- Amended Annual Report (10-K/A)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

_____________________

FORM 10-K AMENDMENT 2

x	ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

	For the Fiscal Year Ended December 31, 2005

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission file number

______________________

AXM PHARMA , INC.

(Exact name of registrant as specified in its charter)

Nevada (State or jurisdiction of incorporation or organization)		20-0745214 (I.R.S. Employer Identification Number)
US Representative Office 17870 Castleton Street, Suite 255, City of Industry, CA 91728 (Address of principal executive offices)		10591 (Zip Code)

(909) 843-6338

(909) 843-6350

(Registrant’s telephone number and facsimile numbers, including area code)

Securities registered pursuant to Section 12(b) of the Act:

Common Stock — $.001 par value

Securities registered pursuant to Section 12(g) of the Act:

Common Stock—$.001 par value

Preferred Stock Purchase Rights

Weishi Wang

PRESIDENT AND CHIEF EXECUTIVE OFFICER

20955 Pathfinder Road,

Suite 100

Diamond Bar, CA 91765

(646) 393-4365

(Name, address and telephone number of agent for service)

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 Act of 1934 during the past12 months and (2) has been subject to such filing requirement for the past 90days. Yes x No o

Aggregate market value of the voting stock held by non-affiliates of the registrant as of April 13, 2006: $9,529,740

TABLE OF CONTENTS

		Page No.

PART I

Item 1.	Explanatory Note	3
Item 2.	Business	4
Item 3.	Properties	15
Item 4.	Legal Proceedings	15
Item 5.	Submission of Matters to a Vote of Security Holders	16

PART II

Item 6.	Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities	17
Item 6A	Recent Sales of Unregistered Securities	17
Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	23
Item 7A	Quantitative and Qualitative Disclosures About Market Risk	28
Item 8.	Financial Statements and Supplementary Data	29
Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure	29
Item 9A.	Controls and Procedures	29
Item 9B.	Other Information	30

PART III
Item 10.	Directors and Executive Officers of the Registrant	30
Item 11.	Executive Compensation	33
Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related
	Stockholder Matters	36
Item 13.	Certain Relationships and Related Transactions	38
Item 14.	Principal Accounting Fees and Services	39

PART IV
Item 15.	Exhibits and Financial Statement Schedules	39
	Signatures	40
	Index to Consolidated Financial Statements	F-1
	Exhibits Index	E-1

Part I

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

Certain statements made under the captions “Business” (Item 1) and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” (Item 7), the notes to our audited financial statements (Item 8) and elsewhere in this Annual Report on Form 10-K/A, as well as statements made from time to time by our representatives may constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements include, without limitation, statements regarding planned or expected manufacturing and sale of pharmaceutical products in China or elsewhere, scale up of facility under United States Good Manufacturing Practices (US GMP) standards, the timing and amount of future sales of pharmaceutical products, the potential market size, advantages or therapeutic uses of our potential products; variation in actual savings and operating improvements resulting from restructurings; and the sufficiency of our available capital resources to meet our funding needs. We do not undertake any obligation to publicly update any forward-looking statement, whether as a result of new information, future events, or otherwise, except as required by law. Such forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause our actual results or achievements to be materially different from any future results or achievements expressed or implied by such forward-looking statements. Such factors include the factors described under “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Risk Factors” and the other factors discussed in connection with any forward-looking statements.

Item 1. Explanatory Note

This Form 10-K/A amends and restates the Form 10-KSB for the year ended December 31, 2005 of AXM Pharma, Inc. (“the Company”) initially filed with the Securities and Exchange Commission (the “SEC”) on April 17, 2006 (the “Original Filing”) as amended and restated in the Form 10-KSBA for the year ended December 31, 2005 of the Company filed with the SEC on May 1, 2006. This Form 10-K/A is intended to supersede such Form 10-KSBA.

This Form 10-K/A is being filed to correct errors and omissions contained in Part II, Item 6A, Item 7 and Item 7A and Part IV, Item 15, of the Original Filing. These errors and omissions result from failure to properly record certain liabilities and expenses related to the issuance of Secured Convertible Promissory Notes and associated Common Stock Purchase Warrants during the quarter ended April 30, 2005 and certain liabilities and expenses related to the issuance of Series C Preferred Stock and associated Common Stock Purchase Warrants during the quarter ended June 30, 2004. For the convenience of the reader, this Form 10-K/A sets forth the Original Filing in its entirety. However, this Form 10-K/A only amends certain information contained in Part II, Item 6A, Item 7 and Item 7A and Part IV, Item 15, “Exhibits and Financial Statement Schedules”, of the Original Filing, solely as a result of and to reflect the correction of such errors and omissions.

This Form 10-K/A adds this Explanatory Note as a new Part I, Item 1 for the convenience of the reader. See also Note 2 to the Financial Statements included in Part IV, Item 15. Forward looking statements made in the Original Filing have not been revised to reflect events, results or developments that occurred or facts that became known to the Company after the date of the Original Filing, and these forward looking statements should be read in their historical context.

In addition, as more fully described in Part II, Item 9A of this report, following the close of the fiscal year ended December 31, 2005 and the filing of the Company’s Original Filing on April 17, 2006, the Company identified inadequacies in the Company’s disclosure controls and procedures that materially affected the Company’s internal control over financial reporting in and following the fiscal year ended December 31, 2005. Management has and will continue to adopt remedial measures in response to these inadequacies.

Pursuant to the rules of the SEC, Item 15 of Part IV of the Original Filing has been amended to include certifications re-executed as of the date of this Form 10-K/A from the Company’s Chief Executive Officer as required by Section 302 and 906 of the Sarbanes-Oxley Act of 2002. The certifications of the Chief Executive Officer are attached to this Form 10-QKB/A2 as Exhibit 31.1 and 32.1.

Item 2.

Business

Overview of AXM Pharma

Introduction

AXM Pharma, Inc., (“AXM”, “our”, “us” or “we”) is a pharmaceutical and nutraceutical company engaged in the production, marketing and distribution of over the counter and prescription pharmaceutical products in The People’s Republic of China (“China”). We have licenses to produce market and distribute drug products in various dosages and forms as well as herbal remedies and vitamins and are currently manufacturing four drug products for sale in China. We conduct our business in China through our wholly owned subsidiary, AXM Pharma (Shenyang) Inc. (“AXM Shenyang”). Further information can be found on our website: www.axmpharma.com. The contents of that website are not incorporated herein by reference thereto.

History

AXM was originally founded as Wholesale on the Net, Inc in 1999, as a Nevada corporation. In 2001, we changed our named to Wickliffe International Corporation. In 2003, we acquired all of the outstanding shares of Werke Pharmaceuticals, Inc (“Werke”), a Chinese based pharmaceutical company. Werke owns all of the outstanding shares of AXM Shenyang, a “Wholly Foreign Owned Enterprise (WFOE) under Chinese law. In connection with the acquisition of Werke, we commenced operations in our current line of business and changed our name to Axiom Pharmaceuticals and, later in 2003, to AXM Pharma, Inc. We conducted a series of private financings in 2003, 2004 and 2005. Prior to March 2004, our common stock was quoted under the symbol “WICK” on the over-the-counter Bulletin Board. In March 2004, we were listed on the American Stock Exchange under the ticker symbol “AXJ .We continue to be listed on AMEX under the ticker symbol “AXJ”.

Business Strategy

Our core business strategy is to manufacture and distribute a diverse group of over the counter and prescription pharmaceutical and nutraceutical products, targeting the markets of China, Hong Kong, Taiwan, Korea, The Philippines, Indonesia, Malaysia, Singapore and Thailand. Our growth plan includes expanding our existing product line with new products licensed from North America and Europe. In 2004, we completed the construction of a manufacturing plant in a special economic zone in Shenyang, China. The plant has been certified as satisfying Chinese “Good Manufacturing Practices (GMP)”, and we intend to apply for certification of the plant under US GMP as well. This designation would allow us to manufacture pharmaceutical products in China for sale in the United States market. However, we cannot predict when if ever we will obtain certification of the Shenyang plant under US GMP.

Manufacturing Capabilities

Our factory in Shenyang includes over 120,000 square feet of production space capable of producing 50,000,000 tubes for ointments, 500,000,000 tablets and 250,000,000 capsules annually. In addition, the plant contains laboratory and administration facilities. The factory is located in a special economic zone, the High-Tech Industrial Development District, established in 1988 by the Chinese government to accelerate the development and industrialization of high-tech industries in the North–Eastern portion of China.

Current Marketed Products

AXM Shenyang currently holds 42 licenses to produce over-the-counter and prescription pharmaceutical products in China. To date, we have undertaken commercial sales of products under four of these licenses under approval from the State Food and Drug Administration of China (“SFDA”). Until the completion of our plant and its certification, our products were produced by third-party manufacturers. In the second quarter of 2005, we began to manufacture our products in our new factory. Currently, all of our products are sold through third-party distributors. Our current marketed products are:

Asarone: Asarone is a tablet form of medication indicated as an anti-septic, anti-inflammatory, asthma reducing, including pediatric asthma, and coughs prevention medicine. Additionally, Asarone has been used to treat slight and severe infantile pneumonia, child pneumonia, adult bacterial pneumonia, and chronic and acute bronchitis, which are symptoms of SARS. Separately, Asarone, in the form of an injectable solution, has been identified as one of eight experimental drugs recommended by the Chinese State Traditional Chinese Medicine Administration for combating SARS.

Elegance: Elegance is a menstrual relief pH balanced lotion formulated with eight herbal extracts. The product is positioned as a therapeutic lotion to relieve vaginal itch, vaginal irritation and vaginitis.

LiveComf: LiveComf is a compound sulfur cream used to alleviate dermatitis, seborrheica, scabies, acne and eczema.

LifeGate: LifeGate is an anti-fatigue capsule categorized as a functional food that is used for increased energy and vitality. The product is sold over-the-counter, addressing both the chronic and acute treatment requirements .

Marketing, Sales and Distribution

We currently employ 90 individuals involved in marketing and sales. Also, we intend to engage additional domestic third-party distributors to penetrate new markets. We are developing educational programs for hospitals, doctors, clinics and distributors with respect to our product lines. These educational programs are intended to improve sales and promotion of our products. We are planning to advertise our products through medical news paper and magazine related media.

As our resources permit, we anticipate expanding our current domestic Chinese distribution beyond the cities in which we currently sell through the utilization of new distribution firms in regions currently not covered. We have developed new distribution and marketing relationships with the following firms:

• China Nat. Pharma. Group (Sinopharm)

• Jin Ming Shi Pharma

• DKSH (Taiwan) Limited

• KerryFlex Supply Chain Solutions Limited

Recent Developments

Liquidity Crisis. We are in urgent need of additional capital. Our cash resources have been depleted. We have not paid our employees in China since January 2006. We are in default under the terms of certain promissory notes as described more fully below under “Risk Factors - We are currently in default on our obligations under our Series C Convertible Promissory Notes.” Our lack of capital has severely constrained our ability to grow our business. These conditions raise substantial doubt about our ability to continue as a going concern. The audit report prepared by our independent registered public accounting firm relating to our consolidated financial statements for the year ended December 31, 2005 includes an explanatory paragraph expressing the substantial doubt about our ability to continue as a going concern. We are currently in discussions with several funding sources in China to obtain financing to support operations going forward, but to date none of these discussions have resulted in additional financing. If we are unable to raise additional capital in the immediate future, we may be forced to cease business operations.

Default on Series C Notes. Under the terms of certain Secured Promissory Notes issued on April 19, 2005, we are obligated to pay interest and principal monthly in cash or shares. However, we are obligated to make payments in cash if our share price falls below a certain price calculated under a formula specified in the Notes. We are currently in default in our payment obligations because we have not been able to pay the required principal and interest to the holders of the Notes. We are in negotiations with the holders with a view to restructuring the terms of the Notes. However, no agreement has been reached and, if we fail to reach an agreement, it will be very difficult for us to raise any new funds from other sources (see “Risk Factors - We are currently in default on our obligations under our Secured Promissory Notes ”.)

Loss of Sunkist License. In 2004, we entered into a Trademark Licensing Agreement with Sunkist Growers Inc. (“Sunkist”) that granted us exclusive rights to manufacture, market and sell certain vitamin and vitamin supplements under the Sunkist brand name and trademark until December 2005 in Hong Kong, Taiwan and Macau and until December 2008 in China. Sales under these licenses accounted for approximately 60% of our total sales in 2005. The agreement also granted us a right of first refusal for any territory in the rest of Asia where Sunkist does not currently license the product categories covered by the agreement with us. Under the terms of the agreement, we were required to achieve certain sales targets each year, for each category of product licensed under the agreement. In order to support our Sunkist license agreement, we entered into distribution agreements with Zuellig Pharma Ltd. and Zuellig & Woo (Hong Kong) Co., Ltd in March 2005 for distribution the Sunkist brand products in China, Hong Kong, Macau and Taiwan. In addition, we entered into agreements with Kerryflex Supply Chain Solutions Limited and executed a Memorandum of Understanding with DKSH Taiwan Limited, to distribute the Sunkist brand products in Hong Kong and Taiwan. In October 2005, we terminated the distribution agreement with Zuellig Pharma, Inc. and Zuellig & Woo (Hong Kong) Co., Ltd.

We failed to achieve certain minimum sales targets during 2004 and 2005 for each category of product and failed to pay the minimum royalties stipulated under the license agreement. As a result, Sunkist terminated our agreement with them for sale of products in China on February 20, 2006. The separate license agreement with Sunkist relating to rights to sell certain products in Hong Kong, Macau and Taiwan expired on its stated termination date in December 2005 and has not been renewed. Sunkist has notified us that we are in default with respect to minimum royalties and has demanded payment of $368,000. This amount in included in our Statement of Financial Position under the caption “Current Liabilities.”

SEC Investigation. The SEC is currently conducting an investigation into the restatement of our June 30, 2005 financial statements. Under prior management, we recorded approximately $2.8 million of revenues related to the sale of Sunkist-branded products through our distributor, Zuellig. These revenues constituted substantially all of our revenues for the quarter ended June 30, 2005. In October 2005, under current management, we determined that such sales were in substance consignment arrangements since we could not determine collectabilty since collections were not due until the distributors shipped the products; therefore,.we should not have recognized any revenues from such sales. We reported this matter to the SEC which then decided to conduct an investigation to determine if we and others may have violated the reporting, anti-fraud, accounting and other provisions of the federal securities laws. The investigation is in a relatively early stage and we are not able to predict its outcome. We are fully cooperating with the SEC in this investigation (see “Risk Factors - We are currently the subject of an SEC investigation into our restatement of our June 30, 2005 financials.”)

Certain Considerations Related to Chinese Pharmaceutical Companies

Chinese Legal Status of AXM Shenyang

AXM Shenyang, is classified as a Wholly Foreign Owned Enterprise (WFOE) under Chinese Company Law. Wholly Foreign Owned Enterprises are limited liability companies established under Chinese Company Law, which are owned exclusively by one or more foreign investors and thus offer controls over the company’s management, technology, and finances that the typical foreign investor requires. Advantages of qualifying as a WFOE include:

●

Ability to carry on business in China rather than just a representative office function;

●

Ability to issue invoices to customers in Renminbi (Chinese currency) and receive Renminbi revenues;

●

Ability to convert Renminbi profits to US dollars for remittance to foreign parent company outside China;

●

Ability to employ staff directly within China;

●

Protection of intellectual know-how and proprietary technology.

Potential disadvantages of operating as a WFOE include unlimited liability for claims arising from operations in China, and potentially less favorable treatment from governmental agencies in China and other Chinese companies than we would receive if we operated through a joint venture with a Chinese Partner. We have not experienced any such disadvantages in operating our business as a WFOE thus far.

Government Regulation

The modernization of regulations for the pharmaceutical industry is relatively new in China and the manner and extent to which the pharmaceutical industry is regulated will continue to evolve. We are subject to the Pharmaceutical Administrative Law, which governs the licensing, manufacture, marketing and distribution of pharmaceutical products in China and sets penalty provisions for violations of provisions of the Pharmaceutical Administrative Law. In addition, as a WFOE, we are subject to the Foreign Company provisions of the Company Law of the China, which governs the conduct of our wholly owned subsidiary, AXM Shenyang and its officers and directors. Changes in these laws or new interpretations of existing laws may have a significant impact on our methods and our costs of doing business.

Additionally, we will be subject to varying degrees of regulation and permitting by governmental agencies in China. For example, in 1999, the SFDA established an administrative system for the classification of prescription and over–the-counter drugs. Since then, the SFDA has issued a series of guidelines on interpretation of the new classification system in such areas as labeling, usage instructions and packaging of over–the-counter products.

Recently, the SFDA implemented new Good Manufacturing Practices guidelines for licensing pharmaceutical products. Our new factory was required to comply with these new guidelines to begin production at the facility and failure to satisfy these new guidelines would have a material adverse effect our business. Our factory received Chinese Good Manufacturing Practices approval in January 2005.

There can be no assurance that future regulatory, judicial and legislative changes will not have a material adverse effect on our business, that regulators or third parties will not raise material issues with regard to our business and operations or our compliance or non-compliance with applicable regulations or that any changes in applicable laws or regulations will not have a material adverse effect on our business.

Chinese Registered Capital Requirements

Pursuant to the Company Law of China, we are required to contribute and maintain a certain amount of “registered capital” in our wholly owned subsidiary, AXM Shenyang. This capital may be in the form of tangible or intangible assets. AXM Shenyang’s current registered capital requirement is US $10,000,000. We are currently in compliance with the registered capital requirements of the Company Law.

Chinese Environmental Laws

We are subject to the environmental laws of China and its local governments. Our operations in China do not involve the use of pollutants. Therefore, we do not incur significant expense related to compliance with such laws nor do we expect to be affected significantly by compliance with such laws.

Licensing and Intellectual Property

The State Food and Drug Administration of the government of China issues licenses and permits for permission to market and manufacture pharmaceutical products in China. Generally, licenses and permits issued by the SFDA are revocable at any time, with or without cause. We have been granted 42 product licenses and permits, of which only four licenses currently are commercialized. We likely will undertake a selection process to decide which of our remaining licenses, if any, will be commercialized, and we will determine the timeframe for such commercialization. None of our registered products are currently patented nor do we have any patents pending before the government of China or any other government.

Research and Development

We have minimal research and development activities. Such activities are focused on quality and laboratory testing of compounds developed by others, and administration of the testing process for such compounds. We have developed working relationships with Shenyang Medical University and the Liaoning Research Institute for Traditional Chinese Medicine and Beijing Shiehe Medical University to acquire new licenses according to market demand in the future.

Competition

We compete with different companies in different therapeutic categories. For example, with regard to Asarone Tablets, we compete with Liuzhou Pharmaceutical Factory, located in Liuzhou City, Guang Xi Autonomous Region. AXM and Liuzhou are the only two companies approved by the SFDA to manufacture Asarone Tablets. However because Liuzhou distributes its Asarone tablets mainly in Southern China and AXM distributes its products mainly in Northern China, the two companies do not directly compete in their respective markets. We compete with two companies for distribution of our product Lifushu herbal antiseptic skin cream, Zhejiang Wenzhou Pharmaceutical Factory and Ying Kou Biochemical Pharmaceutical Factory. However, one of these competitors, Zhejiang Wenzhou, targets its product to public bath houses, and does not compete in the pharmaceutical distribution segments in which AXM sells Weifukang. Ying Kou Biochemical Pharmaceutical Factory’s main business focus is its bulk bioprocessing business. Their herbal antiseptic product is a minor line. Our largest competitor for Cefaxlin Capsules and Norfloxacin Capsules is Yanfeng Pharmaceuticals, also located in Shenyang. Yanfeng Pharmaceutical Company is a recently privatized State Owned Enterprise that employs approximately 400 persons. Their sales territory focus is in Shenyang city. We consider Yanfeng Pharmaceutical Company to be a major competitor.

Employees

At April 13, 2006, we had no employees in our U.S.-based headquarters and 150 full-time employees at our facilities located in China. Certain of our employees in China have instituted legal proceedings in China related to unpaid wages ( see “Risk Factors - We have not made payments to certain of our employees and lenders, and certain service providers have asserted claims against us”.)

Available Information

We file annual, quarterly and special reports, proxy statements and other information with the Securities and Exchange Commission. You may read or obtain a copy of this annual report or any other information we file with the SEC at the SEC’s Public Reference Room at 450 Fifth Street, N.W., Washington, D.C. 20549. You may obtain information regarding the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. Our SEC filings are also available to the public from the SEC web site at www.sec.gov, which contains our reports, proxy and information statements, and other information we file electronically with the SEC. You can also obtain our filings at our website, www.axmpharma.com.

The Company also makes its periodic and current reports available, free of charge, on its website, www.axmpharma.com, as soon as reasonably practicable after such material is electronically filed with the SEC. Information available on our website is not a part of, and should not be incorporated into, this annual report on Form 10-K/A.

Our Board of Directors has adopted a Code of Business Conduct and Ethics which is posted on our website at www.axmpharma.com.

Risk Factors

The following risk factors should be read carefully in connection with evaluating our business and the forward-looking statements that we make in this Report and elsewhere (including oral statements) from time to time. Any of the following risks could materially adversely affect our business, our operating results, our financial condition and the actual outcome of matters as to which forward-looking statements are made in this Report.

Risks Related to Our Financial Condition

If we fail to raise additional capital in the immediate future, we will be forced to cease operations

We are in urgent need of additional capital. Our cash resources have been depleted. We have not paid our employees in China since January 2006. We are in default under the terms of certain promissory notes as described more fully below under “Risk Factors - We are currently in default on our obligations under our Series C Convertible Promissory Notes.” Our lack of adequate capital has severely constrained our ability to grow our business. These conditions raise substantial doubt about our ability to continue as a going concern. The audit report prepared by our independent registered public accounting firm relating to our consolidated financial statements for the year ended December 31, 2005 includes an explanatory paragraph expressing the substantial doubt about our ability to continue as a going concern. We are currently in discussions with several funding sources in China to obtain financing to support operations going forward; however, to date such discussions have not resulted in any additional financing. At this time, we do not know if additional financing will be available, nor can we predict the terms of any such financing. If we are unable to raise additional funds in the immediate future, we may be forced t cease business operations. If additional capital is raised through the sale of equity or convertible debt securities, the issuance of such securities would result in dilution to our existing stockholders. If additional capital is raised through incurrence of indebtedness, our interest expense will likely increase and restrictive covenants imposed by the lenders may impair our ability to grow our business.

Since our inception, we have generated significant losses from operations and we anticipate that we will continue to generate significant losses from operations for the foreseeable future. As of December 31, 2005, our accumulated deficit was approximately $28 million. Our net loss was $9 million and $13 million for the years ended December 31, 2005 and 2004, respectively. Our cash outlays from operations and capital expenditures were $9 million and $10 million for 2005 and 2004, respectively. Our stockholders’ equity decreased from $5 million as of December 31, 2004 to $0.8 million as of December 31, 2005.

We are currently in default on our obligations under our Series C Convertible Promissory Notes.

On April 19, 2005, we entered into a private financing with certain accredited investors and issues secured promissory notes with an aggregate principal amount of $3,425,000. Under the terms of the Notes, we are obligated to pay interest and principal monthly in cash or shares. However, we are obligated to make payments in cash if our share price falls below a certain price calculated under a formula specified in the Notes. We are currently in default in our payment obligations because we have not been able to pay the required repayment of principal and interest to the holders of the Notes. We are in negotiations with the holders with a view to restructuring the terms of the Notes. However, no agreement has been reached and, if we fail to reach an agreement, it will likely be impossible for us to raise any new funds. Moreover, one or more holders of the Notes may bring legal claims seeking to enforce their rights against us.

We have not made payments to certain of our employees and lenders, and certain service providers have asserted claims against us.

Due to our limited available cash in the forth quarter, we were unable to allocate sufficient cash to our Chinese subsidiary, AXM Shenyang, for it to pay its approximately 150 employees. As a result some of these employees have resigned. Further, we received notices from the Labor Arbitration Committee in China that 11 of our current and former employees have filed a labor arbitration claim for unpaid salaries and un-reimbursed expenses in the aggregate amount of RMB429,958 ( $53,081).

In addition, AXM Shenyang obtained loans in the aggregate amount of 8,290,302 RMB (US $1,002,455) between October 22, 2004 and June 26, 2005, through a series of short term non-recourse loans from ten individual Chinese lenders. AXM Shenyang is in default on the principal of these loans and interest of approximately $494,000. Although these loans are not secured by any of our property or assets, we could be subject to legal action if these loans are not repaid. Currently, no lawsuits regarding these loans have been initiated and we are not aware that any lawsuits are being contemplated by any of the lenders. However, we can not assure you that the lenders will not take legal action in the near term.

We have also received demand letters from Saatchi & Saatchi, alleging that we owe them approximately RMB582,055.48 (U.S. $71,770) in connection with advertising services allegedly provided to AXM Shenyang and from Sunkist alleging that we owe them $368,000 for minimum royalty payments.

We do not have the ability to satisfy these contingent liabilities should adverse judgments be entered against us. In addition, these matters make it more difficult for us to raise new capital and divert scarce financial resources and management time to defend against the various claims.

We are currently in litigation with several service providers and our former chief executive officer and an adverse determination in these proceedings could further adversely affect our liquidity.

There is currently pending in Los Angeles superior court, a lawsuit filed by Praxis Advertising and Design, Inc. claiming payment of an unpaid package design fee of $119,800. In addition, in November 2005, Don Bates, Inc., our former U.S. Good Manufacturing Practices consultant, instituted legal action against us in U.S. District Court, District of Nevada, claiming unpaid consultancy fees. Don Bates, Inc. has alleged that $362,652.00, plus accrued interest, is due to them. In November 2005, we became aware of a lawsuit filed in the District Court of Clark County, Nevada by our former CEO Peter Cunningham, whom we fired for cause on July 20, 2005. Mr. Cunningham’s counsel claims to have properly served us with a summons and complaint and took a default against us on November 9, 2005. Mr. Cunningham’s complaint alleges unpaid base salary, unpaid commissions, un-reimbursed expenses and unpaid severance totaling approximately $180,000. We intend to contest these claims and will consider appropriate cross-claims. An adverse determination in one or more of these proceedings would further impair our liquidity.

We are currently the subject of an SEC investigation into our restatement of our June 30, 2005 financials.

The SEC is currently conducting an investigation into the restatement of our June 30, 2005 financial statements. Under prior management, the Company recorded approximately $2.8 of revenues related to the sale of Sunkist-branded products through our distributor, Zuellig. These revenues constituted substantially all of our revenues for the quarter ended June 30, 2005. In October 2005, under current management, we determined that such sales were in substance consignment arrangements since we could not determine collectabilty since collections were not due until the distributors shipped the products; therefore. We should not have recognized any revenues from such sales. We reported this matter to the SEC which then decided to conduct an investigation to determine if we and others may have violated the reporting, anti-fraud, accounting and other provisions of the federal securities laws. The investigation is in a relatively early stage and we are not able to predict its outcome. We are fully cooperating with the SEC in this investigation.

The pendency of the SEC investigation has had a material adverse affect upon our ability to raise new capital. A number of prospective investors have indicated they are not willing to proceed with an investment in the Company until the SEC investigation is resolved. Moreover, if the SEC determines to seek sanctions against the Company following completion of its investigation, such sanctions could create further difficulties for our ability to raise capital and continue in business.

If we fail to continue to meet all applicable American Stock Exchange requirements, our common stock could be delisted, which would adversely affect the market liquidity and price of our common stock .

Our common stock is listed on the American Stock Exchange (AMEX). In order to maintain that listing, we must satisfy minimum financial and other requirements. The AMEX has notified us that we may not be in compliance with their continued listing standards because our substantial operating losses cast doubt upon our ability to continue as a going concern and three of our independent directors resigned in February, including the Chair of our Audit Committee. We have responded to the AMEX with a plan to improve our financial condition and we have notified the AMEX that we have elected two new independent directors, one of whom qualifies as a financial expert. The AMEX is currently considering our responses. If they deem the responses inadequate, or if we are unable to execute our plan to improve our financial condition, then the AMEX may commence delisting proceedings against us. In this regard, it should be noted that our plan depends upon obtaining funds from third parties and, to date, we have not closed any arrangements with such third parties to provide the necessary funding. The AMEX has stated that we must execute upon our plan to improve our financial condition by May 2, 2006.

If we fail to continue to meet all applicable AMEX requirements in the future and AMEX determines to delist our common stock, the delisting could adversely affect the market liquidity of our common stock and the market price of our common stock could decrease. Such delisting could also adversely affect our ability to obtain financing for the continuation of our operations and could result in the loss of confidence by investors, suppliers and employees.

Our disclosure controls and procedures are not effective, which may result in our filing unreliable reports with the SEC.

As a result of the restatement discussed above, we concluded that our disclosure controls and procedures have not been effective to ensure that information required to be disclosed in reports that we file or submit under the Securities Exchange Act of 1934 is processed, summarized and reported within the time periods specified by the SEC. As a result, our SEC reports may not be reliable. This may impair our ability to raise new capital. It may also expose us to new liabilities if we file false or misleading reports. .

We have outstanding warrants that may adversely affect us in the future and cause dilution to existing Shareholders.

In connection with the issuance of the Secured Promissory Notes, we issued warrants to holders of the Notes to purchase our common stock at certain prices as adjusted pursuant to the terms of the warrants. The warrants were issued in tranches with exercise periods expiring on June 24, 2007, August 21, 2008, September 12, 2008, and December 31, 2008. There are currently 3,683,689 warrants outstanding, which are exercisable at a price of $3.00 per share, with the exception of those warrants which expire on June 24, 2007, which are exercisable at a price of $5.50 per share, subject to adjustment in certain circumstances. Exercise of the warrants may cause dilution in the interests of other shareholders as a result of the additional common stock that would be issued upon exercise. In addition, sales of the shares of our common stock issuable upon exercise of the warrants could have a depressive effect on the price of our stock, particularly if there is not a coinciding increase in demand by purchasers of our common stock. Further, the terms on which we may obtain additional financing during the period any of the warrants remain outstanding may be adversely affected by the existence of these warrants as well.

Risks Related to Our Business Operations in China

We may not be able to obtain regulatory approvals for our products or reimbursement from the sale of our products.

The manufacture and sale of pharmaceutical products in China is highly regulated by a number of state, regional and local authorities. These regulations significantly increase the difficulty and costs involved in obtaining and maintaining regulatory approval and reimbursement listings for marketing new and existing products. In addition, our future growth and profitability are, to a significant extent, dependent upon our ability to obtain timely regulatory approvals and reimbursement from the relevant authorities.

Changes in the laws and regulations in China may adversely affect our ability to conduct our business.

The pharmaceutical industry is relatively new in the emerging markets of China that we are targeting, and the manner and extent to which it is regulated in these geographical areas is evolving. As a Chinese corporation, AXM Pharma is subject to the Company Law of The Peoples Republic of China and more specifically to the Foreign Company provisions of the Company Law and the Law on Foreign Capital Enterprises of the People's Republic of China. Additionally, as a pharmaceutical company, we are subject to the Pharmaceutical Administrative Law. Changes in existing laws or new interpretations of such laws may have a significant impact on our methods and costs of doing business. For example, new legislative proposals for pharmaceutical product pricing, reimbursement levels, approval criteria and manufacturing requirements may be proposed and adopted. Such new legislation or regulatory requirements may have a material adverse effect on our financial condition, results of operations or cash flows. In addition, we will be subject to varying degrees of regulation and licensing by governmental agencies in China. There can be no assurance that the future regulatory, judicial and legislative changes will not have a material adverse effect on AXM Pharma, that regulators or third parties will not raise material issues with regard to AXM Pharma or our compliance or non-compliance with applicable laws or regulations or that any changes in applicable laws or regulations will not have a material adverse effect on AXM Pharma or our operations.

We may experience barriers to conducting business due to governmental policy.

The SFDA set up a classification administrative system in 1999 for prescription and over–the-counter drugs. Since then, the SFDA has issued a series of guidelines for interpretation of the new classification system for labeling, usage instructions and packaging of over–the-counter products. The SFDA currently requires that pharmaceutical manufacturers clearly label drugs for over–the-counter sales and distinguish them from those to be sold in hospitals as ethical drugs. We have instituted this policy as required by the SFDA. To date, we have never experienced any problems with compliance with the regulations of the SFDA. We have never been investigated for noncompliance by this agency nor have we violated any regulations of the SFDA.

Our business may be adversely affected by government plans to consolidate state owned pharmaceutical companies in China.

The Ministry of Commerce announced plans to consolidate nearly 5,000 state owned pharmaceutical companies into approximately 12 to 15 companies. The Ministry of Commerce has stated that it targets the size of these remaining firms to be at least U.S. $ 10.0 billion revenue per annum in the future (U.S.$ 5.0 billion by the year 2010). Their primary business will be to make generic pharmaceutical products for sale to state owned hospitals. The planned consolidation has already commenced and is anticipated to continue until the goals of the Ministry of Commerce have been realized. We are not aware, however, at this time of how many companies have been consolidated or when the planned consolidation will be completed. A recent example of the consolidation amongst state owned pharmaceutical companies is the acquisition by the conglomerate Huayuan Group of a 40% stake in Shanghai Pharmaceutical Group. This new company will be involved in manufacture, distribution and research and development. An objective of the consolidation is to establish a manufacturing standard consistent with U.S. Good Manufacturing Practices. It is planned that all products manufactured in The Peoples Republic of China will meet U.S. Good Manufacturing Practices standard in the future.

Capital outflow policies in China may hamper our ability to remit income to the United States.

China has adopted currency and capital transfer regulations. These regulations require that we comply with complex regulations for the movement of capital. In order to comply with these regulations we may have to revise or change the banking structure of our company or its subsidiaries Although we believe that we are currently in compliance with these regulations, should these regulations or the interpretation of them by courts or regulatory agencies change we may not be able to remit all income earned and proceeds received in connection with our operations to the U.S.

Fluctuation of the Renminbi could materially affect our financial condition and results of operations.

The value of the Renminbi fluctuates and is subject to changes in China’s political and economic conditions. Since 1994, the conversion of Renminbi into foreign currencies, including US dollars, has been based on rates set by the People’s Bank of China, which are set daily based upon the previous day’s interbank foreign exchange market rates and current exchange rates on the world financial markets. Since 1994, the official exchange rate for the conversion of Renminbi to US dollars has generally been stable.

On July 21, 2005, the PRC allowed the RMB to fluctuate within a narrow range, ending its decade-old fixed valuation peg to the US dollar. The new RMB rate reflects an approximately 2% increase in value against the US dollar. Historically, the Chinese government has benchmarked the RMB exchange ratio against the US dollar, thereby mitigating the associated foreign currency exchange rate fluctuation risk.

We may face obstacles from the political system in China.

Foreign companies conducting operations in China face significant political, economic and legal risks. The government of the Peoples Republic of China has a history of intervening in business affairs in order to achieve its political objectives. While current policies favor foreign investment, these policies may change without warning. Moreover, corruption and a legal system which is not fully developed pose significant risks for companies doing business in China.

We may have difficulty establishing adequate management, legal and financial controls in China.

China historically has been deficient in Western style management and financial reporting concepts and practices, as well as in modern banking, computer and other control systems. We may have difficulty in hiring and retaining a sufficient number of qualified employees to work in China. As a result of these factors, we may experience difficulty in establishing management, legal and financial controls, collecting financial data and preparing financial statements, books of account and corporate records and instituting business practices that meet Western standards.

Trade barriers and taxes may have an adverse effect on our business and operations.

We may experience barriers to conducting business and trade in our targeted emerging markets in the form of delayed customs clearances, customs duties and tariffs. In addition, we may be subject to repatriation taxes levied upon the exchange of income from local currency into foreign currency, substantial taxes of profits, revenues, assets and payroll, as well as value-added tax. The markets in which we plan to operate may impose onerous and unpredictable duties, tariffs and taxes on our business and products, and there can be no assurance that this will not have an adverse effect on our finances and operations.

It will be extremely difficult to acquire jurisdiction and enforce liabilities against our officers, directors and assets based in China.

Because several of our directors, including Wei Shi Wang, the chairman of our Board of Directors, are Chinese citizens it may be difficult, if not impossible, to acquire jurisdiction over these persons in the event a lawsuit is initiated against AXM Pharma and/or its officers and directors by a shareholder or group of shareholders in the U.S. Also, although our executive officers are U.S. citizens, because they may be residing in China at the time such a suit is initiated, achieving service of process against such persons would be extremely difficult. Furthermore, because the majority of our assets are located in China, it would also be extremely difficult to access those assets to satisfy an award entered against us in U.S. court.

There can be no guarantee that China will comply with the membership requirements of the World Trade Organization.

Due in part to the relaxation of trade barriers following World Trade Organization accession in January 2002, we believe the Chinese market presents a significant opportunity for both domestic and foreign drug manufacturers. With the Chinese accession to the World Trade Organization, the Chinese pharmaceutical industry is gearing up to face the new patent regime that is required by World Trade Organization regulation. The Chinese government has begun to reduce its average tariff on pharmaceuticals. China has also agreed that foreign companies will be allowed to import most products, including pharmaceuticals, into any part of China. Current trading rights and distribution restrictions are to be phased out over a three-year period. In the sensitive area of intellectual property rights, China has agreed to implement the trade-related intellectual property agreement of the Uruguay Round. There can be no assurances that China will implement any or all of the requirements of its membership in the World Trade Organization in a timely manner, if at all.

General Business Risks

We may not be able to adequately protect and maintain our intellectual property.

Our success will depend in part on our ability to protect and maintain intellectual property rights and licensing arrangements for our products. None of our products are patented. As a result, competitors may be able to sell products that are substantially the same as our products. We depend upon licenses from third parties for the rights to sell our products. No assurance can be given that licenses or rights used by us will not be challenged, invalidated, infringed or circumvented, or that the rights granted thereunder will provide competitive advantages to us. There can be no assurance that we will be able to obtain a license to any third-party technology that we may require to conduct our business or that such technology can be licensed at a reasonable cost. There is no certainty that we will not be challenged by our partners for non-compliance with our licensing arrangements. Furthermore, there can be no assurance that we will be able to remain in compliance with our existing or future licensing arrangements. Consequently, there may be a risk that licensing arrangements are withdrawn with no penalties to the licensor or compensation to us.

We may have difficulty competing with larger and better financed companies in our sector.

The prescription and over–the-counter drug markets in China are very competitive and competition may increase. Products compete on the basis of efficacy, safety, side effect profiles, price and brand differentiation. Some of our competitors may have greater technical and financial resources than we do and may use these resources to pursue a competitive position that threatens our products. Our products could be rendered obsolete or uneconomical by the development of new pharmaceuticals to treat conditions addressed by our products, as a result of technological advances affecting the cost of production, or as a result of marketing or pricing action by one or more of our competitors.

We are dependant on certain key existing and future personnel .

Our success will depend, to a large degree, upon the efforts and abilities of our officers and key management employees such as Zhenyu Kong, our President of China Operations and Chief Operating Officer of AXM Shenyang; and, Wang Wei Shi, Chief Executive Officer of AXM Shenyang and Chairman of AXM Pharma. The loss of the services of one or more of our key employees could have a material adverse effect on our operations. We do not currently maintain key man life insurance on any of our key employees. In addition, as our business plan is implemented, we will need to recruit and retain additional management and key employees in virtually all phases of our operations. Key employees will require not only a strong background in the pharmaceutical industry, but a familiarity with language and culture in the markets in which we compete. We cannot assure that we will be able to successfully attract and retain key personnel.

We may be subject to product liability claims in the future.

We face an inherent business risk of exposure to product liability claims in the event that the use of our technologies or products is alleged to have resulted in adverse side effects. Side effects or marketing or manufacturing problems pertaining to any of our products could result in product liability claims or adverse publicity. These risks will exist for those products in clinical development and with respect to those products that receive regulatory approval for commercial sale. Furthermorewe do not currently maintain product liability insurance, although we have not historically experienced any problems associated with claims by users of our products,

There may not be sufficient liquidity in the market for our securities in order for investors to sell their securities.

There is currently only a limited public market for our common stock, which is listed on the American Stock Exchange, and there can be no assurance that a trading market will develop further or be maintained in the future. During the month of March 2006, our common stock traded an average of approximately 134,957 shares per day. As of April 13, 2006, the closing bid price of our common stock on the American Stock Exchange was $.43 per share. As of April 13, 2006, we had approximately 134 shareholders of record not including shares held in street name. In addition, during the past two years our common stock has had a trading range with a low price of $.30 per share and a high price of $7 per share.

The fact that our directors and officers own approximately 27.57 % of our capital stock may decrease your influence on shareholder decisions.

Our executive officers and directors, in the aggregate, beneficially own approximately 27.57% of our capital stock. As a result, our officers and directors will have the ability to influence our management and affairs and the outcome of matters submitted to shareholders for approval, including the election and removal of directors, amendments to our bylaws and any merger, consolidation or sale of all or substantially all of our assets.

Item 3.

Properties

Our corporate and United States offices are located at 17870 Castleton Street, Suite 255, City of Industry, California 91748. The current rent for these premises is $1,842 per month. Our lease expires on January 24, 2009. In January 2006, we closed our office located at 7251 West Lake Mead Blvd, Suite 300, Las Vegas, Nevada, 89128. The rent for the office in Las Vegas was $5,378 per month.

Our principal administrative, sales and marketing facilities are located at No. F.3004 Sankei Torch Bldg, 262A Shifu Road, Shenyang City, Liaoning Province, The People’s Republic of China. The current rent for these facilities is US$2,917 per month and our lease expires in October 2007.

Our factory is located at No. 2 Feiyun Road, Nunnan New District, Shenyang, China. It is a 120,000 square foot facility comprised of a solid dose facility, an ointment facility, and an administrative building.

Item 4.

Legal Proceedings

In February 2006, we became aware of a lawsuit filed in Los Angeles superior court from the Praxi Advertising and Design, Inc. claiming payment of an unpaid package design fee of $119,800.

In November 2005, Don Bates, Inc., our former U.S. Good Manufacturing Practices consultant, instituted legal action against us in U.S. District Court, District of Nevada, claiming unpaid consultancy fees. Don Bates, Inc. has alleged that $362,652.00, plus accrued interest, is due to them. We believe that this suit is without merit as, among other things, the fees billed by the plaintiff for services rendered to us were excessive. We intend to contest this claim and will consider appropriate cross-claims. There has been no discovery in this matter and we cannot predict its outcome.

In November 2005, we became aware of a lawsuit filed in the District Court of Clark County, Nevada by our former CEO Peter Cunningham, whom we fired for cause on July 20, 2005. Mr. Cunningham’s counsel claims to have properly served us with a summons and complaint and took a default against us on November 9, 2005. We are disputing the validity of the service, and have retained counsel. We anticipate that the default will be set aside. Mr. Cunningham’s complaint alleges unpaid base salary, unpaid commissions, un-reimbursed expenses and unpaid severance totaling approximately $180,000. The complaint also requests declaratory relief to amend an allegedly incorrect Form 8-K filing which stated that Mr. Cunningham was fired for cause. We intend to vigorously defend this case and believe hawse have meritorious claims against Mr. Cunningham which may be asserted in a cross-complaint. There has been no discovery in this matter and we cannot predict its outcome.

AXM Shenyang obtained loans in the aggregate amount of 8,290,302 RMB (US $1,002,455) between October 22, 2004 and June 26, 2005, through a series of short term non-recourse loans from ten individual Chinese lenders. AXM Shenyang is in default on the principal of these loans and interest of approximately $494,000. Although these loans are not secured by any of our property or assets, we could be subject to legal action if these loans are not repaid. Currently, no lawsuits regarding these loans have been initiated and we are not aware that any lawsuits are being contemplated by any of the lenders.

In July 2005, we received a demand letter from Saatchi & Saatchi, an advertising firm, that alleged that we owed them approximately RMB 582,055.48 (U.S. $71,770) in connection with advertising services provided to AXM Shenyang. We currently are reviewing their claim and intend to negotiate a settlement of such claim. We do not anticipate that this matter will have a material impact on our business or operations.

The SEC is currently conducting an investigation to determine if we and others may have violated the reporting, anti-fraud, accounting and other provisions of the federal securities laws. This investigation resulted from our restatement of our financial statements for the period ended June 30, 2005. The investigation is currently at an early stage and we are not able to assess the likelihood that the SEC will commence enforcement proceedings against us or the nature and potential impact of any remedies the SEC might seek. We are cooperating fully with the SEC in this investigation.

Item 5.

Submission of Registrant’s Common Equity, Related Stockholder Matters

The Company did not submit any matters to a vote of the security holders during the fourth quarter of fiscal 2005.

PART II

Item 6.

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

The common stock is currently listed on the American Stock Exchange under the symbol “AXJ.” Prior to March 14, 2003, the date on which the reverse acquisition with Werke Pharmaceuticals, Inc. occurred, the common stock was quoted under the symbol “WICK” on the over-the-counter Bulletin Board.

The following table sets forth the quarterly high and low bid prices for the common stock since the quarter ended March 31, 2004. The prices set forth below represent inter-dealer quotations, without retail markup, markdown or commission and may not be reflective of actual transactions.

(a)Fiscal 2004 and 2005	High		Low

Quarter Ended March 31, 2004		7.30		3.80
Quarter Ended June 30, 2004		5.49		3.70
Quarter Ended September 30, 2004		4.35		2.05

Quarter Ended December 31, 2004		3.63		1.80
Quarter Ended March 31, 2005		3.15		2.21
Quarter Ended June 30, 2005		2.75		1.72
Quarter Ended September 30, 2005		2.35		1.23
Quarter Ended December 31, 2005		1.61		0.30

Starting on March 3, 2004, our common stock listed on the American Stock Exchange, also called the AMEX, under the trading symbol “AXJ.”

At April 13, 2006, the closing bid price of our common stock was $.43 per share and there were approximately 134 record holders of our common stock. This number excludes any estimate by AXM Pharma of the number of beneficial owners of shares held in street name, the accuracy of which cannot be guaranteed.

We have not paid cash dividends on any class of common equity since formation and we do not anticipate paying any dividends on our outstanding common stock in the foreseeable future.

Item 6A

Recent Sales of Unregistered Securities

In March 2003, we issued an aggregate of 11,420,000 shares of common stock in exchange for all of the issued and outstanding capital stock of Werke Pharmaceuticals, Inc. The shares issued to the former shareholders of Werke Pharmaceuticals, Inc. were issued to 25 accredited investors pursuant to an exemption from registration under Section 4(2) of the Securities Act and to 33 non-U.S. persons pursuant to an exemption from registration under Regulation S promulgated under the Securities Act.

In April 2003, we issued 30,000 shares of restricted common stock to Rabelaisian Resources, Plc. pursuant to a consulting agreement for business and product development services. The shares were issued pursuant to the exemption from registration provided by Section 4(2) of the Securities Act for issuances not involving a public offering. The shares were valued at $1.80 per share, the market price for shares of our common stock at the time of issuance. The total aggregate value of the consideration paid to Rabelasian Resources was $54,000.

On April 30, 2003, we issued 150,000 shares of restricted common stock to Madden Consulting, Inc. pursuant to a consulting agreement for investor and public relations services. On September 18, 2003, we issued an additional 400,000 shares to Madden Consulting, in connection with renewal of its consulting agreement. The shares were issued pursuant to the exemption from registration provided by Section 4(2) of the Securities Act for issuances not involving a public offering. The shares issued on April 30, 2003, were valued at $1.80 per share and the shares issued on September 18, 2003, were valued at $5.00 per share, the market price for shares of our common stock at the respective times of issuance. The total aggregate value of the consideration paid to Madden Consulting was $270,000 on April 30, 2003, and $2,000,000 on September 18, 2003.

In May, 2003, we issued 25,000 shares of restricted common stock to Robert Alexander pursuant to a consulting agreement for services related to the identification and evaluation of pharmaceutical companies, products and licenses in Canada. The shares were issued pursuant to the exemption from registration provided by Section 4(2) of the Securities Act for issuances not involving a public offering. The shares were valued at $1.50 per share, the market price for shares of our common stock at the time of issuance. The total aggregate value of the consideration paid to Robert Alexander was $37,500.

On May 21, 2003, we issued 40,000 shares of restricted common stock to Amaroq Capital, LLC pursuant to a consulting agreement for services related to business development and financial consulting. The shares were issued pursuant to the exemption from registration provided by Section 4(2) of the Securities Act for issuances not involving a public offering. The shares were valued at $1.75 per share, the market price for shares of our common stock at the time of issuance. The total aggregate value of the consideration paid to Amaroq Capital was $70,000.

In May 2003, we issued 15,000 shares of restricted common stock to McCartney Multimedia, Inc. in consideration for the creation of our website and corporate logo. The shares were issued pursuant to the exemption from registration provided by Section 4(2) of the Securities Act for issuances not involving a public offering. The shares were valued at $1.75 per share, the market price for shares of our common stock at the time of issuance. The total aggregate value of the consideration paid to McCartney Multimedia was $26,250.

In June 2003, we issued 80,000 shares of restricted common stock to Woodbridge Management, Ltd. pursuant to a consulting agreement for services related to business development, corporate strategy, and assistance with joint ventures, mergers and acquisitions. The shares were issued pursuant to the exemption from registration provided by Section 4(2) of the Securities Act for issuances not involving a public offering. The shares were valued at $4.45 per share, the market price for shares of our common stock at the time of issuance. The total aggregate value of the consideration paid to Woodbridge Management was $356,000.

On August 21, 2003, and September 12, 2003, we issued 2,750,000 shares of our preferred stock at a price per share of $2.00 and 2,750,000 warrants, each of which entitles the holder to purchase one share of our common stock for a period of five years from the date of issuance at a price of $3.00 per share, to two accredited investors pursuant to a private equity financing. Each share of preferred stock is convertible, at the option of the holder, into one share of common stock, subject to adjustment for certain occurrences. We also issued a five-year warrant to purchase up to 275,000 units, with each Unit consisting of one share of preferred stock and one warrant at an exercise price of $2.00 per Unit, to TN Capital Equities, Ltd., our placement agent in connection with the private equity financing. The private equity financing described above was made pursuant to the exemption from the registration provisions of the Securities Act provided by Section 4(2) of the Act and Rule 506 of Regulation D promulgated thereunder.

On August 31, 2003, we issued 41,667 shares to Peter Cunningham, our President and Chief Executive Officer, pursuant to the terms of his employment agreement with us. The shares were issued pursuant to the exemption from registration provided by Section 4(2) of the Securities Act for issuances not involving a public offering. The shares were valued at $5.00 per share, the market price for shares of our common stock at the time of issuance. The total aggregate value of the consideration paid to Peter W. Cunningham was $208,335.

On September 18, 2003, we issued 100,000 shares to Lan Hao, our Chief Financial Officer, pursuant to the terms of his employment agreement with us. The shares were issued pursuant to the exemption from registration provided by Section 4(2) of the Securities Act for issuances not involving a public offering. The shares were valued at $5.00 per share, the market price for shares of our common stock at the time of issuance. The total aggregate value of the consideration paid to Lan S. Hao was $500,000.

On December 31, 2003, we issued 860,000 shares of our preferred stock, at a price per share of $2.25 and 1,000,000 warrants. Each share of preferred stock is convertible, at the option of the holder, into one share of common stock, subject to adjustment for certain occurrences. Each warrant entitles the holder to purchase one share of our common stock for a period of five years from the date of issuance at a price of $3.00 per share. Holders of our warrants may also exercise the warrants through a cashless exercise under certain circumstances. In addition, we issued to TN Capital Equities, our placement agent, a five-year warrant to purchase up to 86,000 shares of our preferred stock for $2.25 per share and up to 100,000 warrants to purchase shares of our common stock upon exercise at $3.00 per share, on a pro-rata basis to the number of shares of preferred stock purchased. The private equity financing described above was made pursuant to the exemption from the registration provisions of the Securities Act provided by Section 4(2) of the Act and Rule 506 of Regulation D promulgated thereunder .

On January 26, 2004, the Board authorized the issuance of 100,000 shares of restricted common shares and 50,000 warrants to Great Eastern Securities, Inc. pursuant to an investment banking agreement. The shares are to be released quarterly based upon a vesting schedule of 25,000 shares per quarter during the term of the agreement. Pursuant to an agreement that was executed on December 18, 2003, Great Eastern will provide investor relations related services and assist us with broker relations for our stock. The warrants are for a term of five years and have an exercise price equal to $4.74 per share. The shares were issued pursuant to the exemption from registration provided by Section 4(2) of the Securities Act for issuances not involving a public offering. The shares were valued at $5.65 per share, the market price for shares of our common stock at the time of issuance. The total aggregate value of the consideration paid to Great Eastern Securities, Inc. was $639,828, including a $104,828 charge for the value of the warrants issued.

On February 2, 2004 and April 20, 2004, we issued 200,000 shares of restricted common and 100,000 shares of restricted common, respectively to the Aston Organization pursuant to a consulting agreement and amendment thereto. 20,000 shares were released when the April 20, 2004 amendment was signed. The remaining 180,000 shares are to be released monthly based upon a vesting schedule of 15,000 shares per month during the term of the agreement. The services to be provided under the agreement are investor relations. The shares were issued pursuant to the exemption from registration provided by Section 4(2) of the Securities Act for issuances not involving a public offering. The shares were valued at $5.65 per share and $4.27 per share, respectively, the market price for shares of our common stock at the time of issuance. Therefore, the total aggregate value of the consideration paid to the Aston Organization was $1,557,000.

On May 7, 2004, we issued 120,000 shares of restricted common stock, and 200,000 warrants at $6.00 per warrant, to XCL Partners, Inc. 20,000 shares were released when the agreement was signed on June 24, 2004. The remaining 100,000 shares are to be released monthly based upon a vesting schedule of 10,000 shares per month for ten months , beginning 30 days after effective date of the agreement The services to be provided under the agreement are investor relations. 20,000 warrants shall vest immediately. The remaining 180,000 warrants shall be released monthly based on a vesting schedule of 15,000 warrants per month for eleven months. The shares were issued pursuant to the exemption from registration provided by Section 4(2) of the Securities Act for issuances not involving a public offering. The shares were valued at $4.09 per share, the market price for shares of our common stock at the time of issuance. Therefore, the total aggregate value of the consideration paid to the XCL Partners will be $ 490,800.

On May 10, 2004, we issued 300,000 shares to Madden Consulting, Inc. pursuant to a consulting agreement for investor and public relations services. The shares were issued pursuant to the exemption from registration provided by Section 4(2) of the Securities Act for issuances not involving a public offering. The shares were valued at $3.92 per share, the market price for shares of our common stock at the time of issuance. The total aggregate value of the consideration paid to Madden Consulting was $1,176,000.

On June 24, 2004, we issued 30.425 shares of our preferred stock, at a price per share of $100,000 and 357,936 common stock purchase warrants, each of which entitles the holder to purchase one share of our common stock, $.001 par value, for a period of three years from the date of issuance at a price equal to $5.50 per share to accredited investors pursuant to a private equity financing. Each share of the preferred stock is convertible into a number of fully paid and non-assessable shares of our common stock obtained by dividing the face value of $100,000 per share by the fixed conversion price of $4.25 per share. In addition, we issued to HC Wainwright, our placement agent, a three-year warrant to purchase up to 3 shares of our Series C Preferred Stock at a price of $100,000per share and up to 53,691 warrants on a pro-rata basis to the number of shares of Preferred Stock purchased upon exercise. We also issued 53,691 warrants to The Shemano Group, our co-placement agent. The private equity financing described above was made pursuant to the exemption from the registration provisions of the Securities Act for issuances not involving a public offering provided by Section 4(2) of the Act and Rule 506 of Regulation D promulgated thereunder. The securities issued have not been registered under the Act and may not be offered or sold in the United States absent registration or an applicable exemption from registration requirements.

On June 24, 2004, we issued 100,000 warrants to each of SF Capital Partners Ltd., Gryphon Master Fund, L.P., Banyon Asia Limited and Banyon Mac 24, Ltd. in consideration for services provided related to our recent private equity financing. The private equity financing described above was made pursuant to the exemption from the registration provisions of the Securities Act for issuances not involving a public offering provided by Section 4(2) of the Act and Rule 506 of Regulation D promulgated thereunder. The securities issued have not been registered under the Act and may not be offered or sold in the United States absent registration or an applicable exemption from registration requirements.

On July 21, 2004, we issued 100,000 shares of restricted common stock to Chet Howard, our former Chief Financial Officer and Chief Accounting Officer. The shares were issued pursuant to the exemption from registration provided by Section 4(2) of the Securities Act for issuances not involving a public offering. The shares were valued using the closing stock price on the date of issue, pursuant to which the stock was valued at $3.83 at the time of issuance. The total aggregate value of the consideration paid to Mr. Howard was valued at $383,000.

On July 21, 2004, we issued 100,000 shares of restricted common stock to Harry Zhang, our Chief Accounting Officer of our wholly owned subsidiary. The shares were issued pursuant to the exemption from registration provided by Section 4(2) of the Securities Act for issuances not involving a public offering. The shares were valued using the closing stock price on the date of issue, pursuant to which the shares were valued at $3.83 at the time of issuance. The total aggregate value of the consideration paid to Mr. Zhang was valued at $383,000.

On August 27, 2004, we issued 35,000 stock options to each to Montgomery Simus and Mark Bluer, both of whom are members of our Board of Directors. The options were valued using the Black Scholes value method, pursuant to which the options were valued at a total of $ 190,400 at the time of issuance.

On September 1, 2004, we issued stock options, for an aggregate of 100,000 shares to Dreamvest, LLC pursuant to a consulting agreement. The options were issued pursuant to the exemption from registration provided by Section 4(2) of the Securities Act for issuances not involving a public offering. The options were valued using the intrinsic value method, pursuant to which the options were valued at $2.69 at the time of issuance.

On September 8, 2004, we issued stock options, for an aggregate of 57,500 stock options to RCG Capital Markets Group, Inc., pursuant to a consulting agreement. A Termination Agreement, dated January 14, 2005 terminated the consulting agreement with RCG. The options were issued pursuant to the exemption from registration provided by Section 4(2) of the Securities Act for issuances not involving a public offering. The options were valued using the intrinsic value method, pursuant to which the options were valued at $3.90 at the time of issuance.

On September 10, 2004, we issued 83,334 shares of restricted common shares to Peter Cunningham, our Chief Executive Officer pursuant to his employment agreement. The shares were issued pursuant to the exemption from registration provided by Section 4(2) of the Securities Act for issuances not involving a public offering. The shares were valued at $3.83 per share, the market price for shares of our common stock at the time of issuance. Therefore, the total aggregate value of the consideration paid to Mr. Cunningham was valued at $319,169.

In October 2004, we engaged Byrle Lerner, a beneficial owner of more than five percent of our common stock (6.44%), to provide consulting services to AXM Pharma. Mr. Lerner will receive 60,000 restricted common shares and 100,000 options to purchase our common stock at $2.15 per share for his services. The current agreement with Mr. Lerner is for one year and is terminable by either Mr. Lerner or us upon thirty days written notice.

In October 2004, we engaged Aurelius Consulting to provide marketing and investor relations services. The initial term of the agreement is one year. Aurelius is entitled to receive 12,500 shares of our restricted common stock per quarter during the term of its agreement, in consideration for their services. The initial 12,500 shares were paid on behalf of AXM Pharma by Byrle Lerner in a private transfer. The shares were valued at $2.29 per share, the market price for shares of our common stock at the time of transfer. Therefore, the total aggregate value of the transaction recognized by AXM Pharma was $28,625.

In October 2004, we agreed to issue Mirador Consulting 30,000 restricted common shares pursuant to a consulting agreement with a 3 month term that may be renewed upon the written consent of both Mirador and us. The agreement is for corporate consulting and investor relations services. The 30,000 shares were paid on behalf of AXM Pharma by Byrle Lerner in a private transfer. The shares were valued at $2.15 per share, the market price for shares of our common stock at the time of transfer. Therefore, the total aggregate value of the transaction recognized by AXM Pharma was $64,500.

On January 19 and June 29, 2005, we issued 50,017 and 28,583 shares of common stock as dividends to Series C Preferred shareholders as payment of interest totaling $141,048 and $40,016, respectively.

On March 31, 2005 we issued 350,000 shares of restricted common stock to Madden Consulting as compensation for investor relations consulting services. The stock was valued at $2.74 per share, the closing stock price on the date of issuance, the Company recognized $959,000.

In March 2005, we issued 94,117 shares of common stock to Iroquis Capital for the conversion of 4 shares of Series C Preferred Stock.

In March 2005, we issued 725,000 shares of common stock to SF Capital for the conversion of 725,000 shares of Series A Preferred.

In March 2005, we issued 30,000 shares of restrict stock to each of XCL Partner Inc. and Ashton Organization pursuant to consulting services. The total value the consideration was $80,400 and $79,500, respectively.

On April 1, 2005, we issued 40,000 shares of restricted common stock to Newbridge Securities as compensation for investor relations consulting services. The stock was valued at $2.75 per share, the closing stock price on the date of issuance; the Company recognized $110,000 in expenses for the issuance of this stock. On April 1, 2005 we issued 45,000 shares of stock to Zhu Ming and 10,000 shares of stock to Li Shuzhen, both at $2.75 per share and totaling $151,250 for certain license rights.

On April 19, 2005, AXM Pharma, Inc. accepted subscriptions in the amount of $3,125,000, with 8 accredited investors pursuant to a private equity financing. The placement was co-managed by H.C. Wainwright & Co, Inc. and Chardan Capital Markets. Net proceeds from the offering after estimated costs and expenses, including fees of the placement agent, were approximately $2,767,500. We issued 6.25 Units, each consisting of one (1) $500,000 Secured Promissory Note and three hundred thousand (300,000) Common Stock Purchase Warrants (Series A Warrants) and three hundred thousand (300,000) special Common Stock Purchase Warrants (Series B Warrants). For each $500,000 of Notes purchased pursuant to that certain Note and Warrant Purchase Agreement entered into on April 19, 2005 between the Company and those Purchasers listed on Exhibit A to the Agreement, such Purchaser shall receive a Series A Warrant to purchase up to 300,000 shares of Common Stock at an exercise price of $2.90 per share and a Series B Warrant to purchase up to 300,000 shares of Common Stock at an exercise price per share of $3.50. Each Purchaser shall also be entitled to receive a Series C Warrant to purchase a number of shares of Common Stock equal to one hundred percent (100%) of the number of Conversion Shares issuable upon conversion of such Purchaser’s Note at an exercise price per share equal to the Conversion Price. The Series A Warrants and the Series B Warrants shall expire five (5) years following the Closing Date and the Series C Warrants shall expire one (1) year following the effective date of the registration statement providing for the resale of the Conversion Shares and the Warrant Shares.

Each Note is due on April 19, 2007 and is convertible at the option of the holder anytime in whole or in part at $2.10. The notes bear interest at the rate of nine percent (9%) per annum, convertible into shares of AXM’s common stock, par value $0.001 per share. The interest is payable monthly commencing on the fifth (5 th ) month following the issuance date, in cash or in shares of AXM’s common stock. Commencing on the fifth (5 th ) month following the issuance date and continuing thereafter on the first (1 st ) business day of each month until the maturity date, AXM shall pay the principal installment amount equal to one-twentieth (1/20 th ) of the original principal amount of the note plus any accrued but unpaid interest to the holder; provided, however, if on any principal payment date, the outstanding principal amount of the note plus any accrued but unpaid interest is less than the principal installment amount, then AXM shall pay such lesser amount. AXM may pay the Principal Installment Amount in cash or registered shares of common stock. If AXM elects to pay the principal installment amount in registered shares of common stock, the number of registered shares of common stock to be issued to the holder shall be an amount equal to the Principal Installment Amount divided by eighty-five percent (85%) of the average of the VWAP for the five (5) trading days immediately preceding the principal payment date; provided , that , in no event shall the number of registered shares of common stock to be issued to the holder be greater than an amount equal to the principal installment amount divided by eighty percent (80%) of the VWAP on the date AXM provides the holder with notice as to how AXM will pay the upcoming Principal Installment Amount, which notice must be given ten (10) business days prior to such payment.

The parties to the Note and Purchase Agreement, along with AXM’s wholly owned subsidiary AXM Pharma (Shenyang) Inc., also entered into a Security Agreement dated April 19, 2005. Pursuant to the Security Agreement, Investors are granted a security interest in the real property at which AXM Pharma (Shenyang) Inc.’s factory is located and all equipment and inventory of every kind and nature located on the real property, as well as all proceeds and products of such real property, except for any accounts receivables. This security is senior to all other creditors except for the existing line of credit with Shanghai Pudong Development Bank. Additionally, AXM also granted a security interest in 100% of the shares of its wholly owned subsidiary, Werke Pharmaceuticals, Inc., which owns AXM Shenyang.

In addition to its fees and expenses, the placement agent and co-placement agent, or its assigns, will receive commissions and warrants as follows, but each agent shall only receive such commissions and warrants for the investors participating in the offering through each agent’s own efforts. A selling commissions in an amount equal to 10% of the gross subscription proceeds shall be awarded, as well as one (1) 5-year Warrant to purchase shares of the Company’s Common Stock at $2.90 per share for each 10 shares underlying the Notes and Warrants issued by the Company in connection with the offering.

We are obligated to file a registration statement within 30 days of the closing covering the shares of common stock underlying the Notes and Warrants and an additional number of shares to account for monthly redemptions.

On April 22 and April 26, 2005, we issued totaling 78,329 shares of common stock to SRG Capital for the conversion of fractional shares of Series C Preferred.

On June 14, 2005, we issued 11,700 shares of common stock to Gryphon Master Fund for the conversion of 11,700 shares of Series A Preferred Stock.

On July 1 and August 10, 2005, we issued totaling 111,800 shares of Common Stock to National Financial Service in connection with the conversion of 111,800 shares of its Series A Preferred Stock.

On August 8, 2005, we completed a sale of shares of Common Stock by the exercise of the Company’s warrant for gross proceeds of $2,127,436. This financing was made pursuant to a Special Warrant Offer extended to the purchasers listed in the Note and Warrant Purchase Agreement dated as of April 19, 2005.

On August 31, 2005, we issued 150,000 shares to Madden Consulting, Inc. pursuant to a consulting agreement. The services to be provided under the consulting agreement were investor and public relations, which was valued at $252,000.

On September 9, 2005, we issued 50,000 shares to Ashok Patel pursuant to a consulting agreement. The services to be provided under the consulting agreement were advisory of strategic licensing and marketing, which was valued as $77,000.

On September 19, 2005, we issued 245,645 shares of Common Stock (valued at $334,077) to convertible debenture holders in payment of principal and interest due under the debentures. Of this amount, $171,250 represented principal payments and the balance interest expense.

Equity Compensation Plan Information

Plan Category	(a) Number of securities to be issued upon exercise of outstanding options, warrants and rights		(b) Weighted average exercise price of outstanding options, warrants and rights		(c) Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a)
Equity Compensation plans approved by security holders		2,477,500	$	4.58		522,500
Equity compensation plans not approved by security holders		1,493,334	$	4.05		0
Total		2,477,500	$	4.58		522,500

We did not issue any options in 2005 under our 2005 equity incentive plan, approved by our shareholders in March 2005.

Item 7:

Management’s Discussion and Analysis of Financial Condition and Results of Operations

General

AXM Pharma, Inc. is a pharmaceutical and nutraceutical company engaged in the production, marketing and distribution of over the counter and prescription pharmaceutical products in China. We have licenses to produce, market and distribute drug products in various dosages and forms, as well as herbal remedies and vitamins. Currently, subject to having sufficient resources, we plan to develop sales of Chinese products such as Asarone, Lifegate, LiveComf and Elegance though our operations in Shenyang. Products sold through AXM Shenyang will be sold primarily to the mainland Chinese market, which includes hospital and retail sales. We plan to continue to deemphasize hospital sales in favor of retail sales through pharmacies, which generally provide better margins than hospital sales.

Liquidity and Capital Resources

We are in urgent need of additional capital. Our cash resources have been depleted. We have not paid our employees in China since January 2006. We are in default under the terms of certain promissory notes as described more fully below under “Risk Factors - We are currently in default on our obligations under our Convertible Promissory Notes.” These conditions raise substantial doubt about our ability to continue as a going concern. The audit report prepared by our independent registered public accounting firm relating to our consolidated financial statements for the year ended December 31, 2005 includes an explanatory paragraph expressing the substantial doubt about our ability to continue as a going concern. We are currently in discussions with several funding sourcess in China to obtain financing to support operations going forward; however, to date these discussions have not resulted in our obtaining any additional financing. At this time, we do not know if additional financing will be available, nor can we predict the terms of any additional financing. If we do not raise additional capital in the immediate future, we may be forced to cease operations. If additional capital is raised through the sale of equity or convertible debt securities, the issuance of such securities would result in dilution to our existing stockholders. If additional capital is raised through incurrence of indebtedness, our interest expense will likely increase and restrictive covenants imposed by the lenders may impair our ability to grow our business.

Under the terms of certain Secured Promissory Notes issued on April 19, 2005, we are obligated to pay interest and principal monthly in cash or shares. However, we are obligated to make payments in cash if our share price falls below a certain price calculated under a formula specified in the Notes. We are currently in default in our payment obligations because we have not been able to pay the required repayment of principal and interest to the holders of the Notes. We are in negotiations with the holders with a view to restructuring the terms of the Notes. However, no agreement has been reached and, if we fail to reach an agreement, it will likely be impossible for us to raise any new funds (see “Risk Factors - We are currently in default on our obligations under our Secured Promissory Notes ”.)

Cash Sources and Uses

Total assets increased from $12,516,807 at December 31, 2004 to $13,833,946 at December 31, 2005. The increase is primarily attributable to the receipt of $4,941,192 and $2,654,467 in net proceeds from the placement of securities and short-term bank loans offset by losses incurred in normal operations.

Our total outstanding current liabilities increased to $12,969,219 at December 31, 2005, as compared to approximately $7,553,587 at December 31, 2004. The increase in current liabilities was the result of an increase in short-term loans and accrued interest and principle on the secured promissory notes.

From December 31, 2004, to December 31, 2005, our cash and cash equivalents decreased by approximately $1,163,061. We received net proceeds from the sale of the secured promissory notes of $3,034,000. We also received $1,907,193 form the exercise of warrants to acquire common stock. These amounts were offset by general, administrative and selling expenses of approximately $7,621,405. The sales, general and administrative expenditures were incurred primarily in connection with offerings of securities, marketing expenses and legal, accounting and consulting fees. We incurred approximately $2 million and $5.6 million of non-cash general, administrative and selling expenses in 2005 and 2004, respectively. The non-cash expense is incurred for services (e.g. financial consulting and investor relations services) for which we pay our vendor in shares of our common stock.

Capital used to date in activities associated with the building and certification of the new facilities in Shenyang is approximately US$7.4 million. To fulfill our planned sales expansion, implement the required systems and fund our working capital needs, we will need to raise approximately $6 million in additional funds during 2006. We are currently seeking to raise this additional capital through either sales of our equity securities or debt financing, secured by our factory and equipment in Shenyang, but there cannot be any guarantees that we will be able to raise this additional capital on acceptable terms or at all. We are not currently in a position to generate cash inflows by calling for the exercise of any of our outstanding warrants because the trading price of our stock is below $2.1 per share. If we are not able to raise additional capital, we will be forced to cease operations.

Financing Activities

On August 8, 2005, we completed the sale of 1,488,100 shares of Common Stock for gross proceeds of $2,127,436 (net proceeds of $1,907,193). This financing was made pursuant to a Special Warrant Offer extended to the purchasers listed in the Note and Warrant Purchase Agreement dated as of April 19, 2005. Eight out of the nine original purchasers participated in the Special Warrant Offer.

On April 19, 2005 we completed a private financing with 9 accredited investors. We executed notes totaling $3,125,000. Net proceeds from the issuance of the notes after offering costs were approximately $2,767,500. The notes were issued as a portion of 6.25 Units, each consisting of one (1) $500,000 Secured Promissory Note; three hundred thousand (300,000) Common Stock Purchase Warrants (Series A Warrants); and three hundred thousand (300,000) special Common Stock Purchase Warrants (Series B Warrants ). The Notes bear interest at 9% and are repayable in equal installments during the period September 2005-April 2007 (see description above under Recent Sales of Unregistered Securities .)

Results of Operations

Year Ended December 31, 2005 Compared to Year Ended December 31, 2004.

Revenue - During the fiscal year ended December 31, 2005, we generated $2,021,728 from product sales compared to revenues from product sales for the fiscal year ended December 31, 2004, of $2,115,751. Approximately 60% or our 2005 revenues were derived from the sale of Sunkist labeled products. Due to the termination of our license arrangements with Sunkist, we will have only minimal sales in 2006 derived from the Sunkist-labeled products. The balance of our 2005 sales and all of our 2004 sales were derived from products produced by our Shenyang operations. The decline in sales of Shenyang produced products from 2005 to 2004 is principally a result of lack of adequate capital has severely constrained our ability to market and promote our products.

During the second quarter of 2005, we entered into three international markets for our Sunkist-labeled products: Hong Kong; Taiwan and the PRC. Although we received purchase orders for certain products from distributors in these territories, we concluded that, under our distribution agreements, several of the elements necessary to the recognition of the revenue related to these purchase orders were not in place as of September 30, 2005. Therefore, we restated our financial statements for the quarter ended June 30, 2005. In addition, we concluded that the business arrangements with our distributors for the Sunkist-labeled products were not satisfactory. We therefore entered new distribution agreements with Kerryflex Supply Chain Solutions Limited and a Memorandum of Understanding with DKSH Taiwan Limited in Hong Kong and Taiwan in the forth quarter of 2005. We recognized revenue of Sunkist labeled products of $1.2 million in 2005 taking into account the restatement.

Our license agreements with Sunkist in Hong Kong, Macau and Taiwan expired at December 31, 2005, and our license for China was terminated in February 20, 2006. As a result, we no longer have any right to sell Sunkist-labeled products.

Future revenues will be derived from the sale of products produced at our Shenyang facility. To date, our ability to conduct manufacturing operations at Shenyang and sales activity in China has been severely constrained by our lack of funds. If we are unable to raise substantial additional funds, we may not have the ability to generate significant sales from our Shenyang operation. In such event, we may consider licensing arrangements or other strategies. However, we have no such arrangements in place and no assurance can be given that satisfactory arrangements can be obtained.

Gross Profit - Gross profit on product sales for the fiscal year ended December 31, 2005, was $772,368 compared to $1,065,468 for the fiscal year ended December 31, 2004. The decrease was the result of lower margins on the Sunkist labeled products.

Sales, General and Administrative Expenses - We incurred Sales, General and Administrative expenses of $ 9,629,424, for fiscal year ended December 31, 2005, compared to $15,055,322 for the fiscal year ended December 31, 2004, a decrease of $5,425,898. The decrease in expenses is primarily due to the decrease in consulting fees and personnel costs. We incurred approximately $2 million in 2005 in non-cash SG&A expenses in recognition of stock, warrants and options issued to cover administrative services provided by consultants and approximately $7.6 million of cash expenditures, a decrease of $1.8 million from the same period last year.

Inventory written-off - We delivered Sunkist brand products of Chewchew Bear multi-vitamins to distributors, of which, $313,000 of such product was labeled to be sold in China. However, we had not obtained the necessary import license for this product from the Chinese government as of December 31, 2005. The inventories remain in the distributor’s warehouse in Hong Kong. We can not predict when we will obtain the necessary license to remove this product from the distributor’s warehouse. Accordingly, we have written off the value of this product from our inventory. During 2005, we outsourced and manufactured Sunkist brand products of Leafs vitamin supplement strips in China. The raw material had quality problems, resulting in a write-off of $219,000. As a result of the above, we took an inventory write-off of approximately $532,000 during 2005

Non-Cash Consulting Expenses - During the year ended December 31, 2005, our Board of Directors authorized the issuance of shares of our restricted common stock, warrants and stock options to various consultants in lieu of cash payments. Based upon the common stock trading price at the times of issuance, and FASB rules, we were required to incur non-cash consulting expenses of approximately $2 million for the issuance of these shares during the year ended December 31, 2005.

Net Loss – As a result of the above, we recorded a net loss from operations for the fiscal year ended December 31, 2005, of $9,247,932 compared to a net loss of $13,250,883 for the fiscal year ended December 31, 2004. The decrease is the result of the aforementioned decrease in Selling, General and Administrative expenses. The net loss per share for the year ended December 31, 2005 was $0.45 per share calculated on weighted average shares outstanding of 20,433,762, compared to a net loss per share for the year ended December 31, 2004 of $0.82 calculated on weighted average shares outstanding of 16,066,789.

Critical Accounting Policies

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

Revenue Recognition- Product sales revenue is recognized when the goods are shipped, title and risk of loss passes and collectability is reasonably assured. In situations where a distributor’s sales reporting to us is inadequate or untimely, we have to judge whether all of the elements required for revenue recognition have been met, including assurance of collectability. In such instances, we may conclude that revenue recognition of such sales should be delayed until payments are received from the distributor. Any provision for discounts and estimated returns are accounted for in the period the related sales are recorded.

Allowance for Doubtful Accounts - We maintain allowances for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. The allowance for doubtful accounts is based on specific identification of customer accounts and our best estimate of the likelihood of potential loss, taking into account such factors as the financial condition and payment history of major customers. We evaluate the collectability of our receivables at least quarterly. If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required. The differences could be material and could significantly impact cash flows from operating activities.

Sales Allowances - A portion of our business is to sell products to distributors who resell the products to the end customers. In certain instances, these distributors obtain discounts based on the contractual terms of these arrangements. Sales discounts are usually based upon the volume of purchases or by reference to a specific price in the related distribution agreement. We recognize the amount of these discounts at the time the sale is recognized. Additionally, sales returns allowances are estimated based on historical return data, and recorded at the time of sale. If the quality or efficacy of our products deteriorates or market conditions otherwise change, actual discounts and returns could be significantly higher than estimated, resulting in potentially material differences in cash flows from operating activities.

Inventory - We write down our inventory for estimated obsolescence or unmarketable inventory equal to the difference between the cost of inventory and the estimated market value based upon assumptions about future demand, future pricing and market conditions. If actual future demands, future pricing or market conditions are less favorable than those projected by management, additional inventory write-downs may be required and the differences could be material. Such differences might significantly impact cash flows from operating activities.

Accounting for Stock-Based Compensation - We account for stock-based compensation for employees and non-employee members of our board of directors in accordance with Accounting Principles Board, or APB, Opinion No. 25, “Accounting for Stock Issued to Employees.” Under APB Opinion No. 25, compensation expense is based on the intrinsic value on the measurement date, calculated as the difference between the fair value of our common stock and the relevant exercise price. We account for stock-based compensation for non-employees, who are not members of our board of directors, at fair value using a Black-Scholes option-pricing model in accordance with the provisions of SFAS No. 123, “Accounting for Stock-Based Compensation” and other applicable accounting principles. There were 2,140,000 stock options granted to employees and directors in 2004. There were not any options granted to employees in 2005.

Had compensation expense been determined based on the estimated fair value at the measurement dates of awards under those plans consistent with the method prescribed by SFAS No. 123, our December 31, 2005 and 2004 net loss would have been changed to the pro forma amounts indicated below. No options were granted in 2005.

In December 2002, the Financial Accounting Standards Board issued its Statement No. 148, “Accounting for Stock-Based Compensation — Transition and Disclosure—an amendment of Financial Accounting Standards Board Statement No. 123.” This Statement amends Statement of Financial Accounting Standards No. 123, to provide alternative methods of transition for an entity that voluntarily changes to the fair value based method of accounting for stock-based employee compensation. It also amends the disclosure provisions of Statement of Financial Accounting Standards No. 123 to require prominent disclosure about the effects on reported net income of an entity’s accounting policy decisions with respect to stock-based employee compensation. The transition and annual disclosure provisions of Statement of Financial Accounting Standards No. 148 are effective for fiscal years ending after December 15, 2002, and the interim disclosure provisions were effective for the first interim period beginning after December 15, 2002. We did not voluntarily change to the fair value based method of accounting for stock-based employee compensation, therefore, the adoption of Statement of Financial Accounting Standards No. 148 did not have a material impact on our operations and/or financial position.

Convertible Preferred Stock - Convertible Preferred Sock issued by AXM Pharma is initially offset by a discount representing the relative fair values of the embedded conversion option in the Preferred Stock and the warrants issued with the Preferred Stock. The fair value of the warrants and embedded conversion option are calculated based on available market data using appropriate valuation models. The excess of the sum of the values of the embedded conversion option plus the warrants over the cash proceeds received from the issuance of the Preferred Stock is charged to interest expense.

Secured Promissory Notes - Convertible Secured Promissory Notes that we issued are initially offset by a discount representing the relative fair values of the conversion option embedded in the Notes and warrants issued with the Notes. The fair value of the warrants and embedded conversion option are calculated based on available market data using appropriate valuation models. The excess of the sum of the values of the embedded conversion option plus the warrants over the cash proceeds received from the issuance of the Notes is charged to interest expense. The carrying value of the Notes is accreted to the face amount over the term of the Notes using an effective interest method.

Warrants - Warrants issued in connection with our Secured Promissory Notes and Convertible Preferred Stock have been classified as liabilities due to certain provisions that may require cash settlement in certain circumstances. At each balance sheet date, we adjust the warrants to reflect their current fair value. We estimate the fair value of these instruments using the Black-Scholes option pricing model which takes into account a variety of factors, including historical stock price volatility, risk-free interest rates, remaining term and the closing price of our common stock. Changes in the assumptions used to estimate the fair value of these derivative instruments could result in a material change in the fair value of the instruments. We believe the assumptions used to estimate the fair values of the warrants are reasonable. See Item 6A. Quantitative and Qualitative Disclosures about Market Risk for additional information on the volatility in market value of derivative instruments.

Deferred Financing Costs.- Deferred financing costs attributable to the issuance of Secured Promissory Notes and Convertible Preferred Stock have been amortized to interest expense over the term of those instruments.

Fair Value of Financial Instruments - Financial instruments that are subject to fair disclosure requirements are carried in the financial statements at amounts that approximate fair value and include cash and cash equivalents, accounts receivable and accounts payable. Fair values are based on assumptions concerning the amount and timing of estimated future cash flows and assumed discount rates reflecting varying degrees of perceived risk.

Valuation of Intangibles - From time to time, we acquire intangible assets that are beneficial to our product development processes. We periodically evaluate the carrying value of intangibles, including the related amortization periods. In evaluating acquired intangible assets, we determine whether there has been impairment by comparing the anticipated undiscounted cash flows from the operation and eventual disposition of the product line with its carrying value. If the undiscounted cash flows are less than the carrying value, the amount of the impairment, if any, will be determined by comparing the carrying value of each intangible asset with its fair value. Fair value is generally based on either a discounted cash flows analysis or market analysis. Future operating income is based on various assumptions, including regulatory approvals, patents being granted, and the type and nature of competing products. If regulatory approvals or patents are not obtained or are substantially delayed, or other competing technologies are developed and obtain general market acceptance or market conditions otherwise change, our intangibles may have a substantially reduced value, which could be material .

Deferred Taxes - We record a valuation allowance to reduce the deferred tax assets to the amount that is more likely than not to be realized. We have considered estimated future taxable income and ongoing tax planning strategies in assessing the amount needed for the valuation allowance. Based on these estimates, all of our deferred tax assets have been reserved. If actual results differ favorably from those estimates used, we may be able to realize all or part of our net deferred tax assets. Such realization could positively impact our operating results and cash flows from operating activities.

Value Added Tax - Value added tax payable is reported as a significant liability. The accounting policies adopted by management include full disclosure of the value added tax liability calculated at 17% of the difference between ex-factory price and the cost of raw materials, less the cost of the fees paid to the third-party original equipment manufacturing company.

Litigation - We account for litigation losses in accordance with Statement of Financial Accounting Standards (SFAS) No. 5, “Accounting for Contingencies.” Under SFAS No. 5, loss contingency provisions are recorded for probable losses at management’s best estimate of a loss, or when a best estimate cannot be made, a minimum loss contingency amount is recorded. These estimates are often initially developed substantially earlier than the ultimate loss is known, and the estimates are refined each accounting period, as additional information is known. Accordingly, we are often initially unable to develop a best estimate of loss; therefore, the minimum amount, which could be zero, is recorded. As information becomes known, either the minimum loss amount is increased or a best estimate can be made, resulting in additional loss provisions. Occasionally, a best estimate amount is changed to a lower amount when events result in an expectation of a more favorable outcome than previously expected. Due to the nature of current litigation matters, the factors that could lead to changes in loss reserves might change quickly and the range of actual losses could be significant, which could materially impact our results of operations and cash flows from operating activities.

ITEM 7A

- QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

Fair Value of Warrants and Derivative Liabilities . As of December 31, 2005, the value of our warrant liability was $2.9 million. We estimate the fair value of these instruments using the Black-Scholes option pricing models, which takes into account a variety of factors, including historical stock price volatility, risk-free interest rates, remaining maturity and the closing price of our common stock. We believe that the change in value from period to period is most significantly impacted by the closing price of our common stock at each reporting period. The following table illustrates the potential effect on the fair value of derivative securities of changes in certain assumptions made:

	Increasedecrease
	(in thousands)

10% increase in stock price	$	404
20% increase in stock price	$	818
5% increase in assumed volatility	$	200

10% decrease in stock price	$	(431	)
20% decrease in stock price	$	(808	)
5% decrease in assumed volatility	$	(236	)

Item 8.

Financial Statements and Supplementary Data

The financial statements and financial statement schedules begin on page F-1 of this report.

Item 9.

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

None.

Item 9A. Controls and Procedures

Evaluation and Disclosure Controls and Procedures

We have evaluated the effectiveness of the design and operation of our “disclosure controls and procedures,” as such term is defined in Rules 13a-15e promulgated under the Exchange Act as of this report. Based upon the evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures were not effective as of the end of the period covered by this report to provide reasonable assurance that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is recorded, processed, summarized and report within the time periods specified in SEC rules and forms.

In this regard, our current management noted in particular our restatement necessitated by an improper recognition of revenues in the second quarter of 2005. In order to address this matter, we have undertaken a number of steps to improve our disclosure process. We have changed our Chief Financial Officer and the composition of our Audit Committee. We have appointed an experienced and independent individual who qualifies as a financial expert to serve as Chair of the Audit Committee. We have implemented a more rigorous disclosure process. Nonetheless, in light of our limited financial resources and the concomitant limitations on our financial reporting infrastructure, we believe it is premature to conclude that our disclosure controls and procedures are effective.

Changes in Internal Controls

The Company maintains a system of disclosure controls and procedures. The term “disclosure controls and procedures,” as defined by regulations of the SEC, means controls and other procedures that are designed to ensure that information required to be disclosed in the reports that the Company files or submits to the SEC under the Securities Exchange Act of 1934, as amended (the “Act”), is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by the Company in the reports that it files or submits to the SEC under the Act is accumulated and communicated to the Company’s management, including its Chief Executive Officer and its Principal Financial Officer, as appropriate to allow timely decisions to be made regarding required disclosure.

The Company’s Chief Executive Officer and the Audit Committee of the Board of Directors completed an evaluation of the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended) for the year ended December 31, 2005 and concluded that the Company’s disclosure controls and procedures were not effective as of the end of that period. Specifically, management and the Audit Committee of the Board of Directors believe that the Company’s disclosure controls and procedures have not been adequate in the following respects:

The Company did not maintain effective controls, including policies and procedures, over accounting for financing agreements and related party transactions.

The Company did not maintain effective controls to provide reasonable assurance that management oversight and review procedures were properly performed over the accounts and disclosures in its consolidated financial statements, and that accounts were complete and accurate and consistent with detailed supporting documentation. In addition, the Company did not maintain effective controls over communications among its management to provide reasonable assurance that the preparation of its consolidated financial statements and disclosures were complete and accurate.

These inadequacies prompted management to adopt remedial measures. Certain of these measures have been implemented as of the date of filing of this Form 10-K/A; others are currently in process of being implemented.

Remediation Measures:

As of March 1, 2008, the Company has taken the following steps to remediate the inadequacies in the Company’s disclosure controls and procedure for related party transactions:

Any out of the ordinary course of business payment made to any current or former investor and/or their families and associates will be subject to approval by the Chair of the Company’s Audit Committee.

As of March 1, 2008, the Company has taken the following steps to remediate the inadequacies in the Company’s disclosure controls and procedure for financing agreements:

The finance department has adopted a schedule for preparation of financial reports that provides the CEO and Accounting Manager sufficient lead time to review and comment on the financial reports. Included on the schedule are monthly “close” meetings with the CEO and the Chairman of the Audit Committee to review the closing financial statements.

The Company has created a committee responsible for disclosure matters that will report to senior management. The committee will meet on a monthly basis to determine whether any material events have occurred, or are likely to occur, that may require disclosure in a current or periodic report

The finance department will review with the Chairman of the Audit Committee on a timely basis, and in no event, later than the monthly finance meeting, any events that signal a significant deficiency or material weakness

Item 9B.

Other Information

None.

PART III.

Item 10.

Directors and Executive Officers of the Registrant

The following table and text set forth the names and ages of all directors and executive officers of AXM Pharma as of April 28, 2006. On September 25, 2005, we elected Baozhong Zhang to serve on the Board of Directors. On October 13, 2005, Chet Howard resigned as Chief Executive Officer and Chief Financial Officer of the Company. On that same day, Wang Wei Shi was elected by the Board of Directors to serve as the Company’s Chief Executive Officer and elected Harry Zhang to serve as the Company’s Chief Financial Officer. On March 8, 2006, we elected Elliot M. Maza and Wenzhou Zhang to serve as directors on the Board of Directors. Elliot M. Maza also serves as the Chairman of the Audit Committee.

The Board of Directors is comprised of only one class. All of the directors will serve until the next annual meeting of shareholders, which is anticipated to be held in May of 2006, and until their successors are elected and qualified, or until their earlier death, retirement, resignation or removal. There are no family relationships among directors and executive officers. Also provided herein are brief descriptions of the business experience of each director and executive officer during the past five years and an indication of directorships held by each director in other companies subject to the reporting requirements under the Federal securities laws.

Name	Age	Position

Wang Wei Shi	48	Chairman

Harry Zhang	42	Acting Chief Financial Officer

Elliot M. Maza	50	Director

Baozhong Zhang	61	Director

Wenzhou Zhang	63	Director

Zhenyu Kong	61	President of China Operations & Chief Operating Officer of AXM Sheyang

Ms. Wang Wei Shi, Chairman . Ms. Wang became Chairman of AXM Pharma when we acquired Werke Pharmaceuticals, Inc. in March 2003 and has been Chairman of AXM Shenyang and Vice-Chairman of Werke Pharmaceuticals, Inc. since December 2000. From 1999 until December 2000, Ms. Wang was Chairman and General Manager of Shenyang Tianwei Pharmaceutical Factory, Ltd., a predecessor to AXM Shenyang. Since May 1996, she has also been Chairman of Liaoning Shenda Import and Export Company, a Chinese import/export company. From 1984 through 1988, Ms. Wang was the Manager of the Finance Department of the Shenyang Five Mineral Import and Export Company, a Chinese import/export company. Ms. Wang attended Beijing University and Shenyang University and studied financial management, accounting and economics.

Harry Zhang, Chief Financial Officer. Mr. Zhang became Chief Financial Officer on October 13, 2005. Mr. Zhang has been the Chief Accounting Officer for the our subsidiary, AXM Pharma Shenyang, Inc. since 2004. For the 4 years prior thereto he was employed by the international accounting firm of Deloitte and Touche LLP, initially as a senior auditor in its New York office for 2 years and then as audit manager for its Beijing office for an additional two years.

Elliot M. Maza, Director. Mr. Maza became a director on March 8, 2006. Mr. Maza also currently is the Chief Financial Officer of Emisphere Technologies, Inc. (NASDAQ: EMIS), a biopharmaceutical company. During his career, Mr. Maza has held distinguished positions in the areas of finance and law. While at Emisphere, he has successfully restructured the company’s indebtedness, helped the company raise capital and implemented Section 404 under the Sarbases-Oxley Act. Since December 2004, he has also served as a member of the Board of Directors and chairman of the audit committee of Tapestry Pharmaceuticals Inc. (NASDAQ: TPPH). Previously, he was a Partner at Ernst and Young LLP and a Vice President at Goldman Sachs, JP. Morgan Securities and BT Securities Corporation. Mr. Maza previously practiced law at Sullivan and Cromwell LLP. He received his J.D. degree from the University of Pennsylvania Law School in 1985 and his C.P.A. from the State of New Jersey in 1981.

Baozhong Zhang, Director. Mr. Zhang was elected to serve on the Board of Directors on September 25, 2005. Mr. Zhang has extensive international pharma experience, having spent 36 years in the pharma sector, including 15 years as a vice general manager and general manager of Northeastern Pharmaceutical Group, and 21 years as technician, engineer, vice general manager and general manager with the Sixth Pharmaceutical Factory in Northeast China.

Wenzhou Zhang, Director. Mr. Zhang became a director on March 8, 2006. Mr. Zhang has 38 years of pharmaceutical industry experience and management experience in China. For the past 10 years, he has served as a Vice Official to the State Food and Drug Administration and the State Drug Administration in China. Previous to that time, Mr. Zhang served as the Secretary of Chongqing Municipality, the Chairman of the Chongqing Economic Reform Committee, an official of Chongqing Drug Administration, and as a General Manager of Chongqing Pharmaceutical Factory.

Zhenyu Kong, President of China Operations and Chief Operating Officer of AXM Shenyang. Mr. Kong spent nearly 25 years at China National Pharmaceutical Group, China’s leading pharmaceutical company, where he was Chairman of China National Pharmaceutical Group United Engineering. China National Pharmaceutical Group Corp., also known as, SINOPHARM, is actively engaged in the research and development, capital investment, manufacture and trade of pharmaceuticals and medical instruments. SINOPHARM has achieved an annual sales volume of 10 billion RMB (over 1.2 billion U.S. Dollars) and a total import and export volume of 200 million U.S. Dollars. Prior to becoming Chairman of SINOPHARM, Mr. Kong was the Director of the Planning and Development Department of China National Pharmaceutical Group Corporation. From 1998 to 1999, Mr. Kong was the director of the International Department of China National. Mr. Kong has tremendous expertise in planning and developing extensive product portfolios and commendable strength in research, production, sales and distribution, as well as, international trade. Mr. Kong has held various leadership roles in many industry associations, which solidified his significant place in China’s pharmaceutical industry. He pioneered the organization of national drug and pharmaceutical ingredients exhibitions, national medical equipment exhibitions and other exhibitions in China and abroad. Mr. Kong has played a key role in the shaping of industry structure, improving market regulation, maintaining disaster reserves, overseeing pharmaceutical supplies, encouraging international economic and technological cooperation, as well as, foreign investment and technological exchanges. Mr. Kong attended Beijing Chemical Engineering University from 1963 to 1968.

Audit Committee Financial Expert and Identify Audit Committee :

The Audit Committee focuses its efforts on assisting our Board of Directors to fulfill its oversight responsibilities with respect to AXM Pharma’s:

Quarterly and annual consolidated financial statements and financial information filed with the Securities and Exchange Commission;

System of internal controls;

Financial accounting principles and policies;

Internal and external audit processes; and

Regulatory compliance programs.

The current Audit Committee members are Mr. Maza (Chair), Baozhong Zhang and Wenzhou Zhang. The committee meets periodically with management to consider the adequacy of AXM Pharma’s internal controls and financial reporting process. It also discusses these matters with AXM Pharma’s independent auditors and with appropriate financial personnel employed by AXM Pharma. The committee reviews our financial statements and discusses them with management and our independent auditors before those financial statements are filed with the Securities and Exchange Commission. The committee met 6 times in 2005 and 2006.

The committee has the sole authority to retain and dismiss our independent auditors and periodically reviews their performance and independence from management. The independent auditors have unrestricted access and report directly to the committee.

Audit Committee Financial Expert .

The Board has determined that the Chairman of the committee, Mr. Maza is an “audit committee financial expert” as that term is defined in Item 401(e) of Regulation S-B and “independent” for purposes of currently adopted American Stock Exchange listing standards and Section 10A(m)(3) of the Securities Exchange Act of 1934. Mr Maza is also currently on the Board of Directors and serves as chairman of the audit committee of Tapestry Pharmaceuticals Inc. Our Board of Directors has determined that such simultaneous service does not impair the ability of Mr. Maza to effectively serve as the Chairman of AXM Pharma’s Audit Committee.

Compliance with Section 16(a) of the Exchange Act

Section 16(a) of the Exchange Act requires our officers, directors and persons who own more than 10% of any class of our securities registered under Section 12(g) of the Exchange Act to file reports of ownership and changes in ownership with the SEC. Officers, directors and greater than 10% stockholders are required by SEC regulation to furnish us with copies of all Section 16(a) forms they file.

We believe that there was compliance with all other filing requirements of Section 16(a) applicable to our officers, directors and 10% stockholders during fiscal 2005.

Code of Ethics

The Company has always encouraged its employees, including officers and directors to conduct business in an honest and ethical manner. Additionally, it has always been our policy to comply with all applicable laws and provide accurate and timely disclosure. In February 2005, our Board adopted a formal written code of ethics for all of our employees.

Our codes of ethics are designed to deter wrongdoing and promote honest and ethical conduct and compliance with applicable laws and regulations. These codes also incorporate our expectations of our executives that enable us to provide accurate and timely disclosure in our filings with the Securities and Exchange Commission and other public communications. Our codes of ethics are posted on our website, http://www.axmpharma.com. Any future changes or amendments to our code of ethics, and any waiver of our codes of ethics will also be posted on our website when applicable.

You may obtain a copy of any of our codes of ethics at no cost, by written request to: AXM Pharma, Inc., 17870 Castleton Street, Suite 255, City of Industry, California; or, oral request at: (626) 964-2848.

Item 11.

Executive Compensation

SUMMARY COMPENSATION TABLE

		Annual Compensation						Long Term Compensation
								Awards					Payouts
Name And Principal Position (a)	Year (b)	Salary($) (c)		Bonus($) (d)		Other Annual Compen- sation ($) (e)		Restricted Stock Award(s) $ (f)		Securities Underlying Options/ SARs (#) (g)			LTIP Payouts $ (h)		All Other Compen- sation $ (i)
Wang Wei Shi President, CEO	2005	$	240,000		0		0		0		0			0		0
Chairman of	2004		240,000		0		0		0		300,000	(1)		0		0
the Board	2003		240,000		0		0		0		0			0		0

Harry Zhang CFO,	2005		120,000		0		0		0		0			0		0
Chief	2004		80,000		0		0		383,000		0			0		0
Accounting Officer	2003		0		0		0		0		0			0		0

Peter W.	2005		70,000		0		0		0		0			0		0
Cunningham	2004		240,000		0		0		208,335		40,000	(2)		0		0
Former President and CEO	2003		50,000		0		0		208,335		0			0		0

Chet Howard	2005		100,000		60,000		0		0		0			0		0
Former CFO	2004		120,000		0		0		383,000		0			0		0
	2003		0		0		0		0		0			0		0

(1) The purchase price of the shares of the Common Stock covered by the Option is $4.14 per share.

(2) The purchase price of the shares of the Common Stock covered by the Option is $4.14 per share.

OPTION/SAR IN LAST FISCAL YEAR

Option/SAR Grants

None of our executive officers were granted options or SARs during the last fiscal year.

Aggregated Option/Sar Exercised And Fiscal Year-End Option/Sar Value Table

None of our executive officers exercised options or SARs during the last fiscal year.

Long Term Incentive Plans

None of our executive officers were granted Long Term Incentive awards in the last fiscal year.

Board of Directors

Our directors who are employees do not receive any compensation from AXM Pharma for services rendered as directors. The Board has created three classes of fees for outside directors: (1) outside directors who are “independent,” as defined in the Exchange Act will be paid $4,500.00 per month; (2) outside directors who are not “independent” will receive $3,000.00 per month; and, (3) the Vice Chairman will receive a flat fee of $18,000.00 per month, inclusive of committee fees and the Chairwoman will receive a flat fee of $20,000.00 per month. All board members of U.S. citizenship are entitled to participate in AXM Pharma’s health insurance plan. Since August 24, 2004, our Board of Directors issued 2,030,000 stock options exercisable at $4.14 per share to members of our Board of Directors and employees and an additional 40,000 and 70,000 stock options exercisable at $5.70 and 2.72 per share, respectively. The foregoing options were granted under the Company’s 2004 Incentive and NonStatutory Stock Option Plan.

Employment Agreements

Mr. Cunningham was originally hired to serve as our Chief Operating Officer, but in September 2003, Mr. Cunningham was promoted to the positions of President and Chief Executive Officer. When Mr. Cunningham was promoted, other than the change in his responsibilities, the terms of his employment agreement remained the same. On January 31, 2005, Chet Howard replaced Mr. Cunningham as Chief Executive Officer. Mr. Cunningham became President of International Sales. Although other terms of his employment agreement had not yet been finalized, the Board approved certain aspects of Mr. Cunningham’s compensation, including Mr. Cunningham’s compensation of $10,000 per month for a one-year contract with AXM for this position. The Board also approved a three-month severance package for Mr. Cunningham in the event that he was terminated other than for cause. Additionally, Mr. Cunningham was to receive 3% of net sales based upon a projected budget that had been prepared and approved by the Board. Mr. Cunningham also had the opportunity to receive 5% of net sales if he retained any sales over the stated budget. Mr. Cunningham’s employment agreement was to be amended to reflect his position change, but a new employment agreement was never reached because Mr. Cunningham was terminated for cause on July 20, 2005.

On January 31, 2005, Chet Howard was appointed by the Board of Directors to replace Peter Cunningham as Chief Executive Officer. Mr. Howard became our Chief Executive Officer on February 1, 2005, and continued to act as our Chief Financial Officer until October 13, 2005 when he voluntarily resigned from the position. Pursuant to the terms of his agreement with AXM Pharma, Mr. Howard was paid a Base Salary of $240,000 per year, distributed in equal monthly installments. Mr. Howard also received a $60,000 signing bonus. In addition, Mr. Howard was entitled to receive 250,000 incentive employee stock options per year, vesting quarterly. During the term of his employment under the Agreement, at the Board’s discretion, Mr. Howard was also eligible to participate in all bonus and incentive plans. Mr. Howard was eligible to participate in all employee benefit plans to the extent maintained by the Company, including (without limitation) any life, disability, health, accident and other insurance programs, paid vacations, and similar plans or programs, subject in each case to the generally applicable terms and conditions of the plan or program in question and to the determinations of any committee administering such plan or program. Mr. Howard’s salary, bonus and incentives were reviewed by our Board of Directors and compensation committee with the goal of bringing his salary in line with industry standards. Mr. Howard’s employment agreement was for a two-year term. Mr. Howard voluntarily terminated his employment agreement. Upon his voluntary termination we accrued salary, vested deferred compensation (other than pension plan or profit sharing plan benefits, which were to be paid in accordance with the applicable plan), and accrued vacation pay, all to the date of termination, but no severance compensation. Mr. Howard’s agreement requires that he keep confidential any proprietary information acquired while employed and upon termination of his employment. He was also prohibited from soliciting any employees of AXM Pharma for a period of six months following his termination for any reason.

The Company entered into an employment agreement with Mr. Kong on March 31, 2005; Mr. Kong began his employment on May 1, 2005. The term of the Agreement is for one (1) year beginning on the Effective Date, but may be extended by the mutual agreement of the parties and, unless terminated in writing at least thirty (30) days prior to the expiration of the initial term, shall automatically renew for an additional one-year term on the first anniversary of the Effective Date and on each successive anniversary of the Effective Date unless terminated in writing similarly to the procedure stated above. Mr. Kong’s Base Salary will be US $20,000.00 per month. The Company will contribute $17,500 per month and AXM Shenyang shall contribute the remaining $2,500 per month less any deductions for taxes. Mr. Kong will also receive 200,000 incentive employee stock options per year, vesting quarterly. Mr. Kong is eligible to participate in all employee benefit plans to the extent maintained by the Company for its China-based employees. Mr. Kong may be terminated for cause, upon which he will receive all accrued salary, incentive compensation to the extent earned, vested deferred compensation, and accrued vacation pay, all to the date of termination. Additionally, his incentive compensation and bonuses, to the extent earned, shall be paid within thirty (30) days of the date of the termination. If Mr. Kong’s employment is terminated for any reason, he will retain all of his rights to benefits that have vested, but his rights to participate in those plans will cease upon his employment termination unless the termination is a Termination Other Than for Cause, in which case his rights of participation will continue for a period of three (3) months following the termination of his employment. If Mr. Kong’s employment is terminated in a Termination Other Than for Cause or by Company due to Mr. Kong’s disability, he will be paid as severance pay his Base Salary for the period commencing on the date that his employment is terminated and ending on the date which is one (1) month thereafter. Due to Mr. Kong’s employment with the Company, he will have access to the Company’s Confidential Information. In consideration for that access, Mr. Kong agrees that for a period of twelve (12) months after termination of his employment, he will not use such Confidential Information to compete with the business of the Company. In addition, for a period of twelve (12) months after termination of his employment, he will not induce or attempt to induce any employee of the Company to discontinue his or her employment with the Company for the purpose of becoming employed by any competitor of Company, nor will he initiate discussions, negotiations or contacts with persons known by him to be a customer or supplier of the Company at the time his employment with the Company is terminated, for the purpose of competing with the Company. Notwithstanding anything to the contrary contained in the Agreement, the previously stated Non-Compete provisions will not be applicable in the event of any Termination Other Than for Cause with respect to Mr. Kong’s employment.

The Company currently has no employment agreements in effect with Ms. Wang Wei-Shi or Mr. Harry Zhang.

Stock Option Plans

On February 1, 2005 our Board of Directors approved the 2005 Equity Incentive Plan, which will replace the 2004 Plan. Our shareholders approved the 2005 Plan at our Special Meeting on March 10, 2005. The 2005 Plan is intended to further our growth and financial success by providing additional incentives to our directors, executives and selected employees and consultants so that such participants may acquire or increase their proprietary interest in the Company. Stock options available under the 2005 Plan include "Incentive Stock Options", as defined in Code section 422 and any regulations promulgated under that Section, and "Nonstatutory Options" at the discretion of the Board of Directors. Additionally, Stock Appreciation Rights, Restricted Stock, Restricted Stock Unit, Performance Awards, Dividend Equivalents, or Other Stock-Based Awards may be granted under the Equity Plan. Shares available under the 2005 Plan include 5,000,000 shares of our common stock, plus all Shares remaining available for issuance under the 2004 Plan on the effective date of the Equity Plan. As of April 13, 2006, no stock options have been granted pursuant to the 2005 Plan.

Item 12.

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

As used in this section, the term beneficial ownership with respect to a security is defined by Rule 13d-3 under the Securities Exchange Act of 1934, as amended, as consisting of sole or shared voting power (including the power to vote or direct the vote) and/or sole or shared investment power (including the power to dispose of or direct the disposition of) with respect to the security through any contract, arrangement, understanding, relationship or otherwise, subject to community property laws where applicable.

As of April 13, 2006, we had a total of 22,162,185 shares of common stock and 826,500 (presently convertible into approximately 1,922,093 shares of common stock) shares of preferred stock issued and outstanding, which are the only issued and outstanding voting equity securities of AXM Pharma. Shares of Preferred Stock vote on as converted basis with the common stock. At the date of this Prospectus, each share of Preferred Stock is convertible into one share of common stock.

The following table sets forth, as of April 13, 2006: (a) the names and addresses of each beneficial owner of more than five percent (5%) of our common stock and Preferred Stock (taken together as one class) known to us, the number of shares of common stock and Preferred Stock beneficially owned by each such person, and the percent of our common stock and Preferred Stock so owned; and (b) the names and addresses of each director and executive officer, the number of shares our common stock and Preferred Stock beneficially owned, and the percentage of our common stock and Preferred Stock so owned, by each such person, and by all of our directors and executive officers as a group. Each person has sole voting and investment power with respect to the shares of our common stock and Preferred Stock, except as otherwise indicated. Beneficial ownership consists of a direct interest in the shares of common stock and Preferred Stock, except as otherwise indicated.

NAME AND ADDRESS	AMOUNT AND NATURE OF BENEFICIAL OWNERSHIP			PERCENTAGE OF VOTING OF SECURITIES (1)
Ms. Wang Wei Shi 46 Wen An Road Building 4, 5 th Floor Shenyang, Liaoning, The Peoples Republic Of China 110003		6,047,000	(2)		27.29	%

Harry Zhang STE 2109 Beijing Exchange BLDG NO 128 Jianguo RD, Beijing, 100022 P. R China		100,000			0.45	%

Elliot M. Maza 114 Chestnut Street Englewood, NJ 07631		0			0	%

Chaoying(Charles) Li 14/F, Buiding A, Huixium Plaza, No Beishuan Zhong Road, Chaoyang District Beijing 100101, P.R. China		210,000			0.95	%

Baozhong Zhang 100-7 East Binke Road Shenke District Shenyang Liaoning, F4 110015		0			0	%

Wenzhou Zhang No.2 Feiyun Road Hunnan New District Shenyang, Liaoning. P.R. China		0			0	%

Zhenyu Kong Room 2109 The Exchange Beijing, No.118 Jianguo Road, Chaoyang District Beijing 100022, China		50,000	(3)		0.23	%

Peter W. Cunningham 755 Promontory Point Drive West Newport Beach, California 92660		555,001	(4)		2.5	%

Mr. Chet Howard 11792 Lily Rubin Ave. Las Vegas, NV 89138		200,000	(5)		0.9	%

Gryphon Master Fund, L.P. 500 Crescent Court Suite 270 Dallas, Texas 75201		1,838,200			8.29	%

Byrle Lerner 2904 Via Campesina Palo Verdes Estates, CA 90274		1,165,300	(6)		5.26	%

All directors and officers as a group (10 persons)		7,162,001			32.32	%

(1) All Percentages have been rounded up to the nearest one hundredth of one percent.

(2) Includes 3,137,000 shares owned by Ms. Wang directly, including 300,000 stock options and 2,910,000 shares owned by members of her immediate family.

(3) Includes 50,000 incentive stock options Mr. Kong is entitled to receive through his employment agreement with AXM Pharma. Mr. Kong is entitled to receive an additional 150,000 incentive stock options during the year pursuant to his employment agreement, which provides that he is entitled to receive 200,000 incentive stock options per year, vesting quarterly beginning in May 2005.

(4) Includes 125,001 shares owned by Mr. Cunningham directly and 30,000 shares owned by Rabelaisian Resources, Plc., a company owned by Mr. Cunningham. Also includes 41,667 shares Mr. Cunningham was entitled to receive through his employment agreement with AXM Pharma as Chief Executive Officer. Mr. Cunningham ceased being our Chief Executive Officer on January 31, 2005 and his employment agreement was amended accordingly. Also includes 400,000 stock options granted to Mr. Cunningham on April 29, 2004, under the 2004 Qualified and Nonstatutory Stock Option Plan

(5) Includes 100,000 stock options, at an exercise price of $3.83 per share, granted to Mr. Howard on April 29, 2004, under the 2004 Qualified and Nonstatutory Stock Option Plan.

(6) Includes 60,000 shares of restricted stock Mr. Lerner is entitled to receive under his consulting agreement, dated October 25, 2004.

Changes in Control

As of the date of this filing, there are no arrangements, which may result in a change in control of AXM Pharma, Inc.

Item 13. Certain Relationships and Related Transactions

We are party to a consulting agreement with TriPoint Capital Advisors, LLC, a company in which Mark Elenowitz, a director and significant shareholder of AXM Pharma, indirectly owns a 40% interest. Pursuant to the terms of the consulting agreement, we are required to pay TriPoint a monthly fee of $17,500. The current agreement between Tripoint Capital Advisors and AXM Pharma has a one-year term and is terminable by either party, with or without cause, upon 30 days written notice. Additionally, on May 1, 2002, pursuant to the terms of a previous consulting agreement with TriPoint, Werke Pharmaceuticals, Inc., our wholly owned subsidiary issued TriPoint 500,000 shares of its common stock, which shares were exchanged pursuant to the terms of our share exchange agreement with the shareholders of Werke Pharmaceuticals, Inc. into shares of AXM Pharma common stock. On April 29, 2004, the Board authorized Peter Cunningham to sign a new agreement with Tripoint Capital Advisors for their consulting services. In addition, we are party to a consulting agreement with Investor Communications Company, LLC , a company in which Mark Elenowitz directly benefits from 20% of the stock compensation received from the Company. Pursuant to the terms of the consulting agreement, Werke Pharmaceuticals, Inc. is required to pay Investor Communications Company, LLC a monthly fee of $14,000 and issued to Investor Communications Company, LLC 120,000 shares of its common stock which were subsequently converted into shares of AXM Pharma common stock as a result of the Share Exchange.

In October 2004, we engaged Byrle Lerner, a beneficial owner of more than five percent of our common stock (5.55%), to provide consulting services to AXM Pharma. Mr. Lerner received 60,000 shares of our restricted stock and 100,000 options to purchase our common stock at $2.15 per share for his services. The agreement with Mr. Lerner was for one year and was terminable by either Mr. Lerner or us upon thirty days written notice.

In November 2004, Byrle Lerner paid 12,500 shares of restricted common stock to Aurelius Consulting and 30,000 shares to Mirador Consulting on behalf of AXM Pharma pursuant to consulting agreements with those entities.

On December 31, 2005, AXM Pharma, Inc. received advances of approximately $237,000 from Wei Shi Wang, Chief Executive Officer and Chairman of the Board. The amounts are unsecured and due upon demand.

Item 14. Principal Accounting Fees and Services

Section 4.03

Information required by this item is incorporated by reference to the Proxy Statement to be distributed in connection with our next annual meeting of stockholders.

PART IV

Item 15. Exhibits and Financial Statement Schedules

(a)	(1) Financial Statements

A list of the financial statements filed as a part of this report appears on page F-1.

(2) Financial Statement Schedules

Schedules have been omitted because the information required is not applicable or is shown in the Financial Statements or the corresponding Notes to the Consolidated Financial Statements.

(3) Exhibits

A list of the exhibits filed as a part of this report appears on pages E-1 and E-2, which follow immediately after the financial statements.

(b)	See Exhibits listed under the heading “Exhibit Index” set forth on page E-1.

(c)	Schedules have been omitted because the information required is not applicable or is shown in the Financial Statements or the corresponding Notes to the Consolidated Financial Statements

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this Annual Report on Form 10-K/A to be signed on its behalf by the undersigned, hereunto duly authorized.

AXM PHARMA, INC .

By: /s/ Weishi Wang

Weishi Wang

Chief Executive Officer

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this Annual Report on Form 10-K/A to be signed on its behalf by the undersigned hereunto duly authorized.

Name and Signature	Title	Date

/s/ Wang Wei Shi	Chief Executive Officer	January 16, 2009
Wang Wei Shi

/s/ Zhang Baozhong	Director	January 16, 2009
Zhang Baozhong

/s/ Elliot Maza	Director	January 16, 2009
Elliot Maza

/s/ Tracey O’Neill	Director	January 16, 2009
Tracey O’Neill

AXM Pharma, Inc.

CONSOLIDATED FINANCIAL STATEMENTS

Index

AXM Pharma, Inc.	Page
Report of Independent Registered Public Accounting Firm	F-2
Consolidated Balance Sheet as of December 31, 2005	F-3
Consolidated Statements of Operations for the years ended December 31, 2005 and 2004	F-4
Consolidated Statements of Cash Flows for the years ended December 31, 2005 and 2004	F-6
Consolidated Statement of Stockholders’ Equity for the years ended December 31, 2005 and 2004	F-5
Notes to the Consolidated Financial Statements	F-7

F-1

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors

AXM Pharma, Inc.

City of Industry, California

We have audited the accompanying consolidated balance sheet of AXM Pharma, Inc. as of December 31, 2005 and the related statements of operations, stockholders’ equity, and cash flows for each of the two years then ended. These financial statements are the responsibility of AXM Pharma’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of AXM Pharma, Inc. as of December 31, 2005 and the results of its operations and its cash flows for each of the two years then ended, in conformity with accounting principles generally accepted in the United States of America.

The accompanying consolidated financial statements have been prepared assuming that AXM Pharma, Inc. will continue as a going concern. As discussed in Note 1 to the consolidated financial statements, AXM Pharma has incurred losses of $9,247,932 and $13,250,883 for the years ended December 31, 2005 and 2004, respectively. AXM Pharma will require additional working capital to develop its business until AXM Pharma either (1) achieves a level of revenues adequate to generate sufficient cash flows from operations; or (2) obtains additional financing necessary to support its working capital requirements. These conditions raise substantial doubt about AXM Pharma’s ability to continue as a going concern. Management's plans in regard to this matter are also described in Note 1. The accompanying financial statements do not include any adjustments that might result from the outcome of these uncertainties.

As discussed in Note 2 to the consolidated financial statements, the Company has corrected the method of accounting for convertible instruments effective January 1, 2004.

LBB & Associates Ltd., LLP (formerly Lopez, Blevins, Bork & Associates Ltd., LLP)

Houston, Texas

April 7, 2006, except for Note 2, which is as of July 10, 2008.

F-2

AXM Pharma, Inc.

Consolidated Balance Sheet

December 31, 2005

RESTATED

ASSETS
Current Assets
Cash	$	92,620
Accouns Receivable		1,071,008
Inventories		2,287,487
Prepaid expenses and other		609,207
Total current assets		4,060,322

Property and equipment, net		7,558,010
Licenses		1,601,138
Deferred financing costs		614,476

TOTAL ASSETS	$	13,833,946

LIABILITIES AND STOCKHOLDERS' EQUITY

Current Liabilites
Convertible secured debentures	$	973,279
Acounts payable and accured expenses		5,102,821
Short-term loans		3,960,249
Preferred Stock Derivative Liability		99,725
Conversion Derivative Liability		888,922
Warrant Liability		1,944,223
Total current liabilities		12,969,219

Commitments and Contingencies

STOCKHOLDERS' EQUITY:

Series A, Preferred stock, $.001 par value, 10,000,000 shares authorized, 826,500 shares issed and outstanding		826
Series B, Preferred stock, $.001 par value, 2,000,000 shares authorized, no shares issed and outstanding		-
Series C, Preferred stock, $.001 par value, 100 shares authorized, 17 shares issed and outstanding		-
Common stock, $.001 par value, 50,000,000 shares authorized, 21,609,630 shares issed and outstanding		21,610
Additional paid-in capital		28,619,190
Accumulated deficit		(27,776,899	)
		864,727

TOTAL LIABILILITIES AND STOCKHOLDERS' EQUITY	$	13,833,946

See accompanying summary of accounting policies and notes to the financial statements

F-3

AXM Pharma, Inc.

CONSOLIDATED STATEMENTS OF OPERATION

YEARS ENDED DECEMBER 31, 2005 AND 2004

RESTATED

	2005			2004

Revenues	$	2,021,728		$	2,115,751
Cost of revenues		1,249,360			1,050,283
Gross Profit		772,368			1,065,468

Selling, general and adimistrative		9,629,424			15,526,639

Operating Loss		(8,857,056	)		(14,461,171	)
Interest expense		(7,102,563	)		(673,115	)
Other income		6,711,687			1,883,403
Net Loss	$	(9,247,932	)	$	(13,250,883	)

Net loss applicable to common shareholders:
Net loss	$	(9,247,932	)	$	(13,250,883	)

Net loss per share;

Base and diluted	$	(0.45	)	$	(0.82	)

Weighted average shares outstanding:
Base and diluted		20,433,762			16,066,789

See accompanying summary of accounting policies and notes to the financial statements

F-4

AXM Pharma, Inc.

CONSOLIDATED STATEMENTS OF STOCKHOLDER'S EQUITY

YEARS ENDED DECEMBER 31, 2005 AND 2004

RESTATED

	Shares		Amount		Shares			Amount			Additional paid in capital			Accumulated Deficit			Total

Balance, December 31, 2003		13,728,347		13,728		2,750,000			2,750			12,844,354			(5,278,084	)		7,582,748

Issuance of preferred stock and warrants, net of expense		-		-		860,030			860			1,737,773			-			1,738,633

Issuance of common stock for warrants, net of expense		1,070,016		1,070		-			-			3,271,155			-			3,272,225

Issuance of commons stock and warrants for services		1,161,001		1,161		-			-			5,619,337			-			5,620,498

Conversions of preferred stock		2,076,175		2,077		(1,935,006	)		(1,935	)		(142	)		-			-

Net Loss															(13,250,883	)		(13,250,883	)

Balance, December 31, 2004		18,035,539		18,036		1,675,024			1,675			23,472,477			(18,528,967	)		4,963,221

Issuance of common stock for dividend		78,600		79		-			-			180,985			-			181,064

Issuance of common stock and warrants for assets		55,000		55		-			-			933,434			-			933,489

Issuance of common stock and warrants for services		685,800		685		-			-			1,789,952			-			1,790,637

Issuance of common stock in connection with exercise of warrants		1,488,100		1,488		-			-			1,908,681			-			1,910,169

Issuance of common stock for repayment of principal and interest		245,645		246		-			-			333,833			-			334,079

Issuance of common stock for conversion of preferred stock		1,020,946		1,021		(848,507	)		(849	)		(172	)		-			-

Net Loss															(9,247,932	)		(9,247,932	)

Balance, December 31, 2005		21,609,630		21,610		826,517			826			28,619,190			(27,776,899	)		864,727

See accompanying summary of accounting policies and notes to the financial statements

F-5

AXM PHARMA, Inc.

CONSOLIDATED STATEMENTS OF CASHFLOW

YEARS ENDED DECEMBER 31, 2005 AND 2004

RESTATED

	2005			2004
Cash flows from operating activities:
Net Loss	$	(9,247,932	)	$	(13,250,883	)
Adjustments to reconcile net loos to cash used in operating activities:
Common stock issued for services and dividends		1,971,701			5,620,498
Non-cash interest expense		6,022,544			673,115
Bad Debt					810,793
Inventory write-off		532,105			1,714,200
Depreciation and amortization		56,309			32,167
Change in derivative instruments		(6,711,687	)		(1,883,402	)

Changes in assets and liabilities

Accounts Receivable		(1,040,258	)		1,773,436
Prepaid expenses		-			471,317
Advances		(164,105	)		1,023,578
Inventories		(817,462	)		(1,472,576	)
Accounts payable and accrued expenses		786,916			903,038
Cash flows from operating activities:		(8,611,869	)		(3,584,719	)

Cash flows from investing activities:
Capital Expenditures		(453,943	)		(6,892,907	)

Cash flows from financing activities:

Proceeds from short-term loans		2,958,581			1,001,668
Proceeds from sale of preferred stock		-			4,508,633
Proceeds from exercise of warrants		1,910,169			3,272,225
Proceeds from notes payable		3,034,000
Cash flows from financing activities:		7,902,750			8,782,526

Net decrease in cash		(1,163,062	)		(1,695,100	)

Cash, beginning of period		1,255,682			2,950,782

Cash, end of period	$	92,620		$	1,255,682

Supplemental cash flow information:

Interest paid	$	111,629		$	-

Supplemental non-cash transactions:

Common stock and warrants for assets	$	933,489		$	-
Common stock for principal and interest	$	334,079		$	-

See accompanying summary of accounting policies and notes to the financial statements

F-6

AXM PHARMA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. Nature of Our Business and Liquidity

Nature of our Business. AXM Pharma, Inc., (“AXM”, “our”, “us” or “we”) is a pharmaceutical and nutraceutical company engaged in the production, marketing and distribution of over the counter and prescription pharmaceutical products in The People’s Republic of China (“China”). We have licenses to produce market and distribute drug products in various dosages and forms as well as herbal remedies and vitamins and are currently manufacturing four drug products for sale in China. We conduct our business in China through our wholly owned subsidiary, AXM Pharma (Shenyang) Inc. (“AXM Shenyang”).

Our core business strategy is to manufacture and distribute a diverse group of over the counter and prescription pharmaceutical products, targeting the markets of China, Hong Kong, Taiwan, Korea, The Philippines, Indonesia, Malaysia, Singapore and Thailand. Our growth plan includes expanding our existing product line with new products licensed from North America and Europe. In 2004, we completed the construction of a manufacturing plant in a special economic zone in Shenyang, China. The plant has been certified as satisfying Chinese “Good Manufacturing Practices (GMP)”, and we intend to apply for certification of the plant under US GMP as well. This designation would allow us to manufacture pharmaceutical products in China for sale in the United States market.

• China Nat. Pharma. Group (Sinopharm)

• Jin Ming Shi Pharma

• DKSH (Taiwan) Limited

• KerryFlex Suplly Chain Solutions Limited

Liquidity. We are in urgent need of additional capital. Our cash resources have been depleted. We have not paid our employees in China since January 2006. We are in default under the terms of certain promissory notes as described more fully below under “Risk Factors - We are currently in default on our obligations under our Series C convertible promissory note.” These conditions raise substantial doubt about our ability to continue as a going concern. The audit report prepared by our independent registered public accounting firm relating to our consolidated financial statements for the year ended December 31, 2005 includes an explanatory paragraph expressing the substantial doubt about our ability to continue as a going concern. We are currently in discussions with several banks in China to obtain financing to support operations going forward, but we can offer no assurance that we will obtain additional financing. If additional capital is raised through the sale of equity or convertible debt securities, the issuance of such securities would result in dilution to our existing stockholders. We cannot assure you that financing will be available on favorable terms or at all.

F-7

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Restatement

We have restated our financial statements as of and for the year ended December 31, 2005 to properly record liabilities and expenses related to the issuance of certain Secured Promissory Notes and associated Common Stock Purchase Warrants during the quarter ended April 30, 2005 and certain Series C Preferred Stock and associated Common Stock Purchase Warrants during the quarter ended June 30, 2004. See, Note 7, “Series C Convertible Preferred Stock” and Note 8, “Secured Promissory Notes”.

The accompanying consolidated financial statements for the year ended December 31, 2005 have been restated to reflect these changes.

F-8

Consolidated Balance Sheet

December 31, 2005

	December 31,
	2005 as previously																							December 31,
	reported			Note A			Note B		Note C		Note D			Note E		Note F		Note G			Note H			2005 restated

ASSETS
Current Assets
Cash	$	92,620																							92,620
Accouns Receivable		1,071,008																							1,071,008
Inventories		2,287,487																							2,287,487
Prepaid expenses and other		609,207																							609,207
Total current assets		4,060,322																							4,060,322

Property and equipment, net		7,558,010																							7,558,010
Licenses		1,601,138																				-			1,601,138
Deferred financing costs		685,403																				(70,927	)		614,476

TOTAL ASSETS	$	13,904,873																						$	13,833,946

LIABILITIES AND STOCKHOLDERS' EQUITY

Current Liabilites
Convertible secured debentures	$	1,057,184			(1,057,184	)		-		-					973,279										973,279
Acounts payable and accured expenses		4,718,517								199,219							185,085								5,102,821
Short-term loans		3,960,249																							3,960,249
Preferred Stock Liability		1,308,408						-											(1,208,683	)					99,725
Conversion Liability								2,062,762				(1,173,840	)												888,922
Warrant Liability		802,137						5,471,250		-		(3,578,916	)				-		(750,248	)		-			1,944,223
Total current liabilities		11,846,495																							12,969,219

Commitments and Contingencies

STOCKHOLDERS' EQUITY:

Series A, Preferred stock, $.001 par value, 10,000,000 shares authorized, 826,500 shares issed and outstanding		826																							826
Series B, Preferr ed stock, $.001 par value, 2,000,000 shares authorized, no shares issed and outstanding		-																							-
Series C, Preferred stock, $.001 par value, 100 shares authorized, 17 shares issed and outstanding		-																							-
Common stock, $.001 par value, 50,000,000 shares authorized, 21,609,630 shares issed and outstanding		21,610																							21,610
Additional paid-in capital		28,958,231			(339,041	)																			28,619,190
Accumulated deficit		(26,922,289	)																						(27,776,899	)
		2,058,378																							864,727

TOTAL LIABILILITIES AND STOCKHOLDERS' EQUITY	$	13,904,873																						$	13,833,946

Notes:

A) To reverse the deemed dividend and note payable originally booked to record it properly

B) To re-book the issuance of the converible notes by valuing the conversion of the notes and warrants separately.

C) To accrue the interest on the convertible notes.

D) To revalue the warrant liability and convertible note conversion feature liability at December 31, 2005.

E) To accrete the vaue of the note to its original value.

F) To accrue interest on the preferred stock issued in 2004.

G) To revalue the warrant liability and preferred stock liability asssociated with the preferred stock issuance at December 31, 2005.

H) To amortize placement fee costs paid to the agency for the preferred stock issuance.

F-9

CONSOLIDATED STATEMENTS OF OPERATION

YEAR ENDED DECEMBER 31, 2005

	December 31,
	2005 as previously																				December 31,
	reported			Note A			Note B		Note C		Note D		Note E		Note F		Note G		Note H		2005 - Restated

Revenues	$	2,021,728																				2,021,728
Cost of revenues		1,249,360																				1,249,360
Gross Profit		772,368																				772,368

Selling, general and adimistrative		9,629,424			-																	9,629,424

Operating Loss		(8,857,056	)																			(8,857,056	)
Interest expense		2,231,225			(1,323,684	)		4,766,512		199,219				973,279		185,085		-		70,927		(7,102,563	)
Other Income												4,752,756						1,958,931				6,711,687
Net Loss	$	(11,088,281	)																		$	(9,247,932	)

Net loss applicable to common shareholders:
Net loss	$	(11,088,281	)																			(9,247,932	)
Benefical conversion of preferred stock		-																				-
Deemed dividend from beneficial converision feature of warrants		(428,058	)		-																	-
Net loss applicable to common shareholders:	$	(11,516,339	)																		$	(9,247,932	)

Net loss per share;

Base and diluted	$	(0.56	)																		$	(0.45	)

Weighted average shares outstanding:
Base and diluted		20,433,762																				20,433,762

Notes:

A) To reverse the deemed dividend and note payable originally booked to record it properly

B) To re-book the issuance of the converible notes by valuing the conversion of the notes and warrants separately.

C) To accrue the interest on the convertible notes.

D) To revalue the warrant liability and convertible note conversion feature liability at December 31, 2005.

E) To accrete the vaue of the note to its original value.

F) To accrue interest on the preferred stock issued in 2004.

G) To revalue the warrant liability and preferred stock liability asssociated with the preferred stock issuance at December 31, 2005.

H) To amortize placement fee costs paid to the agency for the preferred stock issuance.

F-10

CONSOLIDATED STATEMENTS OF OPERATION

YEAR ENDED DECEMBER 31, 2004

	December 31,
	2004 as previously													December 31,
	reported			Note A		Note B		Note C		Note D		Note E		2004 restated

Revenues	$	2,115,751													2,115,751
Cost of revenues		1,050,283													1,050,283
Gross Profit		1,065,468													1,065,468

Selling, general and adimistrative		15,055,322					471,317								15,526,639

Operating Loss		(13,989,854	)												(14,461,171	)
Interest expense		-			539,848				96,346				36,921		(673,115	)
Other Income											1,883,403				1,883,403
Net Loss	$	(13,989,854	)											$	(13,250,883	)

Net loss applicable to common shareholders:
Net loss	$	(13,989,854	)												(13,250,883	)
Benefical conversion of preferred stock		(1,413,374	)												-
Deemed dividend from beneficial converision feature of warrants		(1,009,085	)												-
Net loss applicable to common shareholders:	$	(16,412,313	)											$	(13,250,883	)

Net loss per share;

Base and diluted	$	(1.02	)											$	(0.82	)

Weighted average shares outstanding:
Base and diluted		16,066,789													16,066,789

Notes:

A) To properly book the preferred stock that was issued in 2004 along with the warrants issued with it.

B) To book the warrants given to placement agency and to properly record the placement agency fee

C) To record the interest that accrues in association with the preferred stock. It was not booked prior.

D) To revalue the warrant liability and preferred stock liability asssociated with the preferred stock issuance

at December 31, 2004.

E) To amortize the financing costs associated with the preferred stock.

Use of Estimates. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the balance sheet. Actual results could differ from those estimates.

Principles of Consolidation. The consolidated financial statements include the accounts of one subsidiary. All inter-company transactions have been eliminated in consolidation.

Cash and Cash Equivalents. Cash equivalents include highly liquid, temporary cash investments having original maturity dates of three months or less. For reporting purposes, cash equivalents are stated at cost plus accrued interest, which approximates fair value.

Inventories. Inventories are valued at the lower of cost or market. Cost is determined by using the average cost method. Inventories consist primarily of raw materials and packaging for our pharmaceutical products.

F-11

Equipment and Long-Lived Assets. Property and equipment are stated at cost less accumulated depreciation. Major renewals and improvements are capitalized; minor replacements, maintenance and repairs are charged to current operations. Depreciation is computed by applying the straight-line method over the estimated useful lives of machinery and equipment (three to seven years). The majority of our long-lived assets are located in The People’s Republic of China. We perform reviews for the impairment of long-lived assets whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable.

Licenses. Licenses consist of permits to produce pharmaceutical products which were acquired in a business combination. The licenses were valued at their historical cost. The cost of the licenses is not amortized because they have an indefinite life. The licenses are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. The permits are in the Peoples Republic of China. During 2005 and 2004, management of the Company determined that no impairment adjustment related to these intangibles was necessary.

We believe our licenses have market value independent from our ability to exploit them because they can be transferred to third parties. In the event that we fail to exploit them ourselves due to a lack of financial resources, we plan to recover the costs of these licenses by a sale to third parties.

Derivative Instruments. We have issued and outstanding certain instruments with embedded derivative features which we analyze in accordance with the pronouncements relating to accounting for derivative instruments and hedging activities to determine if these instruments are derivatives or have embedded derivatives that must be bifurcated. Under the applicable accounting literature, the estimated value of the embedded derivative, if any, is bifurcated from its host instrument on the date of sale or issuance of the securities or debt based on a valuation utilizing the appropriate valuation model. The embedded derivative liability is classified as such and is marked-to-market and adjusted to fair value at each reporting date and the change in fair value is recorded to other (income) expense, net. In addition, freestanding warrants are accounted for as equity securities or liabilities in accordance with the provisions of the applicable accounting literature. As the conversion rate or exercise price of all outstanding instruments vary with the fair value of our common stock, they are recorded as an obligation at fair value, marked-to-market at each reporting date, and carried on a separate line of the accompanying balance sheet. If there is more than one embedded derivative, their value is considered in the aggregate.

Convertible Preferred Stock - Convertible Preferred Sock issued by AXM Pharma is initially offset by a discount representing the relative fair values of the embedded conversion option and the warrants issued with the Preferred Stock. The fair value of the warrants and embedded conversion option are calculated based on available market data using appropriate valuation models. The excess of the sum of the values of the embedded conversion option plus the warrants over the cash proceeds received from the issuance of the Preferred Stock is charged to interest expense.

F-12

Deferred Financing Costs. Deferred financing costs attributable to the issuance of Secured Promissory Notes and Convertible Preferred Stock have been amortized to interest expense over the term of the notes.

Value Added Tax Payable. We are subject to a value added tax rate of 17% on product sales by The Peoples Republic of China. Value added tax payable is computed net of value added tax paid on purchases for all sales in The Peoples Republic of China.

Revenue Recognition. We recognize product sales revenue when the goods are shipped, title and risk of loss passes and collectability is reasonably assured. In situations where a distributor’s sales reporting to us is inadequate or untimely, we have to judge whether all of the elements required for revenue recognition have been met, including assurance of collectability. In such instances, we may conclude that revenue recognition of such sales should be delayed until payments are received from the distributor. Any provision for discounts and estimated returns are accounted for in the period the related sales are recorded.

Income Taxes. Income taxes are computed using the asset and liability method. Under the asset and liability method, deferred income tax assets and liabilities are determined based on the differences between the financial reporting and tax bases of assets and liabilities and are measured using the currently enacted tax rates and laws. A valuation allowance is provided for the amount of deferred tax assets that, based on available evidence, are not expected to be realized.

Foreign Currency Translation. Transactions and balances originally denominated in U.S. dollars are presented at their original amounts. Transactions and balances in other currencies are converted into U.S. dollars in accordance with Statement of Financial Accounting Standards (SFAS) No. 52, "Foreign Currency Translation,” and are included in determining net income or loss.

For foreign operations with the local currency as the functional currency, assets and liabilities are translated from the local currencies into U.S. dollars at the exchange rate prevailing at the balance sheet date. Revenues and expenses are translated at weighted average exchange rates for the period to approximate translation at the exchange rates prevailing at the dates those elements are recognized in the financial statements. Translation adjustments resulting from the process of translating the local currency financial statements into U.S. dollars are included in determining comprehensive loss.

The reporting currency is the U.S. dollar. The functional currency of our subsidiary, AXM Shenyang, is the Renminbi (“RMB”) which is the local currency in China. The financial statements of our subsidiary are translated into U.S. dollars using period-end exchange rates for assets and liabilities, and average rates of exchange for the period for revenues, costs, and expenses. Net gains and losses resulting from foreign exchange transactions are included in the consolidated statements of operations.

Stock-Based Compensation. We account for stock-based compensation for employees and non-employee members of our board of directors in accordance with Accounting Principles Board, or APB, Opinion No. 25, “Accounting for Stock Issued to Employees.” Under APB Opinion No. 25, compensation expense is based on the intrinsic value on the measurement date, calculated as the difference between the fair value of our common stock and the relevant exercise price. We account for stock-based compensation for non-employees, who are not members of our board of directors, at fair value using a Black-Scholes option-pricing model in accordance with the provisions of SFAS No. 123, “Accounting for Stock-Based Compensation” and other applicable accounting principles. We recorded stock-based compensation expense of approximately $5,600,000 during 2004. There were 2,140,000 stock options granted to employees and directors in 2004. There were not any options granted to employees in 2005.

F-13

	December 31, 2005			December 31, 2004

Net loss applicable to common shareholders:
As reported	$	(9,247,932	)	$	(13,250,883	)
Stock based compensation under fair value method		-			-
Pro forma	$	(9,247,932	)	$	(13,250,883	)

Net loss applicable to common shareholders per share basic and diluted:
As reported	$	(0.45	)	$	(0.82	)
Stock based compensation under fair value method		-			-
Pro forma		(0.45	)	$	(0.82	)

The fair value of each option grant was estimated on the date of grant using the Black-Scholes option pricing model with the following assumptions: risk free rate of 2.0%; volatility of 79% for 2004 with no assumed dividend yield; and expected lives of two to five years. No stock options were issued to employees in 2005.

Fair Value of Financial Instruments. Financial instruments that are subject to fair disclosure requirements are carried in the financial statements at amounts that approximate fair value and include cash and cash equivalents, accounts receivable and accounts payable. Fair values are based on assumptions concerning the amount and timing of estimated future cash flows and assumed discount rates reflecting varying degrees of perceived risk.

Basic and Diluted Net Loss per Share. Basic net loss per share is computed using the weighted average number of common shares outstanding during the period. Diluted net loss per share is computed using the weighted average number of common and, if dilutive, potential common shares outstanding during the period. Potential common shares consist of the incremental common shares issuable upon the exercise of stock options and warrants (using the treasury stock method). For 2005 and 2004, there were no potential common shares outstanding that were related to shares issuable upon the exercise of stock options or warrants.

Impact of Recent Accounting Pronouncements

In November 2004, the FASB issued SFAS No. 151, Inventory Costs, an amendment of ARB No. 43. This statement clarifies the accounting for idle capacity expense, freight, handling costs, and wasted material and is effective for the third quarter of 2005. We believe the adoption of this statement will not have a material effect on our results of operations, cash flows or financial position.

In December 2004, the FASB issued SFAS No. 123(R), Share Based Payment. This statement establishes standards for the accounting for transactions in which an entity exchanges its equity instruments for goods and services. It focuses primarily on accounting for transactions in which an entity obtains employee services in share-based payment transactions (employee stock options). The statement requires the measurement of the cost of employee services received in exchange for an award of equity instruments (such as employee stock options) at fair value on the grant date. That cost will be recognized over the period during which an employee is required to provide services in exchange for the award (the requisite service period). The effective date of this statement is the first quarter of 2006. We are still considering transition methods under this standard.

In December 2004, the FASB issued SFAS No. 153, Exchanges of Non-monetary Assets, an amendment of APB 29. This statement clarifies that all non-monetary transactions that have commercial substance should be recorded at fair value and is effective for the first quarter of 2005. The adoption of this statement did not have a material effect on its results of operations, cash flows or financial position.

3. INVENTORY WRITE-OFF

We delivered Sunkist brand products of Chewchew Bear multi-vitamins to distributors, of which, $313,000 of such product was labeled to be sold in China. However, we had not obtained the necessary import license for this product from the Chinese government as of December 31, 2005. The inventories remain in the distributor’s warehouse in Hong Kong. We can not predict when we will obtain the necessary license to remove this product from the distributor’s warehouse. Accordingly, we have written off the value of this product from our inventory.

F-14

During 2005, we outsourced and manufactured Sunkist brand products of Leafs vitamin supplement strips in China. The raw material had quality problems, resulting in a write-off of $219,000.

As a result of the above, we took an inventory write-off of approximately $532,000 during 2005.

4. ACCOUNTS RECEIVABLE

Our trade accounts receivable are shown net of allowance for doubtful accounts of $0.

AXM Pharma maintains allowances for doubtful accounts for estimated losses resulting from the inability of its customer to make required payments. If the financial condition of AXM Pharma's customer were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required.

5. PROPERTY AND EQUIPMENT

Components of property, plant, and equipment, at December 31, 2005 are as follows:

Land	$	932,286
Vehicles		70,630
Equipment		622,858
Construction in progress		6,011,317
		7,637,091
Less: accumulated depreciation		(79,081	)
	$	7,558,010

Depreciation expense totaled $56,309 and $32,167 in 2005 and 2004, respectively, and was included in selling general and administrative expenses.

AXM Pharma expects to reclassify construction in progress in the first half of 2006.

6. SHORT-TERM LOANS

We have loans outstanding with an aggregate principal amount of $3,960,249 at December 31, 2005. Our wholly owned subsidiary secured these loans from the Shenyang Branch of Shanghai Pudong Development Bank in the amount of 20 million RMB (US$2,416,422) with a one-year term and 5 million (US$609,756) with a term of six months on January 14 and August 18, 2005, respectively. The loans have an annual interest rate of 6.417%, interest is due quarterly and principal is due upon maturity. The loans are secured by our properties through a Mortgage Agreement between AXM (Shenyang) and the Development Bank, and the land-use right of the state-owned land. Both notes mature after December 31, 2005 and are currently in default.

Between October 22, 2004 and July 5, 2005, we secured additional loans through a series of short term, non-recourse loans from individual Chinese lenders. Most of the loans have an interest rate of 24% annually and a maturity of 180 days from inception. We used the proceeds of the loans to finance certain costs associated with construction of our factory in Shenyang, China and operations in China. At December 31, 2005, we had outstanding non-recourse loans due of $934,071 all of which are in default and accruing interest at 40%.

7: SERIES C CONVERTIBLE PREFERRED STOCK

On June 24, 2004, we issued to accredited investors pursuant to a private equity financing, 30.425 shares of our Series C Preferred Stock (the “Series C Prefs”), at a price per share of $100,000 and 357,936 Common Stock Purchase Warrants, each of which entitles the holder to purchase one share of our common stock, $.001 par value, for a period of three years from the date of issuance at a price equal to $5.50 per share. In addition, we issued to HC Wainwright, our placement agent, a three-year warrant to purchase up to 3 shares of Series C Prefs at a price of $100,000 per share, which is convertible into 70,588 common shares, and upon exercise, entitles HC Wainwright up to 35,793 warrants on a pro-rata basis to the number of shares of Series C Prefs purchased upon exercise. We also issued 53,691 warrants to purchase our common stock at $5.50 per share to The Shemano Group, our co-placement agent. Total proceeds were approximately $2,770,000, net of expenses.

F-15

The Series C Prefs carry the rights and preferences set forth in a Certificate of Designation which is incorporated herein by reference (the “Certificate of Designation”). Each share of Series C Pref is initially:

convertible into shares of our Common Stock as determined by dividing the Liquidation Preference Amount per share ($100,000) by the applicable conversion price per share ($4.25) (subject to adjustment in the event of any subdivision, combination of shares, stock dividend, stock split, recapitalization, reclassification, reorganization, merger or other combination). If we issue any shares of our capital stock, other than (i) the issuance or sale of options to purchase shares of Common Stock pursuant to a stock option or equity incentive plan approved by the Board of Directors of the Company, or the issuance or sale of any shares of Common Stock upon the exercise of any such options, (ii) shares of Common Stock issued upon conversion of shares of any of the Series C Preferred Stock, (iii) securities issued in connection with any underwritten primary public offering of the Company’s securities pursuant to a registration statement declared effective by the Securities and Exchange Commission, (iv) the issuance of securities as consideration for a bona fide business acquisition of or by the Company whether by merger, consolidation, sale of assets, sale or exchange of stock or otherwise, which involves a third party which is not affiliated with the Company or its current stockholders or in a strategic alliance or as equity kickers in lease and financing transactions, the primary purpose of which is not to raise equity capital; (v) in the case of (i), (ii) and (iii), any additional shares of Common Stock as may be issued by virtue of anti-dilution provisions, if any, applicable to such options or securities; or (vi) any additional shares of Common Stock as may be issued by virtue of the adjustment provisions applicable to the Series C Preferred, the conversion price of the Series C Preferred Stock Preferred shall be adjusted to that price determined by multiplying the Conversion Price by a fraction, the numerator of which is equal to the sum of (A) the number of shares of Common Stock outstanding immediately prior to the new issuance plus (B) the number of shares of Common Stock which the aggregate consideration for the new common shares to be issued would purchase at a price per share equal to the Conversion price; and the denominator of which is the number of shares of Common Stock outstanding immediately after the new issuance. lowered to a price equal to the securities issued;

entitled to vote on all matters submitted to a vote of the holders of our Common Stock, together with the holders of the Common Stock, on an as-converted basis. Without the written consent or affirmative vote of the Holders of at least 75% of the then outstanding shares of Series C Preferred, we may not authorize or issue any shares of capital stock, or affect certain other changes to the Company’s capital structure;

entitled to dividends at a rate per annum of 6% of the stated Liquidation Preference Amount per share; and

entitled to a liquidation preference equal to the aggregate stated Liquidation Preference Amount of all Series C Preferred shares held by such Holder upon the occurrence of any liquidation, dissolution or winding up of the Company, whether voluntary or involuntary, or in the event of the Company’s insolvency. If any sale or transfer of all or substantially all of the assets of the Company in a transaction or series of transactions (“Asset Sale”) is proposed to occur, we are obligated to given written notice to Holders of Series C Preferred, who shall be entitled to elect that the Asset Sale be deemed a liquidation, dissolution and winding up of the Company and to demand payment of the liquidation preference with respect to such Holder’s shares upon the consummation of the Asset Sale.

F-16

Upon the occurrence of (i) the institution against the Company of any proceedings under the United States Bankruptcy Code or any other federal or state bankruptcy, reorganization, receivership, insolvency or other similar law affecting the rights of creditors generally, which proceeding is not dismissed within thirty (30) days of filing or (ii) the institution by the Company of any proceedings under the United States Bankruptcy Code or any other federal or state bankruptcy, reorganization, receivership, insolvency or other similar law affecting the rights of creditors generally or the making by the Company of a composition or an assignment or trust mortgage for the benefit of auditors, the Holders may elect to have all or any portion of the then-outstanding Series C Preferred redeemed by the Company. Upon the redemption election, we will pay the Holders a redemption payment equal to the aggregate stated Liquidation Preference Amount of the Series C Preferred shares which are to be redeemed.

APB Opinion 14 (as amended), states that a portion of the proceeds of debt securities issued with detachable stock purchase warrants is allocable to the warrants and should be accounted for as paid-in capital. The allocation should be based on the relative fair values of the two securities at time of issuance. APB 14 by its terms does not apply to preferred stock. However, the Emerging Issues Task Force noted in EITF Issues No. 98-5, that a similar methodology would be used in circumstances in which convertible securities are issued along with another security, and that proceeds from the issuance of convertible preferred stock with detachable warrants should be allocated between the preferred stock and the other securities based on the relative fair values of the components. EITF 00-19 provides that proceeds from the issuance of warrants or other derivative instruments that give the counterparty the choice of cash settlement or settlement in shares, should be reported as a liability, which is measured at fair value, with changes in fair value reported in earnings. EITF 00-19 further provides that a contract that contains an indeterminate number of shares to be delivered in a share settlement is essentially a contract that gives the counterparty a choice of cash settlement or settlement in shares and should be recorded as a liability.

Both the Series C Prefs and the Warrants issued with those Prefs contain such provisions as a result of the anti-dilution features contained in the Statement of Designation of the Series C Convertible Preferred Stock, the Warrants and other relevant contracts. Accordingly we have accounted for the Series C Prefs and the associated Warrants as derivative liabilities at the time of issuance using the Black Scholes Option pricing model. On June 24, 2004, the date of the transaction, the value of the warrants issued with the Series C Preferred stock was determined to be $1,135,605, based on a closing stock price of $5.10 on that date. See Note 9: Derivative Instrument Liabilities, for further discussion of the liability related to the warrants.

The Series C Prefs essentially contain a call option on our common stock. APB 14 generally provides that debt securities which are convertible into common stock of the issuer or an affiliated company at a specified price at the option of the holder and which are sold at a price or have a value at issuance not significantly in excess of the face amount are not bifurcated into separate obligations. The terms of such securities generally include (1) an interest rate which is lower than the issuer could establish for nonconvertible debt, (2) an initial conversion price which is greater than the market value of the common stock at time of issuance, and (3) a conversion price which does not decrease except pursuant to anti-dilution provisions. The Series C Prefs do not satisfy these conditions because the initial conversion price of $2.10 per common share was lower than the market value of the common stock at time of issuance, which was $2.50 per share. Accordingly the determination of whether the conversion feature should be accounted for separately should be governed by FASB Statement 133, “Accounting for Derivative Instruments and Hedging Activities”.

We have determined that based on the provisions of FASB Statement 133, the embedded conversion option present in the Series C Prefs should be valued separately at the commitment date. Under FASB 133, a contract that contains an “embedded” derivative instrument; i.e., implicit or explicit terms that affect some or all of the cash flows or the value of other exchanges required by the contract in a manner similar to a derivative instrument, under certain circumstances, must be bifurcated into a host contract and the embedded derivative, with each component accounted for separately. The issuer's accounting depends on whether a separate instrument with the same terms as the embedded written option would be a derivative instrument pursuant to paragraphs 6-11 of this Statement. Although the option embedded in the Series C Prefs is indexed to our own stock, a separate instrument with the same terms as the embedded option would not be classified in stockholders' equity in the statement of financial position, but rather would be classified as a liability due to the contractual provisions of the Series C Prefs that essentially require cash settlement. Therefore, the written option is considered to be a derivative instrument under and should be separated from the host contract. On June 24, 2004, the date of the transaction, the value of the conversion option embedded in the Series C Prefs was determined to be $2,446,743, based on a closing stock price of $5.10 on that date. The excess of the sum of the initial value of the conversion option plus the initial value of the warrants has been charged to interest expense. The liability related to the embedded option in the Series C Prefs and the Warrants will be marked to market for all future periods they remain outstanding with an offsetting charge to earnings. At December 31, 2005, the derivative liability associated the conversion option embedded in the Series C Prefs was $99,724, with the change in fair value recorded in other expenses.

F-17

EITF Issues No. 98-5, “Accounting for Convertible Securities with Beneficial Conversion Features or Contingently Adjustable Conversion Ratios,” and 00-27, “Application of Issue No. 98-5 to Certain Convertible Instruments,” which under certain circumstances require the bifurcation of an embedded conversion feature from the host instrument, provide that when the fair value of the common stock into which the preferred stock can be converted exceeds the proceeds (a beneficial conversion feature), the issuer should allocate a portion of the proceeds equal to that excess to paid-in capital or to a liability if the issuer has a cash payment obligation. Under the guidance of EITF issues 98-5 and 00-27, we determined that any embedded beneficial conversion feature in the Series C Prefs is inherent in the liability recorded for the embedded conversion option in the Series C Prefs and is not accounted for separately.

We incurred placement fees of $272,500 and issued 485,714 warrants to two placement agents in connection with the Series C Preferred stock issuance for the year ended December 31, 2004. The warrants were valued on the closing date, June 24, 2004, using the Black Scholes option pricing model, at a value of $411,599. This amount was recorded as a warrant liability. The warrant liability will be marked to market at each future reporting date. The warrant liability had a value of $15,662 at December 31, 2005. Total costs associated with the issuance of the Series C Pref were $684,099, of which, $471,317 was charged to expense immediately as the holder of the Series C Prefs can convert immediately. The total remaining cost of $212,782 has been allocated to the Warrants, and is being amortized over the 3 year term of the Warrants.

The Series C Prefs carry a cumulative dividend of 6% per annum. Under the Certificate of Designation, dividends accrue from the date specified for payment in the Certificate of Designation of the Series C Prefs. The dividend is payable semi-annually in arrears. As of December 31, 2005, we have accrued dividends payable of $281,431, with a corresponding offset to interest expense.

8. SECURED CONVERTIBLE PROMISSORY NOTES

On April 20, 2005 we completed a private financing with 8 accredited investors. We issued Secured Convertible Promissory Notes (the “Notes”) with an aggregate face amount of $3,125,000. Each Note is due on April 19, 2007 and is convertible at the option of the holder anytime in whole or in part at $2.10 per common share. Net proceeds from the issuance of the Notes after offering costs were approximately $2,767,500.

The Notes were issued as a portion of 6.25 Units, each consisting of one (1) $500,000 Secured Promissory Note; three hundred thousand (300,000) Common Stock Purchase Warrants (Series A Warrants); and three hundred thousand (300,000) special Common Stock Purchase Warrants (Series B Warrants). The Notes bear interest at 9% and are repayable in equal installments during the period September 2005 through April 2007. The Series A Warrants were issued with an exercise price of $2.90 per share and the Series B Warrants were issued with an exercise price per share of $3.50. Each Purchaser also received a Series C Warrant to purchase a number of shares of Common Stock equal to one hundred percent (100%) of the number of Conversion Shares issuable upon conversion of such Purchaser’s Notes at an exercise price per share equal to the Conversion Price. The Series A Warrants and the Series B Warrants expire five (5) years following the Closing Date and the Series C Warrants expire one (1) year following the effective date of the registration statement providing for the resale of the Conversion Shares and the Warrant Shares.

F-18

Both the Notes and the Warrants issued with the Notes contain such provisions as a result of the anti-dilution features contained in the Notes, the Warrants and other relevant contracts. Accordingly we have accounted for the Notes and the associated Warrants as derivative liabilities at the time of issuance using the Black Scholes Option pricing model. On April 20, 2005, the date of the transaction, the value of the warrants issued with the Notes was determined to be $5,471,250, based on a closing stock price of $2.07 on that date. See Note 9: Derivative Instrument Liabilities, for further discussion of the liability related to the warrants.

The Notes essentially contain a call option on our common stock. APB 14 generally provides that debt securities which are convertible into common stock of the issuer or an affiliated company at a specified price at the option of the holder and which are sold at a price or have a value at issuance not significantly in excess of the face amount are not bifurcated into separate obligations. The terms of such securities generally include (1) an interest rate which is lower than the issuer could establish for nonconvertible debt, (2) an initial conversion price which is greater than the market value of the common stock at time of issuance, and (3) a conversion price which does not decrease except pursuant to anti-dilution provisions. The Notes do not satisfy these conditions because the initial conversion price of $2.10 per common share was lower than the market value of the common stock at time of issuance, which we $2.50 per share. Accordingly the determination of whether the conversion feature should be accounted for separately should be governed by FASB Statement 133, “Accounting for Derivative Instruments and Hedging Activities”.

We have determined that based on the provisions of FASB Statement 133, the embedded conversion feature present in the Notes should be valued separately at the commitment date. Under FASB 133, a contract that contains an “embedded” derivative instrument; i.e., implicit or explicit terms that affect some or all of the cash flows or the value of other exchanges required by the contract in a manner similar to a derivative instrument, under certain circumstances, must be bifurcated into a host contract and the embedded derivative, with each component accounted for separately. The issuer's accounting depends on whether a separate instrument with the same terms as the embedded written option would be a derivative instrument pursuant to paragraphs 6-11 of this Statement. Although the option embedded in the Notes is indexed to our own stock, a separate instrument with the same terms as the embedded option would not be classified in stockholders' equity in the statement of financial position, but rather would be classified as a liability due to the contractual provisions of the Notes that essentially require cash settlement. Therefore, the written option is considered to be a derivative instrument under and should be separated from the host contract. On April 20, 2005, the date of the transaction, the value of the conversion option embedded in the Notes was determined to be $2,062,762, based on a closing stock price of $2.07 on that date. This value has been recorded as a liability with a corresponding decrease in the carrying value of the Notes. The excess of the sum of the initial value of the conversion option plus the initial value of the Series A and Series B warrants issued with the Notes has been charged to interest expense. The liability related to the embedded option in the Notes and the Series A and Series B Warrants will be marked to market for all future periods they remain outstanding with an offsetting charge to earnings. At December 31, 2005, the derivative liability associated with the conversion option embedded in the Notes was $ 888,922, with the change in fair value recorded in other expenses. See Note 9: Derivative Instrument Liabilities.

The carrying value of the Notes has initially been recorded at zero because the sum of the initial value of the warrants plus the conversion option embedded in the Notes exceeds the proceeds. The liability for the Notes will accrete to their face amount over the term of the Notes calculated based on an effective interest method with an offsetting charge to interest expense. As of December 31, 2005, the carrying value of the Notes was $973,279.

We determined the initial fair value of the Series A and Series B warrants issued with the Notes to be $5,471,250 based on the Black-Scholes option pricing model. This value has been recorded as a liability with a corresponding decrease in the carrying value of the Notes. This difference will be amortized over the term of the Notes as interest expense calculated using an effective interest method. See Note 9: Derivative Instrument Liability, for a further discussion of the liability related to the issuance of the Series A and Series B Warrants.

F-19

EITF Issues No. 98-5, “Accounting for Convertible Securities with Beneficial Conversion Features or Contingently Adjustable Conversion Ratios,” and 00-27, “Application of Issue No. 98-5 to Certain Convertible Instruments,” provide that when the fair value of the common stock into which the note can be converted exceeds the proceeds (a beneficial conversion feature), the issuer should allocate a portion of the proceeds equal to that excess to paid-in capital or to a liability if the issuer has a cash payment obligation. The beneficial conversion feature recognized is limited to the proceeds received from the issuance of the notes after allocating the value of any warrants issued together with the Notes. Under the guidance of EITF issues 98-5 and 00-27, we determined that the Notes do not contain an embedded beneficial conversion feature because the proceeds from the issuance of the Notes was less than the value of the Warrants issued with the Notes and therefore, the limitation described above is applicable. In addition, under the guidance of EITF issues 98-5 and 00-27, we determined that any embedded beneficial conversion feature in the Notes is inherent in the liability recorded for the embedded conversion option in the Notes and is not accounted for separately.

Under the terms of the Series C Warrants issued with the Notes, each Purchaser is entitled to purchase a number of shares of Common Stock equal to one hundred percent (100%) of the number of Conversion Shares issuable upon conversion of such Purchaser’s Notes, at an exercise price per share equal to the Conversion Price. We recorded the liability for the Notes at an amount equal to the full consideration received upon issuance, less the value of the Series A and Series B Warrants, but without considering the value of the Series C Warrants because the determination of the number of Common Shares underlying the Series C Warrants and the exercise price of the Series C Warrants is dependent on the Conversion Price of the Notes at the time of conversion, which was indeterminate on the issue date of the Notes and Warrants.

We incurred placement fees and legal expenses of approximately $357,500 in connection with the issuance of the Notes. We recorded these costs as deferred financing costs, which are to be amortized over the term of the Notes, without any allocation to the Warrants.

9. DERIVATIVE INSTRUMENT LIABILITIES

Derivative instruments consist of the following:

	December 31, 2005
Warrants issued with Series C Convertible Preferred Stock	$	36,226
Warrants issued to the placement agents		15,663
Warrants issued with Secured Promissory Notes		1,892,334
Preferred stock conversion liability		99,725
Convertible note conversion liability		888,922
	$	2,932,870

Warrants issued with Series C Convertible Preferred Stock. As described above in Note 7, in connection with the issuance of the Series C Prefs, we issued Warrants to purchase up to an aggregate of 357,936 shares of our common stock. We also issued to our placement agent, HC Wainwright, a three-year warrant to purchase up to 3 shares of Series C Prefs at a price of $100,000 per share, which is convertible into 70,588 common shares and 53,691 warrants to purchase our common stock at $5.50 per share to The Shemano Group, our co-placement agent.

As of December 31, 2005 the total number of Warrants issued and outstanding with respect to the Series C Prefs is 357,936. At December 31, 2005 the Series C Pref warrant liability was $36,226 and the Series C placement agency warrant liability was $15,663.

Warrants issued with Secured Promissory Notes. As described above in Note 8, in connection with the issuance of Secured Promissory Notes, we issued Series A and Series B Warrants to purchase up to an aggregate of 3,750,000 shares of our common stock.

F-20

The Warrants issued with the Notes provide the holder with registration rights, which obligate the Company to register the common shares underlying the Warrants within 30 days of the closing. The terms of the Warrants specify a liquidated damages penalty of 1% of the Holder’s initial investment in the Notes for each calendar month that the Company is delinquent in obtaining or maintaining a valid registration statement covering the Common Shares underlying the Notes. Accordingly we have accounted for the Warrants as liabilities. The liability for the Series A and Series B Warrants, measured at fair value, has been offset by a reduction in the carrying value of the Notes. The liability for the Series A and Series B Warrants will be marked to market for each future period they remain outstanding. The value of the Series C Warrants will be offset by a charge to earnings rather than as a discount from the carrying value of the Notes when the value of these Warrants becomes determinable, which will occur upon conversion of the Notes.

As of December 31, 2005 the total number of Series A and Series B Warrants issued and outstanding with respect to the Notes is 3,750,000 and the liability associated with these warrants was $1,892,334.

Conversion Option Embedded in Series C Convertible Preferred Stock . As described above in Note 7, we have determined that based on the provisions of FASB Statement 133, the embedded conversion option present in the Series C Prefs should be valued separately at the commitment date. The option permits the holder to acquire our common stock at a price of $4.25 per share.

The Series C Prefs provide the holder with certain anti dilution rights that render the number of common shares issuable upon a conversion to be indeterminate. In addition, the Series C Prefs provide the holder with certain registration rights, which obligate the Company to register the common shares underlying the Series C Prefs within 30 days of the closing. Accordingly we have accounted for the conversion option embedded in the Series C Prefs as derivative liabilities at the time of issuance using the Black Scholes Option pricing model. The liability for the conversion option, measured at fair value, has been offset by a reduction in the carrying value of the Series C Prefs. The liability for the conversion option will be marked to market for each future period the Series C Prefs remain outstanding. At December 31, 2005, the Series C Pref conversion option liability was $99,725.

Conversion Option Embedded in Secured Promissory Notes . As described above in Note 8, we have determined that based on the provisions of FASB Statement 133, the embedded conversion option present in the Notes should be valued separately at the commitment date. The option permits the holder to acquire our common stock at a price of $2.10 per share.

The Notes provide the holder with certain anti dilution rights that render the number of common shares issuable upon a conversion to be indeterminate. In addition, the Notes provide the holder with certain registration rights, which obligate the Company to register the common shares underlying the Notes within 30 days of the closing. Accordingly we have accounted for the conversion option embedded in the Notes as derivative liabilities at the time of issuance using the Black Scholes Option pricing model. The liability for the conversion option, measured at fair value, has been offset by a reduction in the carrying value of the Notes. The liability for the conversion option will be marked to market for each future period the Notes remain outstanding. At December 31, 2005, the Note conversion option liability was $888,922.

10. STOCKHOLDERS’ EQUITY

Common Stock. We periodically issue common stock for services rendered. Common stock issued is valued at fair market value, which is the quoted market price. During the years ended December 31, 2005 and 2004, we issued 685,800 and 1,161,001 shares of common stock and warrants for services valued at $1,790,637 and $5,620,498, respectively.

On January 19 and June 29, 2005, we issued 50,017 and 28,583 shares of common stock as dividends to Series C Preferred shareholders as payment of interest totaling $141,048 and $40,016, respectively.

In March 2005, we issued 94,117 shares of common stock to Iroquis Capital for the conversion of 4 shares of Series C Preferred Stock.

F-21

In March 2005, we issued 725,000 shares of common stock to SF Capital for the conversion of 725,000 shares of Series A Preferred.

In March, 2005, we issued 30,000 shares of restricted common stock to each of XCL Partner Inc. and Ashton Organization pursuant to consulting services. The total value the consideration was $80,400 and $79,500, respectively.

In March 2005, we issued 10,000 shares of restricted common stock for consulting services. The stock was valued at $26,800.

On April 22 and April 26, 2005, we issued totaling 78,329 shares of common stock to SRG Capital for the conversion of fractional shares of Series C Preferred.

On June 14, 2005, we issued 11,700 shares of common stock to Gryphon Master Fund for the conversion of 11,700 shares of Series A Preferred Stock. On April 22 and April 26, 2005, we also issued totaling 78,329 shares of common stock to SRG Capital for the conversion of fractional shares of Series C Preferred.

On July 1 and August 10, 2005, we issued totaling 111,800 shares of Common Stock to National Financial Service in connection with the conversion of 111,800 shares of its Series A Preferred Stock.

On August 8, 2005, we completed a sale of 1,488,100 shares of Common Stock for the exercise of the Company’s warrant for gross proceeds of $2,127,436. This financing was made pursuant to a Special Warrant Offer extended to the purchasers listed in the Note and Warrant Purchase Agreement dated as of April 19, 2005.

On August 31, 2005, we issued 150,000 shares of restricted common stock to Madden Consulting, Inc. pursuant to a consulting agreement. The services to be provided under the consulting agreement were investor and public relations, which was valued at $252,000.

On September 9, 2005, we issued 50,000 shares of restricted common stock to Ashok Patel pursuant to a consulting agreement. The services to be provided under the consulting agreement were advisory of strategic licensing and marketing, which was valued as $77,000.

On September 19, 2005, we issued 245,645 shares of of restricted common stock (valued at $334,077) to convertible debenture holders in payment of principal and interest due under the debentures. Of this amount, $171,250 represented principal payments and the balance interest expense.

F-22

On September 8, 2005, we issued 60,000 shares of of restricted common stock (valued at $88,200) for services rendered.

On January 26, 2004, the Board authorized the issuance of 100,000 shares of restricted common shares and 50,000 warrants to Great Eastern Securities, Inc. pursuant to an investment banking agreement. The shares are to be released quarterly based upon a vesting schedule of 25,000 shares per quarter during the term of the agreement. Pursuant to an agreement that was executed on December 18, 2003, Great Eastern will provide investor relations related services and assist AXM Pharma with broker relations for our stock. The warrants are for a term of five years and have an exercise price equal to $4.74 per share. The shares were valued at $5.35 per share, the market price for shares of our common stock at the time of issuance. Therefore, the total aggregate value of the consideration paid to Great Eastern Securities, Inc. was $639,828 including a $104,828 charge computed using the black-scholes option pricing model.

On February 2, 2004 and April 20, 2004, we issued 200,000 shares of restricted common and 100,000 shares of restricted common, respectively to the Aston Organization pursuant to a consulting agreement and amendment thereto. 20,000 shares were released when the April 20, 2004 amendment was signed. The remaining 180,000 shares are to be released monthly based upon a vesting schedule of 15,000 shares per month during the term of the agreement. The shares were valued at $5.65 per share and $4.27 per share, respectively, the market price for shares of our common stock at the time of issuance. Therefore, the total aggregate value of the consideration paid to the Aston Organization was $1,557,000. At December 31, 2004, 270,000 common shares had been issued for consideration of $1,387,500. The remaining 30,000 common shares were issued in January and February 2005.

On May 7, 2004, we issued 120,000 shares of restricted common stock, and 200,000 warrants at $6.00 per warrant, to XCL Partners, Inc. 20,000 shares were released when the agreement was signed on June 24, 2004. The remaining 100,000 shares are to be released monthly based upon a vesting schedule of 10,000 shares per month for ten months , beginning 30 days after effective date of the agreement The services to be provided under the agreement are investor relations. 20,000 warrants shall vest immediately. The remaining 180,000 warrants shall be released monthly based on a vesting schedule of 15,000 warrants per month for eleven (11) months. The shares were valued at $4.09 per share, the market price for shares of our common stock at the time of issuance. Therefore, the total aggregate value of the consideration paid to XCL Partners was $957,815 including a $467,015 charge computed using the black-scholes option pricing model. At December 31, 2004, 80,000 common shares had been issued for consideration of $640,100, including $312,900 for the value of the warrants. The remaining 40,000 common shares and 66,000 warrants were issued in January, February, March and April 2005.

On May 10, 2004, we issued 300,000 shares of restricted common stock to Madden Consulting, Inc. pursuant to a consulting agreement. The services to be provided under the consulting agreement were investor and public relations. The shares were valued at $3.92 per share, the market price for shares of our common stock at the time of issuance. Therefore, the total aggregate value of the consideration paid to Madden Consulting was $1,176,000.

On July 21, 2004, we issued 100,000 shares of restricted common stock to Chet Howard, our Chief Financial Officer and Chief Accounting Officer. The shares were valued using the closing stock price on the date of issue, pursuant to which the stock was valued at $3.83 at the time of issuance. Therefore, the total aggregate value of the consideration paid to Mr. Howard was valued at $383,000.

On July 21, 2004, we issued 100,000 shares of restricted common stock to Harry Zhang, our Chief Accounting Officer of our wholly owned subsidiary. The shares were valued using the closing stock price on the date of issue, pursuant to which the shares were valued at $3.83 at the time of issuance. Therefore, the total aggregate value of the consideration paid to Mr. Zhang was valued at $383,000.

F-23

On September 1, 2004, we issued stock options, for an aggregate of 100,000 options to Dreamvest, LLC pursuant to a consulting agreement. The options have an exercise price of $2.69 and were valued using black-scholes option pricing model for a charge of approximately $173,000.

On September 10, 2004, we issued 83,334 shares of restricted common shares to Peter Cunningham, our Chief Executive Officer pursuant to his employment agreement. The shares were valued at $3.83 per share, the market price for shares of our common stock at the time of issuance. Therefore, the total aggregate value of the consideration paid to Mr. Cunningham was valued at $319,169.

Convertible Preferred Stock . AXM Pharma is authorized to issue up to 12,000,100 shares in aggregate of preferred stock, and has to date designated 3 series, which are summarized below:

Total Series

Authorized

Stated Value

Voting

Annual

Dividends per

Conversion

Rate

Series A

10,000,000

2.00

Yes

n/a

1 for 1

Series B

2,000,000

2.25

Yes

n/a

1 for 1

Series C

100

425,000

Yes

705,882 for 1

Dividends are payable semi-annually in January and June for Series C. Accrued but unpaid dividends do not pay interest.

The holder of each share of the Series A, B and C Preferred Stock shall be entitled to the number of votes equal to the number of shares of Common Stock into which such share of Series A Preferred Stock could be converted for purposes of determining the shares entitled to vote at any regular, annual or special meeting of shareholders of AXM Pharma, and shall have voting rights and powers equal to the voting rights and powers of the Common Stock.

On June 24, 2004, we issued 30.425 shares of our Series C preferred stock, at a price per share of $100,000 and 357,936 common stock purchase warrants, each of which entitles the holder to purchase one share of our common stock, $.001 par value, for a period of three years from the date of issuance at a price equal to $5.50 per share to accredited investors pursuant to a private equity financing. Each share of the preferred stock is convertible into a number of fully paid and non-assessable shares of our common stock obtained by dividing the face value of $100,000 per share by the fixed conversion price of $4.25 per share. In addition, we issued to HC Wainwright, our placement agent, a three-year warrant to purchase up to 3 shares of our Series C Preferred Stock at a price of $100,000 per share and up to 35,793 (53,691) warrants on a pro-rata basis to the number of shares of Preferred Stock purchased upon exercise. We also issued 53,691 warrants to The Shemano Group, our co-placement agent. Total proceeds were approximately $2,770,000, net of expenses.

F-24

11. STOCK OPTION PLANS

In April of 2004, our Shareholders approved the “2004 Qualified and Non-statutory Stock Option Plan.” The Board of Directors reserved 3,000,000 shares of our common stock to be issued in the form of incentive and/or non-qualified stock options for employees, directors and consultants to AXM. On April 29, 2004, our shareholders approved and ratified the issuance of 2,140,000 options to employees, directors and consultants. On February 1, 2005, our Board of Directors approved the 2005 Equity Incentive Plan, which will replace the 2004 Plan. Our shareholders approved the 2005 Plan at our Special Meeting on March 10, 2005. Shares available under the 2005 Plan include 5,000,000 shares of our common stock, plus all shares remaining available for issuance under the 2004 Plan.

Stock option activity during the periods indicated is as follows:

	Number of Shares		Weighted Average Exercise Price
Outstanding, December 31, 2003		—	$	—
Granted		2,140,000		4.08
Exercised		—		—
Forfeited		—		—
Expired		—		—
Outstanding, December 31, 2004		—		—
Granted		—		—
Exercised		—		—
Forfeited		—		—
Expired		—		—
Outstanding, December 31, 2005		2,140,000	$	4.08
Exercisable, December 31, 2005		2,140,000	$	4.08

At December 31, 2005, the range of exercise prices and weighted average remaining contractual life of outstanding options was $2.72 to $4.14, respectively. The weighted average grant date fair value of the options issued in 2004 amounted to $2.66. No stock options were issued in 2005 to employees.

12. INCOME TAXES

Our subsidiary, AXM (Shenyang) is incorporated in The People’s Republic of China (PRC), which is governed by the Income Tax Law of the PRC concerning Foreign Investment Enterprises and Foreign Enterprises and various local income tax laws (the "Income Tax Laws''). Under the Income Tax Laws, foreign investment enterprises ("FIE'') generally are subject to an income tax at an effective rate of 33% (30% state income taxes plus 3% local income taxes) on income as reported in their statutory financial statements after appropriate tax adjustments unless the enterprise is located in specially designated regions or cities for which more favorable effective rates apply. Upon approval by the PRC tax authorities, FIEs scheduled to operate for a period of 10 years or more and engaged in manufacturing and production may be exempt from income taxes for two years, commencing with their first profitable year of operations, and thereafter with a 50% exemption for the next three years. As of December 31, 2005, we had not attained profitable operations for tax purposes.

F-25

For the years ended December 31, 2005 and 2004, we incurred net losses and, therefore, had no tax liability. The net deferred tax asset generated by the loss carry-forward has been fully reserved. The cumulative net operating loss carry-forward is approximately $18,000,000 at December 31, 2005, and will expire in the years 2007 through 2025.

Deferred income taxes consist of the following at December 31, 2005 :

Long-term:
Net operating loss	$	6,000,000
Valuation allowance		(6,000,000	)
	$	-

13. VALUE ADDED TAX PAYABLE

We are subject to Chinese value added tax at a rate of 17% on product sales. Value added tax payable on sales is computed net of value added tax paid on purchases for all domestic sales.

14. DISTRIBUTION OF PROFITS

As stipulated by the relevant laws and regulations applicable to China’s foreign investment enterprises, we are required to make appropriations from net income as determined under accounting principles generally accepted in the PRC (“PRC GAAP”) to non-distributable reserves which include a general reserve, an enterprises expansion reserve and employee welfare and bonus reserves.

The general reserve is used to offset future extraordinary losses as defined under PRC GAAP. We may, upon a resolution passed by the owners, convert the general reserve into capital. The employee welfare and bonus reserve is used for the collective welfare of our employees. The enterprise expansion reserve is used for the expansion of AXM Pharma and can be converted to capital subject to approval by the relevant authorities. We did not record any reserves in 2005 and 2004. We incurred losses under accounting principles generally accepted under the PRC. Therefore, we were not required to record such reserves. No such adjustments are required under accounting principles generally accepted in the United States of America in 2005 and 2004.

15. EMPLOYEE RETIREMENT BENEFITS AND POST RETIREMENT BENEFITS

Our employees in the PRC are entitled to retirement benefits calculated with reference to their basic salaries on retirement and their length of service in accordance with a government managed benefits plan. The PRC government is responsible for the benefit liability to these retired employees. We are required to make contributions to the state retirement plan based on 19% of the employees’ monthly basic salaries. We do not have any other post retirement benefit plans and does not provide any post-employment benefits.

16. COMMITMENTS AND CONTINGENCIES

Commitments: Operating Leases. Our corporate and United States offices are located at 17870 Castleton Street, Suite 255, City of Industry, California 91748. The current rent for these premises is $1,842 per month with a 5% increase each year. Our lease expires on January 24, 2009. In January 2006, we closed our office located at 7251 West Lake Mead Blvd, Suite 300, Las Vegas, Nevada, 89128. The rent for the office in Las Vegas was $5,378 per month.

F-26

Our principal administrative, sales and marketing facilities are located at No. F.3004 Sankei Torch Bldg, 262A Shifu Road, Shenyang City, Liaoning Province, The Peoples Republic of China. The current rent for these facilities is US$2,917 per month and our lease expires in October 2007.

Future minimum lease payments under non-cancelable leases with terms in excess of one year are as follows:

Twelve Months Ending December 31,
2006	$	59,866
2007		52,286
2008		24,275
2009		2,034
2010 and thereafter		-
Total	$	138,461

Contingencies . In February 2006, we became aware of a lawsuit filed in Los Angeles superior court from the Praxi Advertising and Design, Inc. claiming payment of an unpaid package design fee of $119,800.

In July 2005, we received a demand letter from Saatchi & Saatchi, an advertising firm, that alleged that we owed them approximately RMB582,055 (U.S. $71,770) in connection with advertising services provided to AXM Shenyang. We currently are reviewing their claim and intend to negotiate a settlement of such claim. We do not anticipate that this matter will have a material impact on our business or operations.

F-27

AXM Pharma received notices from the Labor Arbitration Committee in China that 11 of our current and former employees have filed a labor arbitration claim for unpaid salaries and un-reimbursed expenses in the aggregate amount of RMB429,958 ( $53,081).

AXM Pharma, Inc. is involved in lawsuits, claims and proceedings, including those identified above, which arise in the ordinary course of business. In accordance with SFAS No. 5, “Accounting for Contingencies,” AXM makes a provision for a liability when it is both probable that a liability has been incurred and the amount of the loss can be reasonably estimated. AXM Pharma believes it has adequate provisions for any such matters. AXM Pharma reviews these provisions at least quarterly and adjusts these provisions to reflect the impacts of negotiations, settlements, rulings, advice of legal counsel, and other information and events pertaining to a particular case. Litigation is inherently unpredictable. However, AXM Pharma believes that it has valid defenses with respect to legal matters pending against it. Nevertheless, it is possible that cash flows or results of operations could be materially affected in any particular period by the unfavorable resolution of one or more of these contingencies.

We intend to vigorously defend these and other lawsuits and claims against us. However, we cannot predict the outcome of these lawsuits, as well as other legal proceedings and claims with certainty. An adverse resolution of pending litigation could have a material adverse effect on our business, financial condition and results of operations. AXM Pharma is subject to legal proceedings and claims that arise in the ordinary course of business. AXM Pharma’s management does not expect that the results in any of these legal proceedings will have adverse affect on the Company’s financial condition or results of operations.

17. RELATED PARTY TRANSACTIONS

At December 31, 2005, AXM Pharma, Inc. received advances of approximately $237,000 from Wei Shi Wang, Chief Executive Officer and Chairman of the Board. The amounts are included in accrued expense and are unsecured and due upon demand

F-28

EXHIBITS INDEX

Exhibit Number		Description

4.13^		Securities Purchase Agreement dated as of June 24, 2004

4.14^		Registration Rights Agreement dated as of June 24, 2004

4.15^		Form of Common Stock Purchase Warrant issued June 24, 2004

4.16^		Designation of Rights and Preferences of Series C Preferred Stock dated as of June 24, 2004

4.16#		Loan Agreement between AXM Pharma(Shenyang), Inc. and Shenyang Branch of Shanghai Pudong Development Bank

4.17#		Mortgage Agreement between AXM Pharma (Shenyang) Inc.and Shenyang Branch of Shanghai Pudong Development Bank

4.18##		Form of Note and Warrant Purchase Agreement, dated April 19, 2005, by and between the Company and each of the Purchasers thereto

4.19##		Form of Registration Rights Agreement, dated April 19, 2005, by and between the Company and each of the Purchasers thereto.

4.20##		Form of Convertible Promissory Note dated April 19, 2005

4.21##		Form of Series A Warrant

4.22##		Form of Series B Warrant

4.22##		Form of Series C Warrant

4.23##		Form of Security Agreement, dated April 19, 2005, by and between the Company and each of the Secured parties thereto

4.23##		Form of Mortgage Agreement, dated April 19, 2005, by and between the Company and each of the Mortgagees thereto

4.24###		Form of Series D Warrant

4.25####		2005 Equity Incentive Plan

10.4****		Agreement on Agency for Sale (Distribution) between Shenyang Taiwei Pharmaceutical Factory and Liaoning Weikang Medicine Co., Ltd.

10.5****		Consulting Agreement with Tripoint Capital Advisors, LLC

10.6****		Consulting Agreement with Amaroq Capital, LLC

E-1

10.7****		Consulting Services Agreement with Woodbridge Management, Ltd.

10.8****		Consulting Agreement with Madden Consulting, Inc.

10.9****		Investment Banking Agreement with Great Eastern Securities, Inc.

10.10****		Investor Relations Agreement with the Aston Organization

10.11+++ ²		Incentive and Nonstatutory Stock Option Plan

10.12++++		Consulting Agreement with Byrle Lerner

10.13++++		Consulting Agreement with Aurelius Consulting

10.14++++		Consulting Agreement with Mirador Consulting, Inc

10.15++++		Consulting Agreement with Dreamvest, llc

10.16++++		Consulting Agreement with RCG

10.17++++		Termination Agreement with RCG

10.18(2)(3)		Chet Howard’s Employment Agreement

10.19(2)(4)		Peter Cunningham’s Employment Agreement

10.20(2)(3)		Zhenyu Kong’s Employment Agreement

10.21(5)		Transition Agreement

14.1++		Code of Ethics for Board of Directors

14.2++		Code of Ethics for Executive Officers

16.1^^		Letter from Malone & Bailey, PLLC regarding change in certifying accountant, dated September 2, 2004.

21.1++		Subsidiaries of the Company

31.1+		Certification of Chief Executive Officer and Principal Accounting Officer pursuant to Rule 13a-14(a)

32.1+		Certification of Chief Executive Officer and Principal Accounting Officer pursuant to 18 U.S.C. 1350

99.1****		Form of lock-up agreement by officers, directors and 5% or greater shareholders

E-2

**** Incorporated herein by reference to Exhibits 10.1 to 10.10 of the Company’s Registration Statement on Form SB-2 Dated March 4, 2004.

+++Incorporated herein by reference to Exhibit 10.11 of the Company’s Annual Report on Form 10-KSB/A dated April 6, 2004.

++++Incorporated herein by reference to Exhibit 10.12 to 10.17 of the Company’s Annual Report on Form 10-KSB/A dated April 15, 2005.

+ Filed herewith

++ Incorporated herein by reference to Exhibit 14.1, 14.2 and 21.1 of the Company’s Annual Report on Form 10-KSB dated March 29, 2004

(2) Exhibit represents a management contract or compensatory plan or arrangement.

(3) Incorporate herein by reference to Exhibit 10.1, 10.2, 10.3, and 10.4 of the Company’s Current Report on Form 8-K/A dated April 4, 2005.

(4) Incorporated herein by reference to Exhibit 10.1 of the Post-Effective Amendment No. 6 to the Company’s Registration Statement on Form SB-2 Dated May 17, 2004

(5) Incorporated herein by reference to Exhibits 10.1 of the Company’s Current Report on Form 8-K Dated September 25, 2005

^ Incorporated herein by reference to Exhibits 10.1 to 10.4 of the Company’s Current Report on Form 8-K Dated June 24, 2004

^^ Incorporated by reference to Exhibit 16.1 to the Company’s amendment to Current Report on Form 8-K/A filed on September 2, 2004

# Incorporated herein by reference to Exhibits 10.1 to 10.2 of the Company’s Current Report on Form 8-K Dated January 24, 2005

## Incorporated herein by reference to Exhibits 10.1 to 10.8 of the Company’s Current Report on Form 8-K Dated April 20, 2005

### Incorporated herein by reference to Exhibits 10.1 of the Company’s Current Report on Form 8-K Dated August 9, 2005

####Incorporated herein by reference to Exhibit 99.1 of the Company’s Current Report on Form 8-K dated March 10, 2005.

On January 21, 2005, we filed a report on Form 8-K regarding received collateral a short -term loan.

On February 1, 2005, we filed a report on Form 8-K regarding promoted Chet Howard to Chief Executive Officer..

On March 10, 2005, we file a report on Form 8-K regarding Board of Directors approved the 2005 Equity Incentive Plan.

E-3

On April 20, 2005, we filed a report on Form 8-K regarding results of operations and financial condition.

On January 24, 2005, we filed a report on Form 8-K/A regarding creation of a direct financial obligation

On April 20, 2005, we filed a report on Form 8-K disclosing an additional private financing we completed.

On April 20, 2005, we filed a report on Form 8-K regarding accepted subscription with 8 accredited investors pursuant to a private equity financing.

On May 16, 2005, we filed a report on Form 8-K our financial results for the first quarter of fiscal 2005.

On June 15, 2005, we filed a Form 8-K disclosing a private financing with 9 accredited investors.

10.

On July 21, 2005, we filed a Form 8-K disclosing a termination of employee agreement with Peter Cunningham.

11.

On August 9, 2005, we filed a Form 8-K regarding completed a financing through a Special Warrant Offer.

12.

On August 10, 2005, we filed a Form 8-K regarding received additional commitments pursuant to the private financing.

13.

On August 15, 2005, we filed a Form 8-K regarding held a conference call discussing our fiscal 2005, second quarter results and current events.

14.

On September 25, 2005, we filed a Form 8-K regarding its principal shareholder entered into a Transition Agreement with its former financial consultants, investor relations firm and legal counsel, as well as 2 former directors and certain other related parties.

15.

On October 13, 2005, we filed a Form 8-K disclosing Mr. Chet Howard resigned as Chief Executive Officer and Chief Financial Officer of the Company.

16.

On October 28, 2005, we filed a Form 8-K disclosing the restatement of the second quarter revenue of 2005.

17.

On November 22, 2005, we filed a Form 8-K disclosing estimated revenues and net loss for its third quarter of fiscal 2005.

18.

On October 31, 2005, we filed a Form 8-K regarding default of the principal and interest payments due to the 9 holders of its April, 2005 Convertible Debentures.

E-4

AXM Pharma (CE) (USOTC:AXMP)
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