron can travel through wires connecting the solar cell to an electronic device. It can then wander back to the nanocrystal to join an atom that has a positive charge, which scientifically is called "electron-hole recombination".

A quantum dot solar cell typically uses a thin layer of quantum dot semiconductor material, rather than silicon chips, to convert sunlight into electricity. Quantum Dots, also known as nanocrystals, measure near one billionth of an inch and are a non-traditional type of semiconductor. Management believes that they can be used as an enabling material across many industries and that quantum dots are unparalleled in versatility and flexible in form. See "Note 5" regarding License Agreements with Rice University.

Quantum intends to design and manufacture solar cells using a proprietary thin film semiconductor technology that we believe will allow us to reduce our average solar cell manufacturing costs and be extremely competitive in this market. Quantum will be one of the first companies to integrate non-silicon quantum dot thin film technology into high volume low cost production using proprietary technologies. Our objective is to become one of the first solar module manufacturers to offer a solar electricity solution that competes on a non-subsidized basis with the price of retail electricity in key markets in North America, Europe and Asia. Management believes that the manufacture of our thin film quantum dot solar cells can introduce a cost effective disruptive technology that can help accelerate the conversion from a fossil fuel dependent energy infrastructure to one based on renewable, carbon-neutral energy sources.

We believe that our proposed products also can be a part of the solution to greenhouse gases and global warming.

13 -------------------------------------------------------------------------------- Table of Contents Plan of Reorganization, Recent Financing and Change in Control On November 4, 2008, the Company closed on an Agreement and Plan of Merger and Reorganization by and among the Company, Solterra Renewable Technologies, Inc.

("Solterra"), the shareholders of Solterra and Gregory Chapman as "Indemnitor" (the "Agreement"), which resulted in Solterra becoming a wholly-owned subsidiary of the Company. Pursuant to the Agreement, Mr. Chapman cancelled 40,000,000 shares of Common Stock of the Company owned by him and issued a general release in favor of the Company terminating its obligations to repay Mr. Chapman monies owed to him.

In accordance with the Agreement, the Company issued 41,250,000 shares of its Common Stock to the former stockholders of Solterra. Certain existing stockholders of the Company in consideration of Solterra and its shareholders completing the transaction, issued to the Company a Promissory Note in the amount of $3,500,000 due and payable on or before January 15, 2009, through the payment of cash or, with the consent of the Company, the cancellation of up to 12,000,000 issued and outstanding shares of the Company owned by them. While this note is in default and the Company has made demand for payment and is considering all legal options, our Management does not believe that this Note is collectible.

On November 4, 2008, the Company entered into a Securities Purchase Agreement, Debenture, Security Agreement, Subsidiary Guarantee Agreement, Registration Rights Agreement, Escrow Agreement, Stock Pledge Agreement and other related transactional documents (the "Transaction Documents") to obtain $1,500,000 in gross proceeds from three non-affiliated parties (collectively hereinafter referred to as the "Lenders") in exchange for 3,525,000 restricted shares of Common Stock of the Company (the "Restricted Shares") and Debentures in the principal amount aggregating $1,500,000. Each Debenture has a term of three years maturing on November 4, 2011, which was recently extended to November 4, 2013, bears interest at the rate of 8% per annum and is prepayable by the Company at anytime without penalty, subject to the Debenture holders' conversion rights. Each Debenture is convertible at the option of each Lender into the Company's Common Stock (the "Debenture Shares", which together with the Restricted Shares shall collectively be referred to as the "Securities"), currently at a conversion price of $.12 per share (the "Conversion Price"). The Registration Rights Agreement requires the Company to register the resale of the Securities within certain time limits and to be subject to certain penalties in the event the Company fails to timely file the Registration Statement, fails to obtain an effective Registration Statement or, once effective, to maintain an effective Registration Statement until the Securities are saleable pursuant to Rule 144 without volume restriction or other limitations on sale. The Debentures are secured by the assets of the Company and are guaranteed by Solterra as the Company's subsidiary. In the event the Debentures are converted in their entirety, the Company would be required to issue an aggregate of 12,500,000 shares of the Company's Common Stock, subject to anti-dilution protection for stock splits, stock dividends, combinations, reclassifications and sale of the Company's Common Stock a price below the Conversion Price. Certain changes of control or fundamental transactions such as a merger or consolidation with another company could cause an event of default under the Transaction. We also entered into a Standstill Agreement with the Debenture Holders effective June 1, 2009 which was amended and expired on December 1, 2009. At the time the Standstill Agreement expired, the Company did not have an effective registration statement, registering the resale of all Registrable Securities as required by the Registration Rights Agreement. Nevertheless, management believes that no such registration statement was then or is currently required to be filed with the Securities and Exchange Commission as management believes that all securities of the Company held by the Debenture Holders are saleable pursuant to Rule 144 without volume restriction or other limitations on sale, so long as the Debenture Holders are not affiliated parties of the Company. As of the filing date of this Form 10-Q, the Debenture Holders have taken no action under the Registration Rights Agreement or other transaction documents to notify the Company that it is in default under any of such agreements even though an event of default may be deemed to exist for several reasons; including, without limitation, those enumerated above and the Company's failure to obtain director and officer liability insurance, failure to make a payment of interest on a timely basis and failure to be current from time-to-time with all obligations and responsibilities owed to Rice under our license agreement.

On December 18, 2011 the Company executed an agreement with the debenture holders to extend the maturity date of the convertible debenture to November 4, 2012. All other terms in the original agreement remain unchanged. In addition, the debenture holders were granted 2,000,000 three-year common stock warrants with a strike price of $0.08.

On October 12, 2012 the Company executed an agreement with the debenture holders to extend the maturity date of the convertible debenture to November 4, 2013. All other terms in the original agreement remain unchanged. In addition, the debenture holders were granted 2,000,000 three-year common stock warrants with a strike price of $0.08.

Plan of Operation Since November 4, 2008, the Company is executing its business plan as follows: Solterra plans to: a) Scale up Quantum Dot Production by applying proprietary technology licensed from Rice University for our quantum dot synthesis process and accomplishing large scale production using proprietary Micro-Reactor technology jointly developed through an agreement with Access2Flow an advanced flow chemistry consortium based in the Netherlands. These proprietary technologies enable Solterra to produce the highly desirable tetrapod quantum dots at a cost savings of greater than 75% compared to competing suppliers, and will organically supply Solterra's requirements for quantum dots for its solar cells and other quantum dot enabled products. Additionally, Solterra intends to market these Q-Dots through various existing supply channels into various markets, including but not limited to medical diagnostics and electronics.

The initial pilot scale up will take place at the Access2Flow facilities in the Netherlands and once optimized will be relocated to a solar cell production facility, which is anticipated to be located in Saudi Arabia.

14-------------------------------------------------------------------------------- Table of Contents b) Fabricate solar cells and optimize the performance of solar cells based on a proprietary blend of quantum dots (QDs). The aim is to invest our best efforts to demonstrate and scale up production of low cost quantum dot solar cells having peak efficiency of greater than 6%. The efficiency of solar cells is the electrical power it puts out as percentage of the power in incident sunlight. Within the photovoltaic market, cell pricing and peak efficiency are key benchmarks for consumers in the decision for system selection and installation. The design and manufacture of Solterra's quantum dot based solar cells is projected to allow for the conversion of sunlight into usable electricity at a combination of efficiencies and cell cost at a very low "cents per kilowatt-hour" rate. This work to date has been accomplished on site at the Arizona State University labs but is being relocated better accommodate the logistic requirements of our Chief Science Officer, Professor Ghassan Jabbour, who is working at Kaust University in Saudi Arabia.

Objectives: The Current Objectives of Solterra upon receipt of additional financing are as follows: · Become the first bulk manufacture of high quality tetrapod quantum dots and the first solar cell manufacturer to be able to offer a solar electricity solution that competes on a non-subsidized basis with the price of retail electricity in key markets in North America, South America, Europe the Middle East and Asia.

· Build a robust intellectual property portfolio in third generation photovoltaics, quantum dot process technologies and other quantum dot enabled technologies. Success criteria include completion of preparation and filing of various patent applications in the area of Quantum Dot Solar Cell technology, defining and initiating the strategy to secure a reliable source of key materials, and filing or acquiring additional process related patent applications in solar or printed electronics, which intellectual property would be owned or controlled by Solterra.

· Initiate scaled manufacturing of tetrapod quantum dots, based in part on technology licensed from William H. Marsh Rice University, and building on continued research. Planning includes the implementation of one or more pilot lines based on outcomes of collaboration with Access2Flow, an advanced flow chemistry consortium based in the Netherlands. The design of the pilot line is intended such that the initial target output of the line, at approximately one kilogram per day, can be further scaled at least by an order of magnitude to 100 Kilograms per day in 2012. The output of the tetrapod quantum dots manufacturing will be used for Solterra's quantum dot solar cells as well as stand-alone sales into the biomedical research fields and to third party developers of quantum dot products such as displays, memory and computer and consumer electronics.

· Continue to develop and characterize the Quantum Dot Solar Cell product; moving towards pilot proof line for solar cells and leading to high throughput print line ultimately capable of yearly solar cell output near gigawatt range.

Target cell efficiencies are 6% within one year, 15% within 2 years and greater than 25% within five years. Coupled within cell cost per watt decreasing below $.75/Watt, we intend to pursue initial product sales in early 2013 with significant increases later in 2013.

Liquidity and Capital Resources At December 31, 2012 the Company had a working capital deficit of $3,726,586 with total current assets of $29,724 and liabilities of $3,756,310. Approximately $1,546,018 of these liabilities are owed to our officers, directors and employees for services rendered and expenses not reimbursed through December 31, 2012. The Company has been in the development stage since inception. As a result, the Company has relied on financing through the issuance of common stock and a convertible debenture as well as advances from a director shareholder and employees' wages being partially or fully accrued but not paid.

As of December 31, 2012, the Company lacks sufficient cash and cash equivalent assets and continues to incur losses in its development stage operations. In the past, the Company has been relying on loans from its Chief Executive Officer resulting from private sale transactions in our common stock owned by him. The Company has also relied on various universities to perform work and to provide U.S. licensing rights under business agreements. The Company is in arrears in payments related to these business agreements. The company also owes $1,546,000 in back wages and salaries; employees and consultants have agreed to defer payment of the wages and fees owed to them. Currently, the Company is seeking additional financing; however, no definitive agreements for additional financing have been received and the Company cannot provide any assurance that additional funding will be available to finance our operations on terms acceptable to us, if at all, in order to support our plan of operations. If we are unable to achieve the financing necessary to continue our plan of operations, then our stockholders may lose their entire investment in the Company. See "Notes to Financial Statements." Cash was used in operating activities of $218,434 for the six months ended December 31, 2012. This is a result of a net loss of $1,355,449 partially offset by non-cash items including stock issued for debenture interest $75,862, options issued for services of $181,542, as well as change in accounts payables and accrued liabilities of $39,320, change in accrued liabilities related parties $527,073, and a change in fair value of warrants and embedded conversion feature of $100,000. Cash flows from financing activities during the six months ended December 31, 2012 were $232,897 which consisted of $232,897 from the proceeds of the sale of common stock. This resulted in a increase in cash for the period of $14,463 and cash on hand at the end of the period of $29,724.

15 -------------------------------------------------------------------------------- Table of Contents Cash was used in operating activities of $201,851 for the six months ended December 31, 2011. This is a result of a net loss of $728,258 partially offset by non-cash items including stock issued for debenture interest $72,755, as well as change in accounts payables and accrued liabilities of $36,253, change in accrued liabilities related parties $254,770, change in fair value of warrants and embedded conversion feature of ($469,000), amortization of convertible debenture discount of $586,729 and amortization of deferred finance cost of $36,167 and non-cash warrant expense of $7,644. Cash flows from financing activities during the six months ended December 31, 2011 were $270,000 which consisted of $270,000 from the proceeds of the sale of common stock. This resulted in an increase in cash for the period of $68,247 and cash on hand at the end of the period of $68,149.

These consolidated financial statements have been prepared in accordance with generally accepted accounting principles applicable to a going concern, which assumes that the Company will be able to meet its obligations and continue its operations for its next fiscal year. Realization values may be substantially different from carrying values as shown and these financial statements do not give effect to adjustments that would be necessary to the carrying value and classification of assets and liabilities should the Company be unable to continue as a going concern. At December 31, 2012, the Company had not yet achieved profitable operations, had accumulated losses of $12,822,476 (since its inception), hand had a working capital deficit of $3,726,586 . The company expects to incur further losses in the development of its business, all of which casts substantial doubt about the Company's ability to continue as a going concern. The Company's ability to continue as a going concern is dependent upon its ability to generate future profitable operations and/or to obtain the necessary financing to meet its obligations and repay its liabilities arising from normal business operations when they come due. The Company requires immediate and substantial additional financing during fiscal 2013 to maintain its development stage operations. The Company is exploring all reasonable avenues of financing at this time, including, without limitation, the sale of equity, debt borrowing and/or the receipt of product licensing fees and royalties. We can provide no assurances that such financing will be obtained on terms satisfactory to the Company, if at all. Further, we can provide no assurances that one or more mutually acceptable licensing agreement(s) will be entered into on terms satisfactory to us, if at all. In this respect, see "Note 1" in our notes to the consolidated financial statements for additional information as to the possibility that we may not be able to continue as a "going concern." Off-balance sheet arrangements We have no off-balance sheet arrangements including arrangements that would affect our liquidity, capital resources, market risk support and credit risk support or other benefits.

Officers convert accrued salaries and bonus into warrants In May 2011, David Doderer ($81,250), Robert Glass ($61,250), Ghassan Jabbour ($62,500), Andrew Robinson ($50,000) and Toshinon Ando ($65,000) converted the amount of monies set forth beside their names into five-year warrants to purchase 738,636 shares, 556,818 shares, 568,181 shares, 454,545 shares and 590,909 shares, respectively, In summary, a total of $320,000 was converted into warrants to purchase 2,909,089 shares exercisable at $.11 per share through the expiration date of May 18, 2016.

In November 2010, Steven Squires ($125,000), Brian Lukian ($234,375), David Doderer ($62,500), Robert Glass ($37,500), Ghassan Jabbour ($243,750), Andrew Robinson ($50,000) and Toshinon Ando ($35,000) converted the amount of monies set forth beside their names into five-year warrants to purchase 1,666,666 shares, 3,125,000 shares, 833,333 shares, 500,000 shares, 3,250,000 shares, 666,666 shares and 466,666 shares, respectively, In summary, a total of $788,125 was converted into warrants to purchase 10,508,331 shares exercisable at $.075 per share through the expiration date of November 4, 2015.

Loans from Stephen Squires In January 2010, the board of directors granted Mr. Squires the option to convert his cash loans to the Company into common stock of the Company's subsidiary. In this respect, Mr. Squires has a two-year option to convert up to $200,000 into a maximum of 5% of the outstanding common stock of Solterra. As of the filing date of this Form 10-K, Mr. Squires has declined to exercise this option.

16 -------------------------------------------------------------------------------- Table of Contents In November 2008, Mr. Squires received 35,500,000 shares of the Company's Common Stock as part of a plan of reorganization, 20,000,000 of which he pledged to secure certain company indebtedness. Between December 2008 and December 2010, Mr. Squires privately sold an aggregate of approximately 13,431,000 shares of the Company's Common Stock for an aggregate of $595,000. Mr. Squires advanced to the Company cash loans and made payment of Company expenses utilizing $270,145 of the net proceeds of these private sales. On December 30, 2010, the Board of Directors authorized Mr. Squires to receive 10,000,000 restricted shares of Quantum Material Corp. in recognition of his support of the Company and in cancellation of all outstanding cash loans and advanced expenses totaling $270,145.

Results of operations - Three Months Ended December 31, 2012 and 2011 General and administrative expenses During the three months ended December 31, 2012 the Company incurred $411,997 of general and administrative expenses a increase of $151,099 from the $260,898 recorded for the three months ended December 31, 2011. The increase in general and administrative expenses was primarily due to an increase in remuneration of staff of $131,484.

Included in the expenses for the current three months ended December 31, 2012 were remuneration of staff $323,064, legal and audit of $23,310, travel expense of $34,595, corporate expense of $24,743, and amortization of furniture and equipment of $409. This compares to the three months ended December 31, 2011 which included remuneration of staff $191,580, legal and audit of $18,698, travel expense of $27,954, office expenses of $936, corporate expense of $12,770, other professional fees of $938, and amortization of furniture and equipment of $544.

Research and development expenses.

Research and development expenses of $2,000 were incurred in the three months ended December 31, 2012, compared to $6,671 in the three months ended December 31, 2011. The decrease is the result of a decrease in royalties of $6,671, offset by an increase in patent expense of $2,000.

Amortization of convertible debenture discount The convertible debenture discount of $1,500,000 is being amortized over the 36 month term of the debenture using the effective interest method. The debenture was issued on November 4, 2008. Amortization recorded for the three month period ended December 31, 2012 and 2011 was $nil and $329,585, respectively. The amortized balance of the discount at December 31, 2012 is $nil resulting in the convertible debenture value on the balance sheet net of the discount $1,500,000.

Amortization of deferred finance cost This amount relates to the $315,000 of expenses associated with the $1,500,000 convertible debenture financing raised in November 2008. The deferred financing cost is being amortized using the effective interest method over the thirty-six month life of the debenture. Amortization expense for the three months ended December 31, 2012 and 2011 was $nil and $9,917, respectively.

Interest expense on the convertible debenture This amount relates to the 8% interest associated with the $1,500,000 convertible debenture issued in November 2008.

In December 2012 the Company issued 585,586 shares of common stock to pay accrued interest of $30,333 for the three month period ended December 1, 2012.

Interest expense recorded for the three months ended December 31, 2012 was $37,946 compared to $37,513 in the three month period ended December 31, 2011.

According to the provisions of the Convertible Debenture agreement the Company has elected to issue shares of the Company's Stock to pay accrued interest on the debentures. In the three months ended December 31, 2012 the Company issued 585,586 shares of the Company's restricted Common Stock to pay $30,333 of accrued interest payable. As the provision to pay stock for interest discounts the market price of the stock the Company has attributed this discount to interest expense and additional paid in capital. However the timing of the shares being issued resulted in the share value being less than the interest paid therefore a decrease in interest expense was recorded of $7,613 for the period.

Change in fair value of warrants and embedded conversion feature This amount relates to the change in value of the derivative liabilities. The change recorded in the three months ended December 31, 2012 and 2011 was an increase of $267,000 and an increase of $53,000, respectively, increasing the fair value of embedded conversion feature liability from $346,000 to $446,000.

17 -------------------------------------------------------------------------------- Table of Contents Cash Flow During the three months ended December 31, 2012, cash was used in operations of $170,326. During this period the Company received proceeds from financing activities of $195,397. These changes resulted in an increase of $25,072 in the cash position for three months ended December 31, 2012. The opening cash at October 1, 2012 was $4,654 and the closing balance at December 31, 2012 was $29,724.

Results of operations - Six Months Ended December 31, 2012 and 2011 General and administrative expenses During the six months ended December 31, 2012 the Company incurred $961,187 of general and administrative expenses an increase of $481,167 from the $480,020 recorded for the six months ended December 31, 2011. The increase in general and administrative expenses was primarily due to an increase in remuneration of staff of $461,284, which included expense for warrants issued in lieu of bonuses.

Included in the expenses for the current six months ended December 31, 2012 were remuneration of staff $825,689, legal and audit of $42,810, travel expense of $50,897, corporate expense of $26,721, and amortization of furniture and equipment of $818. This compares to the six months ended December 31, 2011 which included remuneration of staff $364,405, legal and audit of $44,698, travel expense of $38,964, office expenses of $1,361, corporate expense of $15,034, other professional fees of $2,438, and amortization of furniture and equipment of $1,088.

Research and development expenses.

Research and development expenses of $6,000 were incurred in the six months ended December 31, 2012, compared to $13,943 in the six months ended December 31, 2011. The decrease is the result of a decrease in patent expense of $2,281, a decrease in manufacturing of $2,992, and a decrease in royalties of $2,671.

Amortization of convertible debenture discount The convertible debenture discount of $1,500,000 is being amortized over the 36 month term of the debenture using the effective interest method. The debenture was issued on November 4, 2008. Amortization recorded for the six month period ended December 31, 2012 and 2011 was $nil and $586,729, respectively. The amortized balance of the discount at December 31, 2012 is $nil resulting in the convertible debenture value on the balance sheet net of the discount $1,500,000.

Amortization of deferred finance cost This amount relates to the $315,000 of expenses associated with the $1,500,000 convertible debenture financing raised in November 2008. The deferred financing cost is being amortized using the effective interest method over the thirty-six month life of the debenture. Amortization expense for the six months ended December 31, 2012 and 2011 was $nil and $36,167, respectively.

Interest expense on the convertible debenture This amount relates to the 8% interest associated with the $1,500,000 convertible debenture issued in November 2008.

In September 2012 the Company issued 561,729 shares of common stock to pay accrued interest of $30,333 for the three month period ended September 1, 2012.

In the six months ended December 31, 2012 the Company issued 1,147,315 shares of common stock to pay accrued interest of $60,667 for the six month period ended December 1, 2012.

Interest expense recorded for the six months ended December 31, 2012 was $75,862 compared to $72,755 in the six month period ended December 31, 2011.

According to the provisions of the Convertible Debenture agreement the Company has elected to issue shares of the Company's Stock to pay accrued interest on the debentures. In the six months ended December 31, 2012 the Company issued 561,729 shares of the Company's restricted Common Stock to pay $30,333 of accrued interest payable. As the provision to pay stock for interest discounts the market price of the stock the Company has attributed this discount to interest expense and additional paid in capital. However, the timing of the shares being issued, resulted in the share value being less than the interest paid; therefore, a decrease in interest expense was recorded of $7,583 for the period.

18 -------------------------------------------------------------------------------- Table of Contents Change in fair value of warrants and embedded conversion feature This amount relates to the change in value of the derivative liabilities. The change recorded in the six months ended December 31, 2012 and 2011 was an increase of $100,000 and a decrease of $469,000, respectively, decreasing the fair value of embedded conversion feature liability from $346,000 to $446,000.

Cash Flow During the six months ended December 31, 2012, cash was used in operations of $612,378. During this period the Company received proceeds from financing activities of $626,840. These changes resulted in an increase of $14,462 in the cash position for six months ended December 31 2012. The opening cash at June 30, 2012 was $15,261 and the closing balance at December 31, 2012 was $29,724.

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