Edgar Filing: WATER CHEF INC

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-KSB
(Mark One)

[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934

For the Year Ended December 31, 2005

[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

Commission file number: 0-30544

WATER CHEF, INC
--------------------------------------------
(Name of small business issuer in its charter)

DELAWARE 86-0515678
------------------------------ -----------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)

1007 GLEN COVE AVENUE, SUITE 1
GLEN HEAD, NY 11545
-------------------------------------------------
(Address of principal executive offices) (Zip Code)

(516) 656-0059
-------------------------
(Issuer's telephone number)

Securities registered under section 12(b) of the Exchange Act: None.

Securities registered under section 12 (g) of the Exchange Act: Common
stock, Par value $.001

Redeemable Common Stock Purchase Warrants.

Check whether the issuer is not required to file reports pursuant to Section 13
or 15(d) of the Exchange Act.

Check whether the Issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter
period that the registrant was required to file such reports) and (2) has been
subject to such filing requirements for the past 90 days
YES X NO
--- ---

Check if there is no disclosure of delinquent filers in response to Item 405 of
Regulation S-B is contained in this form, and no disclosure will be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-KSB or any
amendment to this Form 10-KSB.

Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). YES NO X
--- ---

The issuer's net sales for the most recent fiscal year were $260,000.

The aggregate market value of the voting stock held by non-affiliates based upon
the last sale price on March 15, 2006 was approximately $16,338,557.

As of March 15, 2006, the Registrant had 182,547,785 shares of its Common Stock,
$0.001 par value, issued and outstanding.

DOCUMENTS INCORPORATED BY REFERENCE
None

Transitional Small Business Disclosure Format (Check one): YES NO X
--- ---

WATER CHEF, INC.
ANNUAL REPORT ON FORM 10-KSB

TABLE OF CONTENTS
PAGE
PART I
ITEM 1. DESCRIPTION OF BUSINESS .....................................2

ITEM 2. DESCRIPTION OF PROPERTY .....................................5

ITEM 3. LEGAL PROCEEDINGS ...........................................6

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS .........6

PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS ....6

ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION ...8

ITEM 7. FINANCIAL STATEMENTS .......................................11

ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE ..................................12

ITEM 8A. CONTROLS AND PROCEDURES ....................................12

ITEM 8B. OTHER INFORMATION ..........................................12

PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS,
PROMOTERS AND CONTROL PERSONS;
COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT ..........13

ITEM 10. EXECUTIVE COMPENSATION .....................................15

ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT AND RELATED STOCKHOLDER MATTERS..................15

ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS..............17

ITEM 13. EXHIBITS ...................................................17

ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES......................19

SIGNATURES ...................................................................20

ITEM 1. DESCRIPTION OF BUSINESS

THE COMPANY

Water Chef, Inc. (the "Company," "Water Chef"), designs and markets water
purification equipment. Water coolers and filters were a substantial part of the
Company's business from 1993 until the fourth quarter of 2001, at which time
this business was sold so that Water Chef could concentrate on the further
development, manufacturing, and marketing of their patented line of "PureSafe"
water purification systems. The accompanying financial statements have been
prepared assuming the Company will continue as a going concern. To date, the
Company has shipped 26 PureSafe units. Revenue has been recognized on only 8
PureSafe units, as 18 units that were shipped to the Kingdom of Jordan have not
met the criteria for revenue recognition due to no reasonable assurance of
collectibility. In addition to those units shipped in 2005, the Company received
payment in 2005 for two additional units that will ship in 2006.

BACKGROUND

The Company was originally incorporated under Arizona law in 1985 and merged
into a Delaware corporation in 1987. In 1993, the Company, then known as Auto
Swap, U.S.A., entered into a reverse merger with Water Chef, Inc., a Nevada
corporation, which manufactured and marketed water coolers and filters.

PRODUCTS

In 2001 the Company decided to concentrate its efforts on the further
development, manufacturing and marketing of the PureSafe Water Station (the
"PureSafe"),because although Water Chef believed that its water dispensers and
its wide variety of consumer oriented water filtration products met or exceeded
the design, quality and performance of competitive products, market
considerations were such as to limit the opportunities for profit and growth.

In 1998, searching for a "killer application," Water Chef management focused on
the worldwide need for safe drinking water for populations who are not served by
municipal water treatment facilities, or are served by municipal systems that
have malfunctioned because of improper maintenance or faulty design. The result
of that activity is the PureSafe Water Station, a turn-key unit that converts
"gray," or bathing grade, water into EPA grade drinking water. The PureSafe
eliminates all living pathogens that pollute non-processed water - bacteria,
cysts, viruses, parasites, etc. - at an affordable cost for the emerging
economies of the world.

The PureSafe was tested by H2M Labs, Inc. which has been approved by Nassau and
Suffolk counties in New York to perform drinking water testing for the various
municipalities in those counties. The specific test performed was a total and
fecal coliform bacteria test, wherein the source water storage tank which feeds
the PureSafe was tested for the presence of total and fecal coliform bacteria.
The source water tank was found to have 50 colonies of coliform bacteria
present. The source water tank was then "spiked" with a three (3) liter
concentration of laboratory grown and cultured bacteria and the storage tank was
measured again with 80,000,000 colonies of bacteria detected. After being
processed through the PureSafe system, the water was tested again, and "FEWER
THAN 2 COLONIES" were detected. In addition to the laboratory test conducted for
Water Chef by H2M Labs, the available scientific literature, in industry
journals such as Water Technology and Water Conditioning and Purification
International, supports the statement that an ozone system such as the one
utilized in the PureSafe effectively eliminates all living pathogens. Ozone was
first used in municipal water treatment in Nice, France in 1904, and then in the
Jerome Park Reservoir in the Bronx, New York in 1906.

The PureSafe is a self-contained, six stage water purification center. It is
housed in the equivalent of a small storage container - approximately four feet
wide, seven feet long, and six and one-half feet high. The unit weighs
approximately eleven hundred pounds (without water) and has been configured for
portability, durability, and easy access to its essentially off-the-shelf
components. It is constructed with weather and UV resistant fiberglass, aluminum
and steel, and is equipped with internal and external lighting.

The core version of the PureSafe can purify and dispense up to 15,000 gallons of
water per day for an all-inclusive cost (labor, power, amortization of the
capital cost, replacement filters, cartridges and media) of approximately
one-half cent per gallon. The process wastes very little water, producing
approximately one gallon of pure drinking water for every gallon processed. The
unit can be moved with a single fork-lift and is transportable by truck or
helicopter. Operating the PureSafe is simple and straightforward. Due to its
turn-key design, minimum wage personnel can be trained to operate the unit. A
system of fail-safes is built into the operation, and aside from easily
installable spares such as filters and cartridges, a maintenance and oversight
program established by Water Chef should maintain the operating efficiencies
built into the system. Water Chef warrants each unit for a period of one year so
long as the consumer adheres to required maintenance protocols, using Water Chef
supplied parts, as prescribed in the maintenance manual. The Company also offers

PRODUCTS (continued)

larger stand-alone versions of the PureSafe to provide pure water in quantities
up to 20,000 gallons per hour. To date, there have been no warranty claims for
the PureSafe product operating in the field.

While each unit is configured to respond to the particular water quality of a
particular site, such as arsenic removal, seawater desalination, oil separation,
etc., the typical unit contains the following components:

a. Inlet connection with macro-filter - designed to strain the input water,
removes large particulates and directs water into the system

b. Inlet pump - self-priming pump which maintains water pressure at minimum 40
p.s.i. throughout the system

c. Pre-depth media filter - a multi-media mixed bed to remove pollutants.
Pressure gauges mounted on the exterior front panel of the unit allow for
visible monitoring of system performance.

d. Ozone generator - provides a rich ozone source that effectively kills all
living pathogens such as bacteria, viruses, cysts, parasites, etc. Unused ozone
reverts back to oxygen and produces no harmful byproducts.

e. Ozone mixing tank - Water Chef's proprietary process for effectively mixing
the ozone into the water and maintaining the required contact time to ensure
oxidation of contaminants.

f. Process pump - provides optimal operation of the ozone processing.

g. Post-depth media filter - another, different, multi-media mixed bed designed
to filter out oxidized or precipitated pollutants and contaminants after the
ozone treatment. Effectively removes metals, organics and inorganics. Pressure
gauges on the front panel indicate the need for backwashing to maintain optimal
performance.

h. Ultraviolet treatment - provided by a UV lamp as a redundant sterilizer step
to eliminate any surviving pathogens or micro-organisms. The UV lamp is tuned to
a frequency which also converts O3 (ozone) back to O2 (oxygen).

i. KDF filter - an ion exchange media containing a proprietary blend of copper,
zinc and other alloys, effectively absorbs chlorine and biological, inorganic
and metallic contaminants.

j. Carbon filter - prevents bacteria re-growth while removing inorganic
compounds and improves water taste and removes odor. The carbon filter also acts
as a redundant ozone destruct mechanism.

k. Mixer - sends ozone treated water to the bottle washing stations.

l. Bottle washing stations - incorporated on the outside front of the unit for
easy access in order to effectively clean bottles used to carry water treated at
the site.

m. Dispensing stations - four individual dispensing lines, each with flow
adjusting valves to help regulate a smooth, steady flow of water into clean
bottles.

MANUFACTURING

In 2000, the Company entered into a subcontracting agreement with Davis Aircraft
Products Inc, ("Davis") for the manufacture of the PureSafe. Based upon the
experience and the resources of Davis, Water Chef's management believes that
Davis can provide the production and manufacturing support services necessary to
supply Water Chef's requirements over the foreseeable future at a price, and
with the quality and performance standards necessary to meet, or exceed, the
needs of the markets that the Company expects to serve. In addition, Davis
supervises much of the Company's research and development activities.

RAW MATERIALS

The PureSafe has been designed to use, for the most part, readily available
off-the-shelf components, sub-systems and equipment. Inasmuch as each of the
components and sub-systems are available from multiple vendors, the Company does
not believe that obtaining these for its sub-contractor, for itself, or for
others if it chooses to manufacture elsewhere, will be a problem.

COMPETITION

Water Chef's modular, turn-key PureSafe Water Station directly addresses the
drinking water needs of those environs which do not today, and are unlikely to
enjoy access to municipally treated water. The Company has produced a turnkey
solution that produces pure water to meet U.S. EPA drinking water standards.
This is a far different market than that addressed by the segment of the
industry which has concentrated on the multi-billion dollar municipal water
treatment sector, or the equally large residential sector. The municipal
solution requires significant investment for infrastructure development
(building plants and laying miles of distribution pipes), and products for
residential markets do not offer the performance or features to meet the needs
of the underdeveloped nations of the world.

Management does recognize that its potential competitors have far more
resources, and that being first to the marketplace is no assurance of success.
It must be assumed that others are working on systems that, if successfully
brought to market, could seriously impact the viability of the Company.

The Company currently has contracts to sell PureSafe units in Laos and Ecuador.
In addition, the Company is actively marketing its products to potential
customers in Bangladesh, China, El Salvador, Egypt and Honduras, and to agencies
and departments of the U.S. Government.

MARKETING

The potential market for the PureSafe is substantial and is both worldwide and
domestic. According to studies performed by the World Health Organization (WHO)
and the United Nations, major parts of Africa, the Middle East, Southeast Asia,
the Indian sub-continent, Latin and South America, the Caribbean, and much of
Eastern Europe is in need of adequate supplies of pure water. Parts of Florida,
Georgia, and other regions in the United States have also reported fresh water
deficits. In part, solving this problem has been a question of appropriate
technology. Secondarily, but just as important, in a vast part of the world is
the need to secure third party financing so that the local populace can enjoy
the benefits of clean water.

Water Chef believes that it has demonstrated that it possesses the technology.
The Company also believes that financing is available for third world economies
from a variety of sources. The challenge for the Company, a virtual unknown in
the industry and with limited capital, is in getting its message in front of
decision makers. To this end, Water Chef has enlisted the aid of some of the
world's most outstanding experts in water purification, especially as it relates
to the needs of underdeveloped countries.

The Company's Scientific Advisory Board is chaired by Dr. Ronald Hart, former
Director of The National Center for Toxicological Research and a U.S. Food and
Drug Administration "Distinguished Scientist in Residence." The Board also
includes Dr. Mohamed M. Salem, Professor of Occupational and Environmental
Medicine, Cairo University; Dr. Richard Wilson, Mallinckrodt Research Professor
of Physics, Harvard University; Dr. Mostafa K. Tolba, former
Under-Secretary-General of the United Nations and Director of the U.N.'s
Environmental Program; and Lord John Gilbert, former Minister of State for
Defense for the United Kingdom under three Prime Ministers and
Secretary/Treasurer of the Tri-Lateral Commission.

Not only have the members of the Scientific Advisory Board provided valuable
input and guidance to the Company with respect to system design, technological
input, remediation approaches and a great deal of information relative to the
unique water problems facing many areas of the world, but they have also been
active in introducing Water Chef to commercial opportunities

During 2004, Water Chef established a relationship with the International
Multiracial Shared Cultural Organization (IMSCO), an NGO (non-governmental
organization) specialized with the Economic and Social Council of the United
Nations. As a result of this relationship Water Chef has received United Nations
certification for its pure water humanitarian projects in Honduras and
Bangladesh, and became eligible to apply for third party funding of these
projects. As of year-end 2004, the Company has submitted these projects for
funding approval, but has received no assurance of funding.

With the recent funding of the Homeland Security Department budget, and a
renewed focus on preparedness in the event of possible future terrorist attacks
in the United States, programs have been initiated to ensure the protection and
preservation of our water resources. Water Chef has been in discussion with
political and government contacts to explore the applications for the PureSafe
as a back-up drinking water system in case of damage to municipal systems. The
Company has also initiated contact with senior government personnel to explore
the use of our technology to safeguard water supplies at U.S. installations
overseas.

PATENTS

The Company filed for patent protection on its PureSafe Water Station in October
of 1998 and received formal notification that the patent had been issued on
February 19, 2002. The Company feels that this patent upholds its claims that
the PureSafe system is a unique product. In addition to its U.S. patent, the
Company has filed for patent protection in the countries of the European Union,
and in Canada, Mexico, China, Hong Kong, Korea and Japan. The patent application
for the European Union (01-126 980.0) was filed on November 13, 2001; Canadian
Application No. 2,362,107 was filed on November 3, 2001; Mexican Application No.
PA/a/2001/12042 was filed on November 23, 2001;the Chinese Application No.
01136187.5 was filed on November 21, 2001, and was found to be in compliance on
June 20, 2003; the Hong Kong Application No. 03107837.9 was filed on October 3,
2003; and the Korean Patent Application No. 10-2001-0070453 was filed on
November 20, 2001. Each of the patent applications has been accepted, Requests
for Examination have been made, and the Company currently has patent protection
in the requested venues.

The name PureSafe Water Station and the stylized water droplet mark have been
trademarked in the United States.

Water Chef has also incorporated patented and proprietary technology in the
PureSafe and is confident that it can protect this intellectual capital
throughout the manufacturing and distribution cycle.

There can be no assurance that any application of the Company's technologies
will not infringe patent or proprietary rights of others, or that licenses which
might be required for the Company's processes or products would be available on
favorable terms. Furthermore, there can be no assurance that challenges will not
be made against the validity of the Company's patent, or that defenses
instituted to protect against patent violation will be successful.

SEASONALITY

The Company does not expect the Pure Safe to be influenced by seasonality.

GOVERNMENT APPROVALS

The Company's marketing efforts to date have been directed to Central and South
America, the Asian sub-continent, and the Middle East. No specific government
approvals are required, except for the possibility that export licenses will be
required in specific instances.

RESEARCH AND DEVELOPMENT

Research and development takes place at the Company's office. Testing, modeling,
simulation and prototype manufacturing are outsourced with much of the ongoing
development taking place at the Company's contract manufacturing facilities
under the supervision of Davis Water Products. The Company estimates to date
that the design, prototyping, development and marketing of the PureSafe Water
Station has cost in excess of $2 million.

INSURANCE

The Company maintains a $1,000,000 umbrella policy, in addition to a $2,000,000
general and product liability policy, which covers the manufacture and marketing
of its products. The Company believes its insurance coverage to be adequate.

EMPLOYEES

As of December 31, 2005, the Company employed one executive officer and two
administrative personnel in its headquarters.

The Company believes there are a sufficient number of persons available at
prevailing wage rates in or near our manufacturing locations that should
expansion of its production require additional employees, they would be readily
available. The Company has no collective bargaining agreement with any of its
employees.

ITEM 2. DESCRIPTION OF PROPERTY

The Company presently has no owned or leased manufacturing facilities, nor does
the Company have a plan to acquire its own manufacturing facility. The PureSafe
Water Station is manufactured for the Company under a contract by Davis Water
Products.

The Company maintains its principle place of business at 1007 Glen Cove Avenue,
Suite 1, Glen Head, New York 11545. The company leases 1,100 square feet in such
building at $2,638 per month on a month-to-month basis.

To the extent possible, the Company intends to utilize leased space for its
future needs.

ITEM 3. LEGAL PROCEEDINGS

In May 2001, the Company entered into a distribution agreement with a company
(the "Sub Distributor") based in Jordan. The Sub Distributor had agreed to
purchase no fewer than 100 units of the Company's "Pure Safe Water Station"
during 2001 and a minimum of 50 units in each of 2002 and 2003. To date, the
Company has shipped 18 units to the Kingdom of Jordan, none of which have met
the criteria for revenue recognition due to no reasonable assurance of
collectibility. The Company has recorded the cost of the inventory shipped as a
loss contingency of $242,035 during the year ended December 31, 2001, since
return of the items is uncertain. The Company has engaged legal counsel in
Jordan, to pursue legal remedies and obtain payment for all units shipped.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

Not Applicable

PART II

ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.

PRICE RANGE OF COMMON STOCK

The Company's common stock is traded on the Over-The-Counter Electronic Bulletin
Board ("OTCBB") under the symbol WTER.OB. This market is categorized as being
"thin" which means that there is generally a paucity of buyers and sellers as
found in the more heavily traded Small Cap and NASDAQ markets. OTCBB stocks
generally do not have the trading characteristics of more seasoned companies as
they lack the market-makers that will make orderly markets as well as the buyers
and sellers that give depth, liquidity and orderliness to those markets. In
addition, the solicitation of orders and/or the recommendations for purchase of
OTCBB stocks is restricted in many cases by the National Association of
Securities Dealers and by individual brokerage firms as well.

The chart below sets forth the range of high and low bid prices for the
Company's common stock based on high and low bid prices during each specified
period as reported by the National Quotation Bureau, Inc. The prices reflect
inter-dealer prices without retail mark-up, markdown, quotation or commission
and do not necessarily represent actual transactions.

HIGH LOW

2004

First Quarter .36 .16
Second Quarter .37 .14
Third Quarter .34 .14
Fourth Quarter .29 .14

2005

First Quarter .28 .14
Second Quarter .21 .11
Third Quarter .29 .13
Fourth Quarter .17 .06

As of the close of business on December 31, 2005, there were 823 common stock
holders of record.

DIVIDENDS

We have not paid any cash dividends on our common stock since our inception and
do not anticipate paying any cash dividends in the foreseeable future. We plan
to retain our earnings, if any, to provide funds for the expansion of our
business. Subject to our obligations to the holders of our Series A and Series D
Preferred shares, and to the holders of our Series F convertible preferred
stock, the holders of our common stock are entitled to dividends when and if
declared by our Board of Directors from legally available funds. Our Board of
Directors will determine future dividend policy based upon conditions at that
point, including our earnings and financial condition, capital requirements and
other relevant factors.

EQUITY COMPENSATION PLAN INFORMATION

The following table provides information as of December 31, 2005 with respect to
our shares of Common Stock that may be issued under our existing equity
compensation plans:

(a) (c)
Number of (b) Number of
securities to be Weighted- securities
issued upon average remaining
exercise of exercise price available for
outstanding of outstanding future issuance
options, options, under equity
warrants, warrants, compensation
and rights and rights plans (1)

Plan Category
-------------

Equity compensation plans approved by security holders - - -
Equity compensation plans not approved by security Holders:
Stock option plans (2) 6,000,000 $0.25 None

(1) Excludes securities listed in column (a)

(2) Consists of 5,000,000 stock appreciation rights granted to David A. Conway
that vest over 5 years and 1,000,000 stock appreciation rights granted to
Marshall S. Sterman that vest over 2 years. These individuals were originally
granted stock options in January 2004 that were later converted to stock
appreciation rights. Mr. Sterman's stock appreciation rights expired on January
7, 2006.

RECENT ISSUANCES OF UNREGISTERED SECURITIES

------------------------------------ ------------- -------------------- ----------------- ---------------- ----------------
Price per Purchase Date of Number
Purchaser Share Amount Class Purchase of Shares
------------------------------------ ------------- -------------------- ----------------- ---------------- ----------------

Late Fee for
Interest Payment
Occidental Engineering Consultants 0.1420 14,200 Common 10/19/2005 100,000
------------------------------------ ------------- -------------------- ----------------- ---------------- ----------------
Salvatore Lo Bue 0.0700 27,625 Common 11/18/2005 394,643
------------------------------------ ------------- -------------------- ----------------- ---------------- ----------------
Anthony Giambrone 0.0700 48,000 Common 11/18/2005 685,714
------------------------------------ ------------- -------------------- ----------------- ---------------- ----------------
Commission
Roger Borsett 0.0600 7,500 Common 11/18/2005 125,000
------------------------------------ ------------- -------------------- ----------------- ---------------- ----------------
Compensation for
Accounting Services
The Resnick Druckman Group LLC 0.0500 6,625 Common 11/18/2005 132,500
------------------------------------ ------------- -------------------- ----------------- ---------------- ----------------
Salvatore Lo Bue 0.0700 24,335 Common 11/29/2005 347,643
------------------------------------ ------------- -------------------- ----------------- ---------------- ----------------
Simplified Employee Pension Plan
FBO Laura A Fonseca 0.0750 35,000 Common 11/29/2005 466,667
------------------------------------ ------------- -------------------- ----------------- ---------------- ----------------
James K Tse 0.0650 25,000 Common 11/29/2005 384,616
------------------------------------ ------------- -------------------- ----------------- ---------------- ----------------
KML 0.0500 30,000 Common 12/19/2005 600,000
------------------------------------ ------------- -------------------- ----------------- ---------------- ----------------
Max Ollech 0.0500 50,000 Common 12/19/2005 1,000,000
------------------------------------ ------------- -------------------- ----------------- ---------------- ----------------
Commission
Raimond Irni 0.0500 7,500 Common 12/19/2005 150,000
------------------------------------ ------------- -------------------- ----------------- ---------------- ----------------

The Company issued these shares in reliance upon the exemption from registration
afforded by Section 4(2) of the Securities Act of 1933 and Regulation D
promulgated there under. These shares were offered to less than 35
"non-accredited" investors and were purchased for investment purposes with no
view to resale.

Proceeds from the sales of these securities were used for general corporate
purposes.

ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION.

INTRODUCTION

DEVELOPMENT OF THE COMPANY

The Company was originally incorporated under Arizona law in 1985 and merged
into a Delaware corporation in 1987. In 1993, the Company, then known as Auto
Swap, U.S.A., entered into a reverse merger with Water Chef, Inc., a Nevada
corporation that manufactured and marketed water coolers and filters.

The PureSafe has been designed by the Company to meet the needs of communities
who either did not have access to municipal water treatment systems, or to those
whose systems had been compromised, either by environmental factors or by faulty
design or maintenance.

Off-Balance Sheet Arrangements

We do not have any off-balance sheet debt nor did we have any transactions,
arrangements, obligations (including contingent obligations) or other
relationships with any unconsolidated entities or other persons that may have a
material current or future effect on financial conditions, changes in financial
conditions, result of operations, liquidity, capital expenditures, capital
resources, or significant components of revenue or expenses.

RESULTS OF OPERATIONS

Sales for the years ended December 31, 2005 and 2004 were $260,000 and $56,290,
respectively. During the year ended December 31, 2005, the Company recognized
the sale of five PureSafe Water Station Systems. Four of these were purchased
for use in Ecuador and the fifth system was purchased by a humanitarian buyer to
be used as part of the tsunami relief effort in Sri Lanka. In addition, Water
Chef received deposits totaling $115,000 during 2005 for relief effort systems
that will be shipped in 2006.

Cost of sales decreased from $62,250 for the year ended December 31, 2004, to
$42,000 for the year ended December 31, 2005, a decrease of $20,250, or 33%. An
analysis of the components of cost of sales follows:

Cost of Sales Product Rent and Overhead Total Cost
Period CGS Payments to Manufacturer of sales
2005 $13,250 $49,000 $62,250
2004 $ 0 $42,000 $42,000

Selling, general and administrative expenses for the year ended December 31,
2005 were $1,194,577 compared to $1,296,265 for the year ended December 31,
2004, a decrease of $101,688 or 8%. The decrease in expense is primarily due to
higher professional fees (approximately $187,000) in 2004.

Interest expense for the year ended December 31, 2005 was $244,191 compared to
$150,228 for the year ended December 31, 2004, an increase of $93,963, or 63%,
primarily related to the accretion of the debt discount, amortization of
deferred financing costs and the issuance of 100,000 shares of common stock
valued at $14,200 for the one month deferral to request payment.

In 2004, the Company recognized a loss on settlement of debt of $2,407,867.

The net loss for the year ended December 31, 2005 was $1,168,328 compared to
$3,757,802 for the year ended December 31, 2004, a decrease of $2,589,474.

LIQUIDITY AND CAPITAL RESOURCES

At December 31, 2005, the Company had a stockholders' deficiency of
approximately $3,577,000 and a working capital deficiency of approximately
$3,100,000. In addition, the Company has a net loss of approximately $1,168,000
and $3,758,000 for the years ended December 31, 2005 and 2004, respectively. The
financial statements have been prepared assuming that the Company will continue
as a going concern. The auditor's report on its financial statements included
elsewhere herein contains an explanatory paragraph about conditions that raise
substantial doubt about the Company's ability to continue as a going concern.
Management's plans with respect to these matters include restructuring its
existing debt and raising additional capital through future issuances of stock
and/or debt. The financial statements do not include any adjustments that might
be necessary should the Company be unable to continue as a going concern. In
November 2005, the Company entered into issued a loan agreement with Southridge
Partners LP, pursuant to which the Company received a loan of $250,000, less
legal fees, secured by four million shares of the Company's common stock owned
by the President and Chief Executive Officer. The loan principal and interest is
due and payable, in cash or shares of common stock, on March 16, 2006. As a
condition of the loan agreement, the Company registered two million shares of
common stock for the benefit of Southridge Partners LP, and registered 430,000
shares of common stock underlying a common stock warrant issued to the lender.

The Company, during 2005 and 2004, raised $494,960 and $790,356, respectively,
through the sale of its common and preferred stock.

Water Chef was a defendant in a legal action brought by certain debenture
holders ("Bridge Loans") in New Hampshire Superior Court seeking repayment of
debenture principal of $300,000 and accrued interest from 1997. On June 22, 2002
a settlement was reached whereby the Company agreed to (i) issue a minimum of
3,000,000 shares of common stock valued at $497,500 in lieu of the principal and
interest owed to the debenture holders who participated in this legal action.
The Company recorded the debentures at $300,000, plus accrued interest of
$39,400, for a total of $339,400. The difference between the $497,500, the value
for the 3,000,000 shares, divided by the average daily trading price for the 30
days subsequent to the settlement, was greater than the original 3,000,000
shares. Due to these requirements, the Company was obligated to issue an
additional 14,037,671 shares. As of December 31, 2004, the Company has issued
the 3,000,000 shares and the additional 14,037,671 shares originally valued at
$497,500. Attached to the original Bridge Loans were warrants for the purchase
of 1,666,667 shares of the Company's common stock at $0.15 per share. The
debenture holders that participated in the legal action had the lives of their
warrants extended from March 2002 to March 2004. In connection with the issuance
of the Bridge Lenders' shares the Company further extended the expiration date
of the warrants to a date twelve months after the effective date of the
Registration Statement filed with the Securities and Exchange Commission on
January 24, 2005 which was declared effective by the Securities and Exchange
Commission on June 7, 2005.

In addition to the above settlement with Bridge Lenders who participated in the
legal action, the Company settled its obligation with debenture holders that did
not participate ("non-participating debenture holders") in the legal action.
These non-participating debenture holders had total debentures of $75,000, plus
accrued interest of $9,850, totaling $84,850 as of the settlement date. In
conjunction with the above settlement, the Company settled these outstanding
non-participating debentures, plus accrued interest, with the issuance of
750,000 shares of common stock valued at $0.0292 per share, or $21,900. The
terms of their warrants were not extended, nor are they entitled to receive
additional shares based on the Company's common stock achieving a certain
average trading price 30 days subsequent to the settlement with the
participating debenture holders. During 2004, the Company issued the 750,000
settlement shares.

Management is currently attempting to settle or restructure the remaining debt,
and plans to satisfy its existing obligations with the cash derived from the
profitable sale of its product.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

Our financial statements are prepared in accordance with accounting principles
generally accepted in the United States of America. Preparation of the
statements in accordance with these principles requires that we make estimates,
using available data and our judgment, for such things as valuing assets,
accruing liabilities and estimating expenses. The following is a list of what we
feel are the most critical estimations that we make when preparing our financial
statements.

Revenue Recognition

Revenue is recognized when products are shipped, title passes and collectibility
is reasonably assured. Allowances for estimated bad debts, sales allowance and
discounts are provided when such sales are recorded.

Stock-Based Compensation

In December 2004, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standard ("SFAS") No. 123 (revised 2004),
"Shared-Based Payment." SFAS 123(R) addresses the accounting for share-based
payment transactions in which an enterprise receives employee services in
exchange for (a) equity instruments of the enterprise or (b) liabilities that
are based on the fair value of the enterprise's equity instruments or that may
be settled by the issuance of such equity instruments. SFAS 123(R) requires an
entity to recognize the grant-date fair-value of stock options and other
equity-based compensation issued to employees in the income statement. The
revised statement generally requires that an entity account for those
transactions using the fair-value-based method, and eliminates the intrinsic
value method of accounting in APB 25, which was permitted under SFAS No. 123, as
originally issued. The revised statement requires entities to disclose
information about the nature of the share-based payment transactions and the
effects of those transactions on the financial statements.

SFAS No. 123(R) is effective for small business issuers' financial statements
for the first annual reporting period that begins after December 15, 2005.

We have used stock in the past to raise capital and as a means of compensation
to employees.

Derivative Financial Instruments

The Emerging Issues Task Force ("EITF") Issue No. 05-4 "The Effect of a
Liquidated Damages Clause on a Freestanding Financial Instrument Subject to EITF
Issue No. 00-19, `Accounting for Derivative Financial Instruments Indexed to,
and Potentially Settled in, a Company's Own Stock" ("EITF No. 05-4") addresses
financial instruments, such as stock purchase warrants, which are accounted for
under EITF 00-19 that may be issued at the same time and in contemplation of a
registration rights agreement that includes a liquidated damages clause. The
consensus for EITF No. 05-4 has not been finalized. In November 2005 the Company
issued a convertible promissory note, a registration rights agreement and
warrants (See Note 6). Based on the interpretive guidance in EITF Issue No.
05-4, Due to certain factors and the liquidated damage provision in the
registration rights agreement, the Company determined that the embedded
conversion option and the warrants are derivative liabilities and the
registration statement becoming effective on January 30, 2006, the value of the
registration rights was deemed to be de minims.

Effects of Recent Accounting Policies

In December 2004, the FASB issued SFAS No. 123R, "Share Based Payment." This
statement is a revision of SFAS No. 123, "Accounting for Stock-Based
Compensation" and supersedes APB Opinion No. 25, Accounting for Stock Issued to
Employees, and its related implementation guidance. SFAS No. 123R addresses all
forms of share based payment ("SBP") awards including shares issued under
employee stock purchase plans, stock options, restricted stock and stock
appreciation rights. Under SFAS No. 123R, SBP awards result in a cost that will
be measured at fair value on the awards' grant date, based on the estimated
number of awards that are expected to vest. This statement is effective for
public entities that file as small business issuers - as of the beginning of the
first annual reporting period that begins after December 15, 2005.

Management believes the adoption of this pronouncement will have a material
impact on the Company's financial statements, whereby the Company, upon
adoption, expects to record a charge for the granting of future employee stock
options.

In May 2005, the FASB issued SFAS No. 154 - Accounting for Change in Error
Corrections - a replacement of APB Opinion No. 20 and FASB Statement No. 3. This
statement replaces APB Opinion No. 20, "Accounting Changes" and FASB Statement
No. 3 "Reporting Accounting Changes in Interim Financial Statements," and
changes the requirement for the accounting for and reporting changes in
accounting principle. This statement applies to changes required by an
accounting pronouncement in the unusual instance that the pronouncement does not
include specific transition provisions. When a pronouncement includes specific
transition provisions, those provisions should be followed. This statement is
effective for accounting changes and corrects errors made in fiscal years
beginning after December 15, 2005.

Management believes the adoption of this pronouncement will not have a material
effect on the Company's financial statements.

TheEITF reached a tentative conclusion on EITF Issue No. 05-1, "Accounting for
the Conversion of an Instrument that Becomes Convertible upon the Issuer's
Exercise of a Call Option" that no gain or loss should be recognized upon the
conversion of an instrument that becomes convertible as a result of an issuer's
exercise of a call option pursuant to the original terms of the instrument. The
consensus for EITF No. 05-1 has not been finalized.

The application of this pronouncement is not expected to have an impact on the
Company's financial position, results of operations, or cash flows.

In June 2005, the FASB ratified EITF Issue No. 05-2, "The Meaning of
`Conventional Convertible Debt Instrument' in EITF Issue No. 00-19, Accounting
for Derivative Financial Instruments Indexed to, and Potentially Settled in a
Company's Own Stock" ("EITF No. 05-2"), which addresses when a convertible debt
instrument should be considered `conventional' for the purpose of applying the
guidance in EITF No. 00-19. EITF No. 05-2 also retained the exemption under EITF
No. 00-19 for conventional convertible debt instruments and indicated that
convertible preferred stock having a mandatory redemption date may qualify for
the exemption provided under EITF No. 00-19 for conventional convertible debt if
the instrument's economic characteristics are more similar to debt than equity.
EITF No. 05-2 is effective for new instruments entered into and instruments
modified in periods beginning after June 29, 2005.

The Company has applied the requirements of EITF No. 05-2, See Note 6 with
respect to the impact of this pronouncement on the Company's financial
statements.

In June 2005, the EITF reached consensus on Issue No. 05-6, "Determining the
Amortization Period for Leasehold Improvements" (EITF 05-6). EITF 05-6 provides
guidance on determining the amortization period for leasehold improvements
acquired in a business combination or acquired subsequent to lease inception.
The guidance in EITF 05-6 will be applied prospectively and is effective for
periods beginning after June 29, 2005. EITF 05-6 did not have a material impact
on the Company's consolidated financial position or results of operations.

In September 2005, the FASB ratified EITF Issue No. 05-7, "Accounting for
Modifications to Conversion Options Embedded in Debt Instruments and Related
Issues" ("EITF No. 05-7"), which addresses whether a modification to a
conversion option that changes its fair value affects the recognition of
interest expense for the associated debt instrument after the modification and
whether a borrower should recognize a beneficial conversion feature, not a debt
extinguishment, if a debt modification increases the intrinsic value of the debt
(for example, the modification reduces the conversion price of the debt). EITF
No. 05-7 is effective for the first interim or annual reporting period beginning
after December 15, 2005.

The Company is currently in the process of evaluating the effect that the
adoption of this pronouncement will have on its financial statements.

On September 28, 2005, the FASB ratified the following consensus reached in EITF
Issue 05-8 ("Income Tax Consequences of Issuing Convertible Debt with a
Beneficial Conversion Feature"): a) The issuance of convertible debt with a
beneficial conversion feature results in a basis difference in applying SFAS No.
109, Accounting for Income Taxes. Recognition of such a feature effectively
creates a debt instrument and a separate equity instrument for book purposes,
whereas the convertible debt is treated entirely as a debt instrument for income
tax purposes. b) The resulting basis difference should be deemed a temporary
difference because it will result in a taxable amount when the recorded amount
of the liability is recovered or settled. c) Recognition of deferred taxes for
the temporary difference should be reported as an adjustment to additional
paid-in capital. This consensus is effective in the first interim or annual
reporting period commencing after December 15, 2005, with early application
permitted. The effect of applying the consensus should be accounted for
retroactively to all debt instruments containing a beneficial conversion feature
that are subject to EITF Issue 00-27 , "Application of Issue No. 98-5 to Certain
Convertible Debt Instruments" (and thus is applicable to debt instruments
converted or extinguished in prior periods but which are still presented in the
financial statements).

Management is evaluating the impact of this pronouncement on the Company's
financial statements.

ITEM 7. FINANCIAL STATEMENTS

The Company's financial statements for the years ended December 31, 2005 and
2004 are included herein and consist of:

Report of Independent Registered Public Accounting Firm F-1

Balance Sheet F-2

Statements of Operations F-3

Statement of Changes in Stockholders' Deficiency F-4-5

Statements of Cash Flows F-6

Notes to Financial Statements F-7

ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE

During the year ended December 31, 2005, no change in accountants occurred and
there were no disagreements with accountants.

ITEM 8A. CONTROLS AND PROCEDURES

Evaluation and Disclosure Controls and Procedures
-------------------------------------------------

The Company, under the supervision and with the participation of the Company's
management, including the Company's Chief Executive Officer and Chief Financial
Officer, has evaluated the effectiveness of the design and operation of the
Company's "disclosure controls and procedures," as such term is defined in Rules
13a-15e promulgated under the Exchange Act as of this report. Based upon that
evaluation, the Chief Executive Officer and Chief Financial Officer has
concluded that the Company's disclosure controls and procedures were 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 reported within the time periods specified in SEC rules and
forms. The Company's Chief Executive Officer and Chief Financial Officer have
also concluded that our disclosure controls and procedures are effective also to
ensure that information required to be disclosed in reports filed or submitted
under the Exchange Act are accumulated and communicated to the Company's
management to allow timely decisions on required disclosure.

Management is aware that there is a lack of segregation of duties at the Company
due to the small number of employees managing administrative and financial
matters. This constitutes a significant deficiency in the financial reporting.
Management has mitigated these factors by hiring an independent
accountant/bookkeeper to review and compile our financial statements on a
quarterly and annual basis.

At this time management has decided that considering the employees involved and
the control procedures in place and the potential benefits of adding additional
employees to clearly segregate duties does not justify the additional expense.

Management will periodically reevaluate this situation. If the situation changes
and sufficient capital is secured, it is the Company's intention to increase
staffing to mitigate the current lack of segregation of duties within the
general administrative and financial functions.

Changes in Internal Controls
----------------------------

Management has evaluated the effectiveness of the disclosure controls and
procedures as of December 31, 2005. Based on such evaluation, management has
concluded that the disclosure controls and procedures were effective for their
intended purpose described above. There were no changes to the internal controls
during the fourth quarter ended December 31, 2005 that have materially affected
or that are reasonably likely to affect the internal controls.

Limitations on the Effectiveness of Controls
--------------------------------------------

A control system, no matter how well conceived and operated, can provide only
reasonable, not absolute, assurance that the objectives of the control system
are met. Because of the inherent limitations in all control systems, no
evaluation of controls can provide absolute assurance that all control issues
and instances of fraud, if any, within a company have been detected. The
Company's disclosure controls and procedures are designed to provide reasonable
assurance of achieving its objectives. The Company's principal executive officer
and principal financial officer concluded that the Company's disclosure controls
and procedures are effective at that reasonable assurance level.

ITEM 8B. OTHER INFORMATION

NONE

PART III

ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT

At year-end 2005, the Company's Directors, Executive Officers and Scientific
Advisory Board Members are:

Name Age Position(s) with the Company

David A. Conway 64 Director, Chairman,President,
Chief Executive Officer and
Chief Financial Officer

John J. Clarke ++ 64 Director

Ronald W. Hart + 63 Chairman, Scientific
Advisory Board

Mohamed M. Salem + 54 Scientific Advisory Board

Marshall S. Sterman++ 74 Director

Richard Wilson + 80 Scientific Advisory Board

Mostafa K. Tolba + 84 Scientific Advisory Board

Lord John Gilbert + 80 Scientific Advisory Board

+ Members of the Advisory Board will receive an honorarium, in the form of cash
or common stock, for their service at the discretion of the Board of Directors.

++ Member of Audit Committee and Compensation Committee. Mr. Sterman, by reason
of education, training and experience is the Company's "recognized financial
expert" on the Audit Committee

David A. Conway

Mr. Conway was elected to the Board of Directors in 1997 and joined the Company
as President and Chief Executive Officer in 1998. Previously, he held the
positions of President and COO of a privately held public relations and
marketing company; Director and VP Administration of KDI Corporation (NYSE); VP
Administration Keene Corporation (NYSE) and earlier positions with CBS and
Goldman Sachs & Co. Mr. Conway, who served as an infantry officer in the US
Army, holds undergraduate and graduate degrees from Fordham University and is
listed in Who's Who in America.

John J. Clarke

John J. Clarke rejoined the Company's Board of Directors in March 2004. Mr.
Clarke had previously served as a member of the Company's Board of Directors
from July 1997 to February 2000 when he resigned from the Board due to his heavy
workload. Mr. Clarke is a Principal and co-founder of the Baldwin and Clarke
Companies, a diversified financial services organization, where he has been
employed since 1976, and is a founding director of two New Hampshire commercial
banks. Mr. Clarke currently serves as a Director of Centrix Bank.

Ronald W. Hart (Ph.D.)

Dr. Hart agreed to form the Board of Scientific Advisors in 2000 and became
Chairman at that time. Dr. Hart is an internationally recognized scientist and
scholar who was Director of the National Center for Toxicological Research and
was named "Distinguished Scientist in Residence" by the US Food and Drug
Administration in 1992. Recognized for his pioneering work on aging and his
studies on nutrition and health, Dr. Hart has been appointed visiting professor
at a number of universities, including Cairo University, Seoul National
University and Gangzhou University. He received his doctorate in physiology and
biophysics from the University of Illinois.

Mohamed M. Salem (MD/PhD.)

Dr. Salem was appointed to the Scientific Advisory Board in early 2001. Dr.
Salem is Professor of Occupational and Environmental Medicine at the Kasr
El-Aini School of Cairo University. An internationally recognized expert on the
health effects of environmental and water contaminants including pesticides,
lead and other metals, Dr. Salem is credited with establishing infectious
disease control programs at medical centers and other public entities throughout
the Middle East. Dr. Salem is a principal of Salem Industries, an import and
export company, which is one of the leading suppliers of chemicals and oil field
equipment in the Middle East. Dr. Salem holds both an M.D. and Ph.D. from Cairo
University.

Marshall S. Sterman

Mr. Sterman was elected to the Board of Directors in 2000. Mr. Sterman is
President of the Mayflower Group, a Massachusetts based merchant bank, where he
has been employed since 1986. He previously served as managing partner of
Cheverie and Company and MS Sterman & Associates, merchant banking firms and
principal of Sterman & Gowell Securities, an investment banking and securities
firm. Mr. Sterman served as an officer in the US Navy and holds his BA from
Brandeis University and his MBA from Harvard University.

Richard Wilson (Ph.D.)

Dr. Wilson was appointed to the Scientific Advisory Board in February 2001. Dr.
Wilson is the Mallinckrodt Research Professor of Physics at Harvard University.
Dr. Wilson is one of the foremost scientific authorities in the fields of water
quality remediation and purification, and is currently Professor of the Energy
Research Group at the University of California. Dr. Wilson is a member of the
Advisory Board of the Atlantic Legal Foundation, and is one of the principal
scientists studying the resolution of the water problems in Chernobyl and in
Bangladesh where toxic levels of arsenic contaminate the water supply. Dr.
Wilson holds his Ph.D. from Oxford University.

Mostafa K. Tolba (Ph.D.)

Dr. Tolba joined the Scientific Advisory Board in June 2001. Dr. Tolba served as
Under-Secretary-General of the United Nations, and Executive Director of the
United Nations Environmental Program from 1976 to 1992. Dr. Tolba is currently
President of the International Center for Environment and Development
headquartered in Geneva, Switzerland, and Emeritus Professor of Science at the
Kasr El-Aini School of Medicine at Cairo University. He received his Ph.D. in
Macrobiology from Imperial College, London, England.

Lord John Gilbert (Ph.D.)

Lord John Gilbert joined the Scientific Advisory Board in 2001. Lord Gilbert
served as Minister of State for Transportation, Minister of State for Finance,
and as Minister of State for Defense in the United Kingdom under three Prime
Ministers. Lord Gilbert is Secretary/Treasurer of the Tri-Lateral Commission and
a member of the House of Lords. He was educated at Marchant Taylors' School and
St. John's College, Oxford, and holds a Ph.D. in International Economics and
Statistics from New York University.

Marshall S. Sterman and John J. Clarke are the members of the Company's Audit
Committee. The Board of Directors has determined that Mr. Sterman is an "audit
committee financial expert" as defined in Item 401(e) of Regulation S-B.

Compliance with Section 16(a) of the Securities Exchange Act of 1934

Section 16(a) of the Securities Exchange Act of 1934, as amended, requires our
executive officers and directors, and persons who beneficially own more than ten
percent of our common stock, to file initial reports of ownership and reports of
changes in ownership with the Securities and Exchange Commission. Executive
officers, directors and greater than ten percent beneficial owners are required
by Securities and Exchange Commission regulations to furnish us with copies of
all Section 16(a) forms they file. Based upon a review of the copies of such
forms furnished to us and written representations from our executive officers
and directors, we believe that during the year ended December 31, 2005 there
were no delinquent filers except as follows: Marshall S. Sterman filed a Form 5
on February 14, 2006 in which he reported transactions that occurred on May 20,
2005, June 20, 2005, June 21, 2005, August 20, 2005, September 12, 2005,
September 13, 2005, October 25, 2005, October 26, 23005 and October 27, 2005
that were not timely reported on a Form 4 (thirteen transactions) and John J.
Clarke filed a Form 5 on February 14, 2006 for transactions that occurred on
August 12, 2005, September 7, 2005, and September 8, 2005 that were not timely
reported on a Form 4.

Code of Ethics

We adopted a code of ethics in 2005 that was filed as Exhibit 14.1 to our
Quarterly Report on Form 10-QSB filed with the Securities and Exchange
Commission on August 15, 2005. The code of ethics applies to each of our
directors and officers, including the chief financial officer and chief
executive officer, and all of our other employees and the employees of our
subsidiaries.

ITEM 10. EXECUTIVE COMPENSATION

SUMMARY COMPENSATION TABLE

Name and Principal Long Term
Position Annual Compensation Compensation
--------------------- -------------------------------- ----------------------------------

Securities
Restricted Underlying All
Other Annual Stock Options/ Other
Salary Bonus Compensation Award(s) SARs Compensation
Year ($) ($) ($) ($) (#) ($)
---- ------ ----- ------------ -------- -------- --------

David A. Conway 2005 $350,000 -- -- -- -- --
President/CEO 2004 $303,750 -- -- -- 5,000,000 --
2003 $165,000 -- -- -- -- --

The Company did not issue any stock options or common stock appreciation rights
during fiscal 2005.

The Company has no Long-Term Incentive Plans at this time.

DIRECTORS' COMPENSATION

Directors of the Company do not receive cash compensation for serving as
members; they are reimbursed for their out of pocket expenses related to
meetings and other Company related activity for which they are called upon. In
the past certain directors have received common stock for service to the
Company.

In 2005, Mr. Sterman was compensated at the rate of $6,000 per month for
consulting services performed for the Company. The Company may pay for these
services in cash or stock, and may terminate these services at its option. There
is $267,500 due to him for this service as of December 31, 2005.

The Company's directors have been paid success fees for helping the Company in
various equity and debt financings in previous years. These payments have been
both in cash and common stock, such payments being made based on industry-wide
standards and arms-length transactions

EMPLOYMENT AGREEMENTS

Mr. Conway entered into a five-year employment agreement in January 2004. The
agreement provides for base salary of $350,000 per year, participation in the
company's employee benefit programs and a life insurance policy in the amount of
$5,000,000. In addition, Mr. Conway was granted a stock appreciation right,
vesting at 20% per year for five years, for 5,000,000 shares of Water Chef
common stock at a strike price of $0.25 per share. Mr. Conway was originally
granted stock options in January 2004 that were later converted to stock
appreciation rights.

ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS

Set forth below is information as of December 31, 2005, concerning stock
ownership of all persons known by the Company to own beneficially 5% or more of
the any class of the securities of the Company, all Directors, the Executive
Officers, and all Directors and Executive Officers of the Company as a group
based on the number of shares of common stock issued and outstanding as of the
date of this report. For purposes of the report, beneficial ownership is defined
in accordance with the Rules of the Securities and Exchange Commission and
generally means the power to vote and/or dispose of the securities regardless of
any economic interest.

Common Stock Series A Series D Series F
Beneficially Owned(1) Preferred Stock Preferred Stock Convertible
Beneficially Beneficially Preferred Stock
Owned(1) Owned(1) Beneficially
Owned(1)
Shares % Shares % Shares % Shares %
------ - ------ - ------ - ------ -

David A. Conway (2) (3) 25,110,782 13.8% -- -- -- -- -- --
Water Chef, Inc.
1007 Glen Cove Ave., Suite 1
Glen Head, NY 11545

Marshall S. Sterman 650,000 * -- -- -- -- -- --
46 Neptune Street
Beverly, MA 01915

John J. Clarke 1,098,359 * -- -- -- -- -- --
116B S. River Rd.
Bedford, NH 03110

Jerome Asher & Anne Asher JTWROS -- -- 5,000 9.5% -- -- -- --
2701 N Ocean Blvd Apt E-202
Boca Raton, FL 33431

Robert D. Asher -- -- 5,000 9.5% -- -- -- --
72 Old Farm Road
Concord, MA 01742

John A. Borger -- -- -- -- 10,000 10.8% -- --
806 E Avenida Pico
Suite I PMB #262
San Clemente, CA 92673

C Trade Inc -- -- -- -- -- -- 9,375 10.4%
25-40 Shore Blvd., Ste. 6C
Astoria, NY 11102

Robert Kaszovitz -- -- -- -- -- -- 10,000 11.1%
1621 51st Street
Brooklyn, NY 11204

Kollel Metzioynim Lhoroah -- -- -- -- -- -- 5,000 5.6%
254 Wallabout St., Apt. 2A
Brooklyn, NY 11206

Olshan Grundman Frome Rosenzweig & -- -- -- -- -- -- 5,000 5.6%
Wolosky LLP
65 East 55th Street
New York, NY 10022

Eugene D. Trott -- -- -- -- -- -- 41,668 46.3%
459 12th St, Apt. 3B
Brooklyn, NY 11215

Shirley M. Wan -- -- -- -- 6,000 6.5% -- --
5455 Chelsen Wood Dr.
Lawrence, NY 11559

All executive officers and directors as 26,942,482 14.8% -- -- -- -- -- --
a Group (2)
* less than 1%

1. Total Voting Shares are comprised of all common shares issued and
outstanding.

2. Includes 6,310,464 shares held in an IRA Trust.

3. In March 2002, Mr. Conway voluntarily surrendered the anti-dilution agreement
that insured 32.6% ownership of the voting shares to Mr. Conway and his
affiliates.

4. Does not include Officers or Directors of the Company who were not such as of
the date of record.

ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

Beginning on January 1, 2002, Mr. Sterman was compensated at the rate of $6,000
per month for consulting services performed for the Company. The Company may pay
for these services in cash or stock, and may terminate these services at its
option.

ITEM 13. EXHIBITS

(a) Exhibits:

Number Description of Exhibit
------ ----------------------

3.1 Amended and Restated By-Laws of Water Chef, Inc. -
Incorporated herein by reference to Exhibit 3(ii) to the
Form 10-KSB/A filed November 17, 2003.

3.2 Amended and Restated Certificate of Incorporation of Water
Chef, Inc. - Incorporated herein by reference to Exhibit 3.2
to the Form SB-2 filed January 24, 2005.

3.3 Certificate of Amendment of Restated Certificate of
Incorporation of Water Chef, Inc. dated August 2, 1993 -
Incorporated herein by reference to Exhibit 3.3 to the Form
SB-2 filed January 24, 2005.

3.4 Certificate of Amendment of Restated Certificate of
Incorporation of Water Chef, Inc. dated August 2, 1992 -
Incorporated herein by reference to Exhibit 3.4 to the Form
SB-2 filed January 24, 2005.

3.5 Certificate for Renewal and Revival of Certificate of
Incorporation - Incorporated herein by reference to Exhibit
3.5 to the Form SB-2 filed January 24, 2005.

3.6 Certificate of Amendment of Restated Certificate of
Incorporation of Water Chef, Inc. dated February 20, 2002 -
Incorporated herein by reference to Exhibit 3.6 to the Form
SB-2 filed January 24, 2005.

3.7 Certificate of Correction filed to correct a certain error
in the Certificate of Amendment of the Restated Certificate
of Incorporation of Water Chef, Inc. dated May 7, 2004 -
Incorporated herein by reference to Exhibit 3.7 to the Form
SB-2 filed January 24, 2005.

4.1 Certificate of Designation of Series A Preferred Stock of
Water Chef, Inc. - Incorporated herein by reference to
Exhibit 4.1 to the Form 10-KSB/A filed November 17, 2003.

4.2 Certificate of Designation of Series C convertible preferred
stock of Water Chef, Inc. - Incorporated herein by reference
to Exhibit 4.2 to the Form 10-KSB/A filed November 17, 2003.

4.3 Certificate of Designation of Series D Preferred Stock of
Water Chef, Inc. - Incorporated herein by reference to
Exhibit 4.3 to the Form 10-KSB/A filed November 17, 2003.

4.4 Certificate of Designation of Series F convertible preferred
stock of Water Chef, Inc. - Incorporated herein by reference
to Exhibit 4.4 to the Form SB-2 filed January 24, 2005.

Number Description of Exhibit
------ ----------------------

4.5 Series B Warrant to Purchase Common Stock and Allonge to and
Amendment and Extension of Common Stock Purchase Warrant -
Incorporated herein by reference to Exhibit 4.4 to the Form
10-KSB/A filed November 17, 2003.

4.6 Series B Second Allonge to and Amendment and Extension of
Common Stock Purchase Warrant - Incorporated herein by
reference to Exhibit 4.6 to the Form SB-2 filed January 24,
2005.

4.7 Subordinated Debentures - Incorporated herein by reference
to Exhibit 4.5 to the Form 10-KSB/A filed November 17, 2003.

10.1 Mutual Settlement Agreement and General Release, dated June
20, 2002, by and between the Company; K. Thomas and Callaway
Decoster, as husband and wife; K. Thomas Decoster,
individually; Michael P. and Roberta S. Gaudette, as husband
and wife; Dominic M. Strazzulla; the Felix A. Hertzka
Estate; Claudette L. Gelfand and the Claudette L. Gelfand
Revocable Trust; Catherine C. Griffin; Michael B. and Diane
L. Hayden, as husband and wife; Alexander Harris; Holly O.
Harris; and Joseph R. Fichtl and the Joseph R. Fichtl 1995
Trust - Incorporated herein by reference to Exhibit 10.1 to
the Form 10-KSB/A filed April 15, 2004.

10.2 Addendum to Settlement Agreement, dated June 20, 2002, by
and between the Company; K. Thomas and Callaway Decoster, as
husband and wife; K. Thomas Decoster, individually; Michael
P. and Roberta S. Gaudette, as husband and wife; Dominic M.
Strazzulla; the Felix A. Hertzka Estate; Claudette L.
Gelfand and the Claudette L. Gelfand Revocable Trust;
Catherine C. Griffin; Michael B. and Diane L. Hayden, as
husband and wife; Alexander Harris; Holly O. Harris; and
Joseph R. Fichtl and the Joseph R. Fichtl 1995 Trust Trust -
Incorporated herein by reference to Exhibit 10.2 to the Form
10-KSB/A filed April 15, 2004.

10.3 Subdistributorship Agreement dated May 18, 2001 between 4
Clean Waters LTD. and the Company - Incorporated herein by
reference to Exhibit 10.2 to the Form 10-KSB/A filed
November 17, 2003.

10.4 Convertible Promissory Note dated November 17, 2000 to 4
Clean - Lindh Joint Venture by the Company - Incorporated
herein by reference to Exhibit 10.1 to the Form 10-KSB/A
filed November 21, 2004.

10.5 Preliminary Agreement, dated September 8, 2004 by, and
among, Water Chef, Inc., Samaritan Group International, and
International Multiracial Shared Cultural Organization
(IMSCO) - Incorporated herein by reference to Exhibit 10.1
to the Form 10-QSB filed November 17, 2004.

10.6 Loan Agreement, dated as of November 16, 2005, by and
between Water Chef, Inc. and Southridge Partners LP -
Incorporated herein by reference to Exhibit 99.1 to the Form
8-K filed November 23, 2005.

10.7 Registration Rights Agreement, dated as of November 16,
2005, by and between Water Chef, Inc. and Southridge
Partners LP - Incorporated herein by reference to Exhibit
99.2 to the Form 8-K filed November 23, 2005.

10.8 Promissory Note issued by Water Chef, Inc. on November 16,
2005 to Southridge Partners LP for the principal sum of
$250,000 - Incorporated herein by reference to Exhibit 99.3
to the Form 8-K filed November 23, 2005.

10.9 Three Year Warrant issued to Southridge Partners LP, dated
November 16, 2005, to purchase 430,000 shares of common
stock at a price of $0.14 per share - Incorporated herein by
reference to Exhibit 9.4 to the Form 8-K filed November 23,
2005.

31.1* Certification of Chief Executive Officer and Chief Financial
officer pursuant to Section 302 of the Sarbanes-Oxley Act.

32.2* Certification of Chief Executive Officer and Chief Financial
Officer pursuant to 8 U.S.C. Section 1350 As adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

* filed herewith

ITEM 14. PRINCIPAL ACCOUNTANT FEES

Our principal accountant for the audit of our annual financial statements for
our fiscal years ended December 31, 2005 and 2004 was Marcum & Kliegman LLP.

The following table shows the fees paid or accrued by us during the periods
indicated.

Year ended
Type of Service 2005 2004
--------------- ---- ----
Audit fees (1) $ 95,000 $ 72,500
Audit-Related Fees (2) 10,000 10,000
Tax Fees (3) -- --
All Other Fees (4) -- --
-------- --------
Total $105,000 $ 82,500
======== ========

(1) Comprised of the audit of our annual financial statements and reviews of our
quarterly financial statements.

(2) Comprised of services rendered in connection with our capital raising
efforts, registration statement and consultations regarding financial accounting
and reporting.

(3) Comprised of services for tax compliance, tax return preparation, tax advice
and tax planning.

(4) Fees related to other filings with the SEC, including consents.

Under the Sarbanes-Oxley Act of 2002, all audit and non-audit services performed
by the Company's independent accountants must now be approved in advance by the
Audit Committee to assure that such services do not impair the accountants'
independence from the Company. Accordingly, the Audit Committee has adopted an
Audit and Non-Audit Services Pre-Approval Policy (the "Policy") which sets forth
the procedures and the conditions pursuant to which services to be performed by
the independent accountants are to be pre-approved. Pursuant to the Policy,
certain services described in detail in the Policy may be pre-approved on an
annual basis together with pre-approved maximum fee levels for such services.
The services eligible for annual pre-approval consist of services that would be
included under the categories of Audit Fees, Audit-Related Fees, Tax Fees and
All Other Fees in the above table as well as services for limited review of
actuarial reports and calculations. If not pre-approved on an annual basis,
proposed services must otherwise be separately approved prior to being performed
by the independent accountants. In addition, any services that receive annual
pre-approval but exceed the pre-approved maximum fee level also will require
separate approval by the Audit Committee prior to being performed. The Audit
Committee may delegate authority to pre-approve audit and non-audit services to
any member of the Audit Committee, but may not delegate such authority to
management.

All of the engagements and fees for the year ended December 31, 2005 were
approved by the Audit Committee. Of the total number of hours expended during
M&K's engagement to audit the Company's financial statements for the year ended
December 31, 2005, none of the hours were attributed to work performed by
persons other than M&K's full-time, permanent employees.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this Report to be signed on its behalf by the
undersigned thereunto duly authorized.

WATERCHEF, INC.

March 22, 2006 /s/ David A. Conway
-----------------------------------
Date David A. Conway
President, Chief Executive
Officer and Chief Financial
Officer (Principal Operating
Officer)

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders of Water Chef, Inc.
Glen Head, New York

We have audited the accompanying balance sheet of Water Chef, Inc., (a
development stage company) as of December 31, 2005 and the related statements of
operations, stockholders' deficiency and cash flows for the years ended December
31, 2005 and 2004 and for the cumulative period from January 1, 2002
(commencement as a development stage company) to December 31, 2005. These
financial statements are the responsibility of the Company'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. The Company is not required to
have, nor were we engaged to perform, an audit of its internal control over
financial reporting. Our audits included consideration of internal control over
financial reporting as a basis for designing audit procedures that are
appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the Company's internal control over financial
reporting. Accordingly, we express no such opinion. An audit also includes
examining on a test basis, evidence supporting the amounts and disclosures in
the financial statements, 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 Water Chef, Inc., (a
development stage company) as of December 31, 2005 and the results of its
operations and its cash flows for the years ended December 31, 2005 and 2004 and
for the cumulative period from January 1, 2002 (commencement as a development
stage company) to December 31, 2005 in conformity with accounting principles
generally accepted in the United States of America.

The accompanying financial statements have been prepared assuming the Company
will continue as a going concern. As discussed in Note 2 to the financial
statements, the Company has had recurring losses, and has a working capital and
stockholders' deficiency as of December 31, 2005. These conditions raise
substantial doubt about its ability to continue as a going concern. Management's
plans in regard to these matters are also described in Note 2. The financial
statements do not include any adjustments that might result from the outcome of
this uncertainty.

/s/ Marcum & Kliegman LLP
----------------------------------
Marcum & Kliegman LLP

New York, New York
March 8, 2006

F-1

WATER CHEF, INC.
(A Development Stage Company Commencing January 1, 2002)
BALANCE SHEET
DECEMBER 31, 2005

ASSETS

CURRENT ASSETS:

Cash $ 244,595
Inventories 30,000
Prepaid expenses 22,964
------------
TOTAL CURRENT ASSETS 297,559

Patents and trademarks, Net 17,257

Deferred financing costs, Net 4,687

Other assets 3,162
------------
TOTAL ASSETS $ 322,665
============

LIABILITIES AND STOCKHOLDERS' DEFICIENCY

CURRENT LIABILITIES:

Accounts payable (including related party of $4,842) $ 194,016
Accrued expenses and other current liabilities 324,173
Accrued compensation 537,417
Accrued consulting and director fees 549,083
Customer deposits 115,000
Notes payable (including accrued interest of $540,426) 1,208,286
Convertible promissory note including accrued interest
of $2,500 and net of debt discount of $112,800) 139,700
Fair-value of detachable warrants 31,900
Fair-value of embedded conversion option 150,300
Accrued dividends payable 147,470
------------
TOTAL CURRENT LIABILITIES 3,397,345

LONG-TERM LIABILITIES:
Loans payable to stockholder (including accrued
interest of $129,089) 501,870
------------
TOTAL LIABILITIES 3,899,215
------------

COMMITMENTS AND CONTINGENCIES --

STOCKHOLDERS' DEFICIENCY:
Preferred stock, $.001 par value;
10,000,000 shares authorized;
235,585 shares issued and outstanding,
(liquidation preference $1,624,300) 236
Common stock, $.001 par value;
190,000,000 shares authorized;
181,779,000 shares issued;
181,774,600 shares outstanding 181,779
Additional paid-in capital 20,830,154
Treasury stock, 4,400 common shares, at cost ( 5,768)
Accumulated deficit through December 31, 2001 (14,531,596)
Deficit accumulated during development stage (10,051,355)
------------
TOTAL STOCKHOLDERS' DEFICIENCY ( 3,576,550)
------------
TOTAL LIABILITIES AND STOCKHOLDERS' DEFICIENCY $ 322,665
============

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

F-2

WATER CHEF, INC.
(A Development Stage Company Commencing January 1, 2002)
STATEMENTS OF OPERATIONS

For the Period
Year Ended December 31, January 1, 2002
------------------------------ to December 31,
2005 2004 2005
------------- ------------- -------------

Sales $ 260,000 $ 56,290 $ 356,290
------------- ------------- -------------
Costs, Expenses and (Income):
Cost of sales 42,000 62,250 438,680
Selling, general and administrative -
including stock based compensation of
$53,827 and $473,878 for the year
ended December 31, 2005 and 2004, respectively
and $777,390 for the period from
January 1, 2002 to December 31, 2005 1,194,577 1,296,265 4,097,587
Non-dilution agreement termination costs -- ( 223,858) 2,462,453
Interest expense (including interest Expense
for related party of $23,868 in both years
2005 and 2004 and $95,472 for the period
January 1, 2002 to December 31, 2005) 244,191 150,228 726,008
Financing Costs - extension of warrants 74,700 -- 74,700
Loss on settlement of debt -- 2,407,867 2,614,017
Stock appreciation rights ( 121,340) 121,340 --
Change in fair value of warrants and
embedded conversion option ( 5,800) -- ( 5,800)
------------- ------------- -------------
1,428,328 3,814,092 10,407,645
------------- ------------- -------------
Net loss ( 1,168,328) ( 3,757,802) ( 10,051,355)
------------- ------------- -------------
Deemed dividend on preferred stock -- ( 2,072,296) ( 2,072,296)

Preferred stock dividends ( 66,436) ( 134,366) ( 466,666)
------------- ------------- -------------
( 66,436) ( 2,206,662) ( 2,538,962)
------------- ------------- -------------
Net loss applicable to
common stockholders $( 1,234,764) $( 5,964,464) $( 12,590,317)
============= ============= =============

Basic and Diluted Loss Per Common Share $( 0.01) $( 0.05)
============= =============
Weighted Average Common Shares Outstanding -
Basic and Diluted 166,132,433 121,549,857
============= =============

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

F-3

WATER CHEF, INC.
(A Development Stage Company Commencing January 1, 2002)
STATEMENT OF STOCKHOLDERS' DEFICIENCY

Preferred Stock Common Stock Additional
---------------------------- --------------------------- Paid-in
Shares Amount Shares Amount Capital
------------ ------------ ------------ ------------ ------------

BALANCE - JANUARY 1, 2002 145,500 $ 146 86,614,286 $ 86,614 $ 12,339,469
Extension of life of warrants -- -- -- -- 111,000
Proceeds from sale preferred stock
($1.00 Per share) 125,000 125 -- -- 117,375
Proceeds from sale of common stock
($0.025 Per share) -- -- 2,500,000 2,500 97,500
Common stock issued for services
($0.08 Per share) -- -- 450,000 450 35,550
Collection of subscription receivable -- -- -- -- --
Net Loss -- -- -- -- --
------------ ------------ ------------ ------------ ------------
BALANCE - DECEMBER 31, 2002 270,500 $ 271 89,564,286 $ 89,564 $ 12,700,894
Proceeds from sale of preferred stock
March 31, 2003
($1.00-$2.00 Per share) 62,500 63 -- -- 74,937
June 30, 2003
($0.50 Per share) 75,000 75 -- -- 37,425
September 30, 2003
($1.00-$2.40 per share) 163,281 163 -- -- 228,346
December 31, 2003
($1.33-$2.80 Per share) 145,450 145 -- -- 258,717
Preferred stock issued for services
March 31, 2003
($1.00 Per share) 30,000 30 -- -- 29,970
June 30, 2003
($1.00 Per share) 51,250 51 -- -- 51,199
September 30, 2003
($1.00 per share) 67,035 67 -- -- 66,968
December 31, 2003
($1.88-$4.00 Per share) 22,150 22 -- -- 65,378
Collection of subscription receivable -- -- -- -- --
Write-off of subscription receivable -- -- -- -- --
Net Loss -- -- -- -- --
------------ ------------ ------------ ------------ ------------
BALANCE - DECEMBER 31, 2003 887,166 $ 887 89,564,286 $ 89,564 $ 13,513,834
Proceeds from sale of preferred stock
March 31, 2004
($2.40-$4.80 Per share) 130,077 130 -- -- 400,126
June 30, 2004
($0.80 Per share) 15,625 16 -- -- 12,484
Preferred stock issued for services
March 31, 2004
($2.00-$4.80 Per share) 49,433 49 -- -- 158,483
Proceeds from sale of common stock
September 30,2004
($0.03-$0.15 per share) -- -- 2,541,595 2,541 205,059
December 31, 2004
($0.05-$0.10 Per share) -- -- 2,487,500 2,488 187,512
Common stock issued for services
March 31, 2004
($0.05 Per share) -- -- 477,133 477 23,380
September 30,2004
($0.05-$0.15 per share) -- -- 1,857,800 1,858 126,792
December 31, 2004
($0.08-$0.10 Per share) -- -- 532,500 533 40,968
Preferred stock dividend -- -- -- -- (81,034)
Common stock issued for satisfaction of liabilities
June 30, 2004
($0.15 Per share) -- -- 37,786,629 37,787 5,635,934
December 31, 2004
($0.134 Per share) -- -- 411,100 411 54,839
Preferred stock converted to common stock
June 30, 2004 (133,250) (133) 5,108,332 5,108 (4,975)
September 30, 2004 (269,263) (269) 12,103,854 12,104 (11,835)
December 31, 2004 (65,375) (65) 3,015,000 3,015 (2,950)

Net loss -- -- -- -- --
------------ ------------ ------------ ------------ ------------
BALANCE - DECEMBER 31, 2004 614,413 $ 615 155,885,729 $ 155,886 $ 20,258,617

F-4

WATER CHEF, INC.
(A Development Stage Company Commencing January 1, 2002)
STATEMENT OF STOCKHOLDERS' DEFICIENCY
(Continued)

Proceeds from sale of common stock
March 31,2005
($0.05 per share) -- -- 200,000 200 9,800
June 30,2005
($0.05-$0.06 per share) -- -- 700,000 700 39,300
September 30,2005
($0.07-$0.10 per share) -- -- 2,455,357 2,455 202,545
December 31, 2005
($0.05-$0.07 Per share) -- -- 3,879,283 3,879 236,081
Common stock issued for services
March 31, 2005
($0.05-$0.10 Per share) -- -- 230,000 230 17,770
December 31, 2005
($0.05-$0.06 Per share) -- -- 407,500 408 21,219
Preferred stock dividend -- -- -- -- (66,436)
Extension of 1,666,667 warrants -- -- -- -- 74,700
Common stock issued for satisfaction of liabilities
September 30, 2005
($0.07 Per share) -- -- 571,428 571 39,429
December 31, 2005
($0.142 Per share) -- -- 100,000 100 14,100
Preferred stock converted to common stock
March 31, 2005 (55,970) (56) 2,518,800 2,519 (2,463)
June 30, 2005 (34,020) (34) 1,360,800 1,361 (1,327)
September 30, 2005 (286,650) (287) 13,382,583 13,383 (13,096)
December 31, 2005 (2,188) (2) 87,520 87 (85)

Net loss -- -- -- -- --
------------ ------------ ------------ ------------ ------------
BALANCE - DECEMBER 31, 2005 235,585 $ 236 181,779,000 $ 181,779 $ 20,830,154
============ ============ ============ ============ ============

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

F-4(Con't)

WATER CHEF, INC.
(A Development Stage Company Commencing January 1, 2002)
STATEMENT OF STOCKHOLDERS' DEFICIENCY
-continued-

Accumulated Deficit
Deficit Accumulated
Stock Through During Total
Subscription Treasury December Development Stockholders'
Receivable Stock 31, 2001 Stage Deficiency
------------ ------------ ------------ ------------ ------------

BALANCE - JANUARY 1, 2002 $ (67,500) $ (5,768) $(14,531,596) $ -- $ (2,178,635)
Extension of life of warrants -- -- -- -- 111,000
Proceeds from sale preferred stock
($1.00 Per share) -- -- -- -- 117,500
Proceeds from sale of common stock
($0.025 Per share) -- -- -- -- 100,000
Common stock issued for services
($0.08 Per share) -- -- -- -- 36,000
Collection of subscription receivable 30,200 -- -- -- 30,200
Net Loss -- -- -- (1,589,746) (1,589,746)
------------ ------------ ------------ ------------ ------------
BALANCE - DECEMBER 31, 2002 (37,300) (5,768) (14,531,596) (1,589,746) (3,373,681)
Proceeds from sale of preferred stock
March 31, 2003
($1.00-$2.00 Per share) -- -- -- -- 75,000
June 30, 2003
($0.50 Per share) -- -- -- -- 37,500
September 30, 2003
($1.00-$2.40 per share) -- -- -- -- 228,509
December 31, 2003
($1.33-$2.80 Per share) -- -- -- -- 258,862
Preferred stock issued for services
March 31, 2003
($1.00 Per share) -- -- -- -- 30,000
June 30, 2003
($1.00 Per share) -- -- -- -- 51,250
September 30, 2003
($1.00 per share) -- -- -- -- 67,035
December 31, 2003
($1.88-$4.00 Per share) -- -- -- -- 65,400
Collection of subscription receivable 15,500 -- -- -- 15,500
Write-off of subscription receivable 21,800 -- -- -- 21,800
Net Loss -- -- -- (3,535,479) (3,535,479)
------------ ------------ ------------ ------------ ------------
BALANCE - DECEMBER 31, 2003 -- (5,768) ( 14,531,596) ( 5,125,225) (6,058,304)

Proceeds from sale of preferred stock
March 31, 2004
($2.40-$4.80 Per share) -- -- -- -- 400,256
June 30, 2004
($0.80 Per share) -- -- -- -- 12,500
Preferred stock issued for services
March 31, 2004
($2.00-$4.80 Per share) -- -- -- -- 158,532
Proceeds from sale of common stock
September 30,2004
($0.03-$0.15 per share) -- -- -- -- 207,600
December 31, 2004
($0.05-$0.10 Per share) -- -- -- -- 190,000
Common stock issued for services
March 31, 2004
($0.05 Per share) -- -- -- -- 23,857
September 30,2004
($0.05-$0.15 per share) -- -- -- -- 128,650
December 31, 2004
($0.08-$0.10 Per share) -- -- -- -- 41,501
Preferred stock dividend -- -- -- -- (81,034)
Common stock issued for satisfaction of liabilities
June 30, 2004
($0.15 Per share) -- -- -- -- 5,673,721
December 31, 2004
($0.134 Per share) -- -- -- -- 55,250
Preferred stock converted to common stock
June 30, 2004 -- -- -- -- --
September 30, 2004 -- -- -- -- --
December 31, 2004 -- -- -- -- --
Net loss -- -- -- (3,757,802) (3,757,802)
------------ ------------ ------------ ------------ ------------
BALANCE - DECEMBER 31, 2004 -- $ (5,768) $(14,531,596) $ (8,883,027) $ (3,005,273)

F-5(Con't)

WATER CHEF, INC.
(A Development Stage Company Commencing January 1, 2002)
STATEMENT OF STOCKHOLDERS' DEFICIENCY
-continued-

Proceeds from sale of common stock
March 31,2005
($0.05 per share) -- -- -- -- 10,000
June 30,2005
($0.05-$0.06 per share) -- -- -- -- 40,000
September 30,2005
($0.07-$0.10 per share) -- -- -- -- 205,000
December 31, 2005
($0.05-$0.07 Per share) -- -- -- -- 239,960
Common stock issued for services
March 31, 2005
($0.05-$0.10 Per share) -- -- -- -- 18,000
December 31, 2005
($0.05-$0.06 Per share) -- -- -- --
21,627
Preferred stock dividend -- -- -- -- (66,436)
Extension of 1,666,667 warrants -- -- -- -- 74,700
Common stock issued for satisfaction of liabilities
September 30, 2005
($0.07 Per share) -- -- -- --
40,000
December 31, 2005
($0.142 Per share) -- -- -- -- 14,200
Preferred stock converted to common stock
March 31, 2005 -- -- -- -- --
June 30, 2005 -- -- -- -- --
September 30, 2005 -- -- -- -- --
December 31, 2005 -- -- -- -- --

Net loss -- -- -- (1,168,328) (1,168,328)
------------ ------------ ------------ ------------ ------------
BALANCE - DECEMBER 31, 2005 -- $ (5,768) $(14,531,596) $(10,051,355) $ (3,576,550)
============ ============ ============ ============ ============

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

F-5Con't)

WATER CHEF INC.
(A Development Stage Company Commencing January 1, 2002)

STATEMENTS OF CASH FLOWS

For the period
Years Ended December 31, January 1, 2002
---------------------------- to December 31,
2005 2004 2005
------------ ------------ ------------

CASH FLOWS FROM OPERATING ACTIVITIES
Net loss $ (1,168,328) $ (3,757,802) $(10,051,355)
Adjustments to reconcile net loss to
net cash used in operating activities
Amortization of patents 1,854 1,855 7,416
Interest expense - deferred financing 2,813 -- 2,813
Stock based compensation 53,827 473,878 777,390
Accretion of debt discount 75,200 -- 75,200
Change in fair value of warrants and
embedded conversion option ( 5,800) -- ( 5,800)
Loss on settlement of debt -- 2,407,867 2,614,017
Non-dilution agreement termination cost -- ( 223,858) 2,462,453
Inventory reserve -- -- 159,250
Write-off of stock subscription receivable -- -- 21,800
Financing costs - warrant extension 74,700 -- 74,700
Change in assets and liabilities
Inventory ( 30,000) 26,500 ( 30,000)
Prepaid expenses ( 5,851) ( 5,893) 33,536
Accounts payable, accrued expenses, accrued dividends,
accrued compensation, accrued consulting and director
fees, customer deposits and other current liabilities 422,350 265,998 1,472,139
------------ ------------ ------------
NET CASH USED IN OPERATING ACTIVITIES ( 579,235) ( 811,455) (2,386,441)
------------ ------------ ------------

CASH FLOWS FROM FINANCING ACTIVITIES
Reduction of stock subscription receivable 20,000 -- 65,700
Proceeds from sale of preferred stock -- 412,756 1,130,127
Proceeds from sale of common stock 494,960 377,600 972,560
Proceeds from sale of common stock to be issued -- -- 200,000
Deferred financing costs ( 7,500) -- ( 7,500)
Proceeds from convertible promissory note 250,000 -- 250,000
Repayment of notes payable ( 15,362) -- ( 15,362)
------------ ------------ ------------
NET CASH PROVIDED BY FINANCING ACTIVITIES 742,098 790,356 2,595,525
------------ ------------ ------------

NET INCREASE(DECREASE)IN CASH 162,863 ( 21,099) 209,084

CASH AT BEGINNING OF YEAR 81,732 102,831 35,511
------------ ------------ ------------
CASH AT END OF YEAR $ 244,595 $ 81,732 $ 244,595
============ ============ ============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the year for:
Interest $ 44,638 $ 20,000 $ 64,888
============ ============ ============

NON-CASH FINANCING ACTIVITIES:

COMPENSATION SATISFIED BY ISSUANCE OF COMMON STOCK $ -- $ 55,250 $ 55,250
============ ============ ============
COMMON STOCK ISSUED IN SATISFACTION OF LIABILITIES $ 40,000 $ 5,673,721 $ 5,713,721
============ ============ ============

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

F-6

WATER CHEF, INC.
(A Development Stage Company Commencing January 1, 2002)

NOTES TO FINANCIAL STATEMENTS

1. DESCRIPTION OF BUSINESS

Water Chef, Inc. (the "Company"), is a Delaware Corporation currently engaged in
the design, marketing and sale of water dispensers and purification equipment
both in and outside the United States. The Company's corporate headquarters is
in Glen Head, NY.

2. BASIS OF PRESENTATION AND CONTINUED OPERATIONS

Basis of Presentation

The Company discontinued its water cooler and filtration operations in November
2001. As a result, the Company has refocused its efforts on raising capital and
developing markets for its proprietary technology. Therefore, for financial
purposes, the Company has determined that it has re-entered the development
stage commencing January 1, 2002. The Company's statements of operations,
stockholders' deficiency and cash flows for the year ended December 31, 2005
represent the financial information cumulative, from inception/commencement,
required by Statement of Financial Accounting Standards ("SFAS") No. 7,
"Development Stage Enterprises."

Going Concern

The accompanying financial statements have been prepared in conformity with
accounting principles generally accepted in the United States of America, which
contemplate continuation of the Company as a going concern and the realization
of assets and the satisfaction of liabilities in the normal course of business.
The carrying amounts of assets and liabilities presented in the financial
statements do not purport to represent realizable or settlement values. The
Company incurred losses from operations of $1,168,328 and $3,757,802 for the
years ended December 31, 2005 and 2004, respectively. The Company has a working
capital deficit and a stockholders' deficiency of approximately $3,100,000 and
$3,577,000 at December 31, 2005, respectively. These conditions raise
substantial doubt about the Company's ability to continue as a going concern.

Management's plans with respect to these matters include restructuring its
existing debt and raising additional capital through future issuances of stock
and/or debt. The accompanying financial statements do not include any
adjustments that might result from the outcome of this uncertainty and these
adjustments may be material

3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Patents and Trademarks - Patents and trademarks are amortized ratably over 9 to
14 years. The Company assesses the carrying value of its patents for impairment
each year. Based on its assessments, the Company did not incur any impairment
charges for the years ended December 31, 2005 and 2004, respectively.

Stock-Based Compensation - In December 2002, the Financial Accounting Standards
Board ("FASB") issued SFAS No. 148, "Accounting for Stock-Based Compensation -
Transition and Disclosure - an amendment of FASB Statement No. 123." SFAS No.
148 amends SFAS No. 123, "Accounting for Stock-Based Compensation," to provide
alternative methods of transition for a voluntary change to the fair value based
method of accounting for stock-based employee compensation. In addition, SFAS
No. 148 amends the disclosure requirements of SFAS No. 123 to require prominent
disclosures in both annual and interim financial statements about the method of
accounting for stock-based employee compensation and the effect of the method
used on reported results. The Company accounts for stock-based compensation
according to APB Opinion No. 25.

The following table summarizes relevant information as to reported results under
the Company's intrinsic value method of accounting for stock awards, with
supplemental information as if the fair value recognition provision of SFAS No.
123 had been applied for the periods ended December 31, 2005 and 2004 as
follows:

F-7

WATER CHEF, INC.
(A Development Stage Company Commencing January 1, 2002)

NOTES TO FINANCIAL STATEMENTS
Continued

Years ended December 31,
2005 2004
------------- -------------
Net loss applicable to common
stockholders as reported $ ( 1,234,764) $ ( 5,964,464)

Add:
Stock-based employee compensation,
included in reported net loss -- --

Less:
Stock-based employee compensation,
net of tax effect determined under fair
value method for all awards (121,340) (169,870)

------------- -------------
Pro-forma net loss under fair
value method $ ( 1,356,104) $ ( 6,134,334)
============= =============
Basic and Diluted Net Loss per Common Share:

As reported $ (0.01) $ (0.05)
============= =============
Pro-forma $ (0.01) $ (0.05)
============= =============

Revenue Recognition - Revenues are recognized when product is shipped, title
passes and collectibility is reasonably assured. Allowances for estimated bad
debts, sales allowances and discounts are provided when such sales are recorded.

Inventories - Inventories consists of finished goods and are stated at the lower
of cost or market utilizing the first-in, first-out method. As of December 31,
2005, inventory was comprised of $30,000 of finished goods.

Shipping and Handling Costs - Shipping and handling costs are expensed as
incurred as part of cost of sales. These costs were deemed to be immaterial
during each of the reporting periods.

Advertising Costs - Advertising costs are expensed as incurred. Advertising
costs, which are included in selling, general and administrative expenses, were
deemed immaterial for the years ended December 31, 2005 and 2004, respectively.

Income Taxes - Income taxes are accounted for under SFAS No. 109, "Accounting
for Income Taxes," which is an asset and liability approach that requires the
recognition of deferred tax assets and liabilities for the expected future tax
consequences of events that have been recognized in the Company's financial
statements or tax returns. Valuation allowances are established when necessary
to reduce deferred assets to the amounts expected to be realized.

Loss Per Share - Basic loss per share was computed using the weighted average
number of outstanding common shares. Diluted loss per share includes the effect
of dilutive common stock equivalents from the assumed exercise of options,
warrants and convertible preferred stock. Common stock equivalents were excluded
in the computation of diluted loss per share since their inclusion would be
anti-dilutive. Total shares issuable upon the exercise of options, warrants and
the conversion of preferred stock and convertible debt for the years ended
December 31, 2005 and 2004, were 21,270,105 and 34,230,804, respectively.

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 and disclosure of contingent assets and
liabilities at the date of the financial statements and revenues and expenses
during the reporting period. Actual results could differ from those estimates.

F-8

WATER CHEF, INC.
(A Development Stage Company Commencing January 1, 2002)

NOTES TO FINANCIAL STATEMENTS
Continued

Fair Value of Financial Instruments - The carrying amounts of the financial
instruments reported in the balance sheet approximate their fair market value
due to the short-term maturities of these instruments.

Impairment of Long-Lived Assets - In the event that facts and circumstances
indicate that the cost of an asset may be impaired, an evaluation of
recoverability would be performed. If an evaluation is required, the estimated
future undiscounted cash flows associated with the asset would be compared to
the asset's carrying amount to determine if a write-down to fair value is
required.

Research and Development - Research and development costs consist of
expenditures incurred during the course of planned research and investigation
aimed at the discovery of new knowledge, which will be useful in developing new
products or processes. The Company expenses all research and development costs
as incurred. There were no research and development costs incurred during the
years ended December 31, 2005 and 2004, respectively.

Recent Accounting Pronouncements

In December 2004, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standard ("SFAS") No. 123R, "Share Based
Payment." This statement is a revision of SFAS Statement No. 123, "Accounting
for Stock-Based Compensation" and supersedes APB Opinion No. 25, Accounting for
Stock Issued to Employees, and its related implementation guidance. SFAS 123R
addresses all forms of share based payment ("SBP") awards including shares
issued under employee stock purchase plans, stock options, restricted stock and
stock appreciation rights. Under SFAS 123R, SBP awards result in a cost that
will be measured at fair value on the awards' grant date, based on the estimated
number of awards that are expected to vest. This statement is effective for
public entities that file as small business issuers - as of the beginning of the
first annual reporting period that begins after December 15, 2005.

The Company believes the adoption of this pronouncement will have a material
impact on the Company's financial statements, whereby the Company, upon
adoption, expects to record a charge for the granting of future employee stock
options.

In May 2005, the FASB issued SFAS No. 154 - Accounting for Change in Error
Corrections - a replacement of APB Opinion No. 20 and FASB Statement No. 3. This
statement replaces APB Opinion No. 20, "Accounting Changes" and FASB Statement
No. 3 "Reporting Accounting Changes in Interim Financial Statements," and
changes the requirement for the accounting for and reporting changes in
accounting principles. This statement applies to changes required by an
accounting pronouncement in the unusual instance that the pronouncement does not
include specific transition provisions. When a pronouncement includes specific
transition provisions, those provisions should be followed. This statement is
effective for accounting changes and corrects errors made in fiscal years
beginning after December 15, 2005.

The application of this pronouncement is not expected to have an impact on the
Company's financial position, results of operations, or cash flows.

In September 2005, the FASB ratified the following consensus reached in Emerging
Issues Task Force ("EITF") Issue 05-8 ("Income Tax Consequences of Issuing
Convertible Debt with a Beneficial Conversion Feature"): a) the issuance of
convertible debt with a beneficial conversion feature results in a basis
difference in applying FASB Statement of Financial Accounting Standards SFAS No.
109, Accounting for Income Taxes. Recognition of such a feature effectively
creates a debt instrument and a separate equity instrument for book purposes,
whereas the convertible debt is treated entirely as a debt instrument for income
tax purposes. b) the resulting basis difference should be deemed a temporary
difference because it will result in a taxable amount when the recorded amount
of the liability is recovered or settled. c) recognition of deferred taxes for
the temporary difference should be reported as an adjustment to additional
paid-in capital. This consensus is effective in the first interim or annual
reporting period commencing after December 15, 2005, with early application
permitted. The effect of applying the consensus should be accounted for
retroactively to all debt instruments containing a beneficial conversion feature
that are subject to EITF Issue 00-27,,"Application of Issue No. 98-5 to Certain
Convertible Debt Instruments" (and thus is applicable to debt instruments
converted or extinguished in prior periods but which are still presented in the
financial statements).

The application of this pronouncement is not expected to have an impact on the
Company's financial position, results of operations, or cash flows.

EITF reached a tentative conclusion on EITF Issue No. 05-1, "Accounting for the
Conversion of an Instrument that Becomes Convertible upon the Issuer's Exercise
of a Call Option" that no gain or loss should be recognized upon the conversion
of an instrument that becomes convertible as a result of an issuer's exercise of
a call option pursuant to the original terms of the instrument. The consensus
for EITF No. 05-1 has not been finalized.

F-9

WATER CHEF, INC.
(A Development Stage Company Commencing January 1, 2002)

NOTES TO FINANCIAL STATEMENTS
Continued

The application of this pronouncement is not expected to have an impact on the
Company's financial position, results of operations, or cash flows.

The Company has applied the requirements of EITF No. 05-2, (See Note 6) with
respect to the impact of this pronouncement on the Company's financial
statements.

In June 2005, the EITF reached consensus on Issue No. 05-6, "Determining the
Amortization Period for Leasehold Improvements" (EITF 05-6). EITF 05-6 provides
guidance on determining the amortization period for leasehold improvements
acquired in a business combination or acquired subsequent to lease inception.
The guidance in EITF 05-6 will be applied prospectively and is effective for
periods beginning after June 29, 2005. EITF 05-6 will not have a material impact
on the Company's consolidated financial position or results of operations.

The Company is currently in the process of evaluating the effect that the
adoption of this pronouncement will have on its financial statements.

EITF Issue No. 05-4 "The Effect of a Liquidated Damages Clause on a Freestanding
Financial Instrument Subject to EITF Issue No. 00-19, `Accounting for Derivative
Financial Instruments Indexed to, and Potentially Settled in, a Company's Own
Stock" ("EITF No. 05-4") addresses financial instruments, such as stock purchase
warrants, which are accounted for under EITF 00-19 that may be issued at the
same time and in contemplation of a registration rights agreement that includes
a liquidated damages clause. The consensus for EITF No. 05-4 has not been
finalized. In November 2005 the Company issued a convertible promissory note, a
registration rights agreement and warrants (See Note 6). Based on the
interpretive guidance in EITF Issue No. 05-4, Due to certain factors and the
liquidated damage provision in the registration rights agreement, the Company
determined that the embedded conversion option and the warrants are derivative
liabilities and the registration statement becoming effective on January 30,
2006, the value of the registration rights was deemed to be de minims.

4. PATENTS AND TRADEMARKS

Patents and trademarks as of December 31, 2005 consist of the following:

Patents $ 24,500
Trademarks 1,555
--------
Total cost 26,055
--------
Accumulated amortization (8,798)
--------
Patents and Trademarks, Net $ 17,257
========

Amortization expense for the years ended December 31, 2005 and 2004 was $1,854
and $1,855, respectively. The following table presents the Company's estimate
for amortization expense for each of the five succeeding years and thereafter.

F-10

2006 $ 1,854
2007 1,854
2008 1,854
2009 1,854
2010 1,854
2011 and thereafter 7,987
--------
$ 17,257

5. NOTES PAYABLE

Notes payable and accrued interest at December 31, 2005 consist of the
following:

(a) $ 177,116
(b) 846,533
(c) 184,637
--------------

Total $ 1,208,286
==============

(a): These are unsecured notes bearing interest ranging from 10% to 15% per
annum, with no specific due date for repayment. An amount due on these notes,
inclusive of $93,893 in interest is $177,116, at December 31, 2005. No demands
for repayment have been made by the note holder.

(b) In April 2001, the Company issued a $400,000 promissory note at an interest
rate of 2% per month. In consideration for the issuance of this note, 500,000
shares of the Company's common stock were issued to the note holder and a
$74,000 debt discount was recorded and fully amortized in the year ended
December 31, 2001. The principal balance and accrued interest were payable on
September 1, 2001. The Company did not make such payment and was required to
issue an additional 100,000 penalty shares of its common stock to the note
holder. The Company recorded additional interest expense of $12,300 related to
the issuance of these penalty shares. The amount due on this note, inclusive of
$446,533 in interest, is $846,533 at December 31, 2005.

(c) In November 2000, the Company entered into a Convertible Promissory Note
agreement, whereby the Company may be advanced a maximum of $300,000. The
Company was advanced the following: $100,000 in November 2000, $50,000 in
December 2000 and $50,000 in January 2001. No further cash advances were made to
the Company. The Convertible Promissory Note agreement also called for the
payment of $100,000 of Company expenses. The advances bear interest at 10% per
annum and were to have been repaid as of January 15, 2002. A maximum of
6,000,000 shares could have been issued upon conversion had the full $300,000
been advanced. As of December 31, 2005, the balance of the convertible
promissory note principal was $184,637 and no interest was owed

6. CONVERTIBLE PROMISSORY NOTES

In November 2005, the Company entered into a Convertible Promissory Note
agreement for $250,000. The Convertible Promissory Noted bears interest at a
rate of 8% per annum and will mature in March 2006. The Company granted 430,000
warrants to the holder, which are exercisable at $0.14 per share and have a life
of three years. The warrants carry a cashless exercise provision.

The note included certain conversion features as follows:

o convertible at any time after the maturity date, at the option of the
holder,
o convertible at 85% of the average of the three 3 lowest closing bid
prices for the common stock, for the ten trading days ending on the
trading day immediately before the conversion date.

The Convertible Promissory Note agreement required the Company to file a
registration statement no later than sixty business days and no less than the
amount of subscribed shares, and to cause the registration statement relating to
the registrable securities to become effective the earlier of five business days
after notice from the Securities and Exchange Commission that the registration
statement may be declared effective, or (b) one hundred twenty days.

The Convertible Promissory Note agreement included a liquidated damages clause,
which stipulates if the registration statement is not filed by the filing date
or declared effective by the effective date, then upon failure of either event
the subscriber shall be entitled to liquidated damages, payable in cash, in the
sum of one percent (1%) of the principal amount of the Note:

F-11

WATER CHEF, INC.
(A Development Stage Company Commencing January 1, 2002)

NOTES TO FINANCIAL STATEMENTS
Continued

a. for each 30 day period after the filing date that transpires until the
date that the Company files the registration statement, and
b. for each 30 day period after the effective date that transpires until
such date as the registration statement is declared effective.

The gross proceeds of $250,000 were recorded net of a discount of $188,000. The
debt discount consisted of $47,200 related to the warrants and $140,800 related
to the embedded conversion option. The warrants and the embedded conversion
option were accounted for under EITF issue No. 00-19 "Accounting for Derivative
Financial Instruments Index to and Potentially Settled in a Company's Own Stock"
and EITF 05-4, view A "The effect of a Liquidated Damages Clause on a
Freestanding Financial Instrument." Due to certain factors and the liquidated
damage provision in the registration rights agreement, the Company determined
that the embedded conversion option and the warrants are derivative liabilities.
Accordingly, the warrants and the embedded conversion option will be marked to
market through earnings at the end of each reporting period. Due to the fact
that the registration statement became effective on January 30, 2006, the value
of the registration rights was deemed to be de minims. The warrants and the
conversion option are valued using the Black-Scholes valuation model. For the
year ended December 31, 2005, the Company reflected a gain of $5,800
representing a change in the value of the warrants and conversion option. The
debt discount of $188,000 is being accreted over a period of four months and as
a result, a charge of $75,200 was recorded for the year ended December 31, 2005.

This Convertible Promissory Note is secured by 4,000,000 shares held by an
officer of the Company. The balance due under this note at December 31, 2005 is
$250,000 plus accrued interest of $2,500. The Company incurred fees of
approximately $7,500 at the closing date of the note. These costs have been
capitalized as of December 31, 2005 as deferred financing costs and will be
amortized to interest expense over the life of the note and for the year ended
December 31, 2005, $2,813 has been amortized.

7. LOANS PAYABLE - STOCKHOLDER

At December 31, 2004, the Company is obligated to its Chief Executive Officer
who is also a significant stockholder for loans and advances made to the Company
totaling $372,781, plus accrued interest of $129,089. These advances have been
accruing interest ranging from 6% to 12% per annum. The loans have no repayment
terms and the stockholder has agreed not to demand payment until July 1, 2007 at
the earliest. The Company has reported the obligation as a long-term liability
on the balance sheet.

8. COMMON STOCK ISSUED

On June 4, 2004, the Company convened a special meeting of its common, Series A
Preferred, Series C Preferred, Series D Preferred, Series F Preferred
stockholders (together the "Stockholders"). The Stockholders, voting as a single
class, voted and approved a proposal to amend the Certificate of Incorporation
to increase the Company's authorized capital stock from 100,000,000 shares to
200,000,000 shares, consisting of 190,000,000 shares of common stock and
10,000,000 shares of preferred stock.

During the year ended December 31, 2005, the Company recorded the following
transactions:

a. Cash

During the year ended December 31, 2005, the Company received $494,960 for
7,234,640 shares of its common stock.

b. Services

During 2005, the Company issued to various parties an aggregate of 637,500
shares of its common stock for a value of $39,627 in connection with
professional services.

c. Conversion of preferred stock into common stock

During year ended December 31, 2005, the Company issued to various parties an
aggregate of 17,349,703 shares of its common stock in connection with the
conversion of preferred stock.

d. Settlement of debt

During year ended December 31, 2005, the Company issued to a note holder 571,428
for the settlement $40,000 of debt.

F-12

WATER CHEF, INC.
(A Development Stage Company Commencing January 1, 2002)

NOTES TO FINANCIAL STATEMENTS
Continued

e. Extension of debt

In November 2005, the Company issued 100,000 shares of its common stock for a
value of $14,200 to a note holder for an agreement to defer requesting payment
for a period of one month. The principal amount of the note is $400,000, and
accrued interest is approximately $423,000.

9. PREFERRED STOCK

The Company is authorized to issue 10,000,000 shares of $.001 par value
preferred stock, issuable in series with rights, preferences, privileges and
restrictions as determined by the board of directors.

At December 31, 2005, outstanding preferred shares were as follows:
Liquidation
Current Preference
Annual Total Dividend (including
Authorized Outstanding Par Dividend Dividend Arrearage dividend
Shares Shares Value Requirement Arrearage Per Share arrearage)

Series A 400,000 52,500 $ 53 $ 52,500 $ 570,100 $ 10.86 $1,095,100
Series D 2,000,000 93,000 93 55,800 529,200 5.69 529,200
Series F 1,000,000 90,085 90 32,986 147,263 1.13 --
---------- ---------- ---------- ---------- ----------

235,585 $ 236 $ 141,286 $1,246,563 $1,624,300
========== ========== ========== ========== ==========

Series A:

The Series A preferred stock provides for a 10% cumulative dividend, based on
the $10 per share purchase price, payable annually in the Company's common stock
or cash, at the Company's option. The Series A preferred stock is not
convertible, and is redeemable solely at the Company's option at a price of $11
per share plus accrued dividends. The Series A preferred stockholders have
voting rights equal to common stockholders.

In the event of the liquidation, dissolution or winding up of the Company,
whether voluntary or involuntary, holders of the Series A preferred stock are
entitled to receive out of the assets of the Company the sum of $10.00 per share
of Series A preferred stock then outstanding, plus a sum equal to all dividends
(whether or not earned or declared) on such shares accrued and unpaid thereon to
the date of final payment or distribution, before any payment or distribution
upon dissolution, liquidation or winding up shall be made on any series or class
of capital stock ranking junior to Series A preferred stock as to such payment
or distribution.

Series C:

During the year ended December 31, 2002, the Company sold Series C 15%
Convertible Preferred stock at $1.00 per share. These shares convert in one
year. All dividends are cumulative and are payable in shares of the Company's
common stock valued at the then-current market price per share, or upon
conversion, whichever is earlier. The conversion rate for shares, and accrued
dividends payable, is 33.33 shares of common for each $1.00 of preferred stock
and dividends payable, or $0.03 for each share of common stock. The Series C
Preferred stockholders have voting rights equal to the common stockholders. The
Series C preferred stock has no stated rights in the assets of the Company upon
liquidation. During 2002, the Company sold 125,000 shares of Series C preferred
stock. For each share of preferred stock purchased, the buyers also receive the
right to receive an additional 33.33 shares of common stock upon conversion, as
the market value of the stock was $0.015 at issuance.

Series D:

The Series D preferred stock provides for a 12% cumulative dividend, based on
the $5 per share purchase price, payable semi-annually in the Company's common
stock or cash, at the Company's option. The Series D preferred stock is not
convertible, and is redeemable solely at the Company's option at a price of
$5.75 per share plus accrued dividends. The Series D Preferred stockholders have
voting rights equal to the common stockholders.

F-13

WATER CHEF, INC.
(A Development Stage Company Commencing January 1, 2002)

NOTES TO FINANCIAL STATEMENTS
Continued

In the event of the liquidation, dissolution or winding up of the Company,
whether voluntary or involuntary, holders of the Series D preferred stock are
entitled to receive out of the assets of the Company the sum of all dividends
(whether or not earned or declared) on such shares accrued and unpaid thereon to
the date of final payment or distribution, before any payment or distribution
upon dissolution, liquidation or winding up shall be made on any series or class
of capital stock ranking junior to Series D preferred stock as to such payment
or distribution.

Series F:

In April 2003, management authorized the Company to raise up to $550,000 through
a private placement by issuing 10% two-year convertible preferred instruments.
The preferred, designated as Series F, and provided for one million shares in
total and can be convertible into shares of Water Chef's common stock at such
time as the stockholders of the corporation approve an increase in the
authorized capital stock of the corporation, which occurred on June 4, 2004. All
dividends are cumulative and are payable in shares of the Company's common stock
valued at the then current market price per share, at the time of maturity, or
upon conversion, whichever is earlier. The conversion rate for shares and
accrued dividends payable is 40 shares of common for each share of preferred
stock. The Series F convertible preferred stockholders have voting rights equal
to the common stockholders. The Series F convertible preferred stock has no
stated rights in the assets of the Company upon liquidation.

Although there was a discount upon the issuance of all of the Series F preferred
stock in accordance with EITF 98-5, a security is not yet convertible if certain
contingencies exist which are dependent upon the occurrence of a future event
outside the control of the security holder. In this case, the shares can only be
converted into common stock after the stockholders of the Company approve an
increase in the authorized capital stock of the corporation. In accordance with
EITF 98-5, any beneficial conversion (discount) feature is measured at the
commitment date, but will not be recognized as an adjustment to earnings until
the contingency is resolved, (the date the increase in shares are approved). In
June 2004, the Company voted and approved a proposal to amend the Certificate of
Incorporation to increase the Company's authorized capital stock from
100,000,000 to 200,000,000 shares, consisting of 190,000,000 shares of common
stock and 10,000,000 shares of preferred stock. During June 2004, the Company
recorded the deferred contingent beneficial conversion adjustment of $2,072,296
as a deemed dividend since the contingency was resolved.

In connection with Series F Preferred Stock conversions, the Company recorded
dividends of $66,436 and $41,915 for each of the years ended December 31, 2005
and 2004, respectively.

10. STOCK OPTION, STOCK APPRECIATION RIGHTS AND WARRANT GRANT PLAN

The Company's president and director were issued 6,000,000 options to purchase
common stock of the Company in January 2004. The total options granted may be
converted to common stock at an exercise price of $0.25 and expire in five
years. Those options were converted to stock appreciation rights [the
"Conversion"] in November 2004. The Conversion consisted of 5,000,000 stock
appreciation rights granted to the President which vest over 5 years and
1,000,000 stock appreciation rights granted to the director which vest over 2
years.

In March 1997, the Company, in connection with Bridge Loans for $375,000 issued
warrants to purchase 2,500,001 shares of common stock at $.15 per share. These
warrants had a life of five years and were to have expired in March 2002. In the
year ended December 31, 2000, a total of 333,334 common shares were issued upon
the exercise of a like number of warrants, for net proceeds of $50,000. Of the
remaining 2,166,667 un-exercised warrants at March 2002, a total of 1,666,667
warrants had their lives extended for an additional two years until March 2004
and then later for another twelve months until March 2005. The remaining balance
of 500,000 warrants was not extended, and accordingly they have expired. The
extension of the exercise date was part of a settlement that the Company had
reached with certain debenture holders that had brought a legal action against
the Company. In June 2005, the Company extended for the second time the life of
the warrants for one year. The Company recorded an additional charge of $74,700,
which has been included in the statements of operations.

The fair value of each stock option, or warrant granted, is estimated on the
date of grant using the Black-Scholes option-pricing model. During the year
ended December 31, 2005, the Company granted 433,00 warrants in connection with
the Convertible Promissory Note [Note 6]. The Company did not grant, nor issue
any options in the year ended December 31, 2005. The Company did not grant, nor
issue, options or warrants in the year ended December 31, 2004.

The following tables illustrate the Company's warrant issuances and balances
outstanding as of, and during the years ended December 31, 2005 and 2004:

F-14

WATER CHEF, INC.
(A Development Stage Company Commencing January 1, 2002)

NOTES TO FINANCIAL STATEMENTS
Continued

Shares Underlying Weighted Average
Warrants Exercise Price
----------------- ----------------
Outstanding at December 31, 2003 1,166,667 $ 0.15
Granted - -
Expired - -
Exercised - -
----------------- ---------------
Outstanding at December 31, 2004 1,666,667 $ 0.15
Granted 433,000 0.14
Expired - -
Exercised - -
----------------- ---------------
Outstanding at December 31, 2005 2,099,667 $ 0.15
================= ===============

The following is additional information with respect to the Company's warrants
as of December 31, 2005:

WARRANTS OUTSTANDING WARRANTS EXERCISABLE
----------------------------------------------- -----------------------------
Weighted
Average Weighted
Number of Remaining Average Number of Weighted
Exercise Outstanding Contractual Exercise Exercisable Average
Price Warrants Life Price Warrants Exercise Price
--------- ------------ ------------ ------- ------------ --------------
$ 0.15 2,099,667 10 Months $ 0.15 2,099,667 $ 0.15
========= ============ ============ ======= ============ ============

11. LEASES

The Company's lease for its administrative facilities located in Glen Head, New
York is on a month to month basis.

Rent expense, for the years ended December 31, 2005 and 2004 was $30,189 and
$29,246, respectively.

12. LITIGATION

In the normal course of business, the Company may be involved in legal
proceedings in the ordinary course of business. Such matters are subject to many
uncertainties, and outcomes are not predictable with assurance. The Company
currently is not involved in any legal proceedings which are not in the ordinary
course of business.

13. INCOME TAXES

The Company accounts for income taxes under SFAS No. 109, Accounting for Income
Taxes. SFAS No. 109 requires the recognition of deferred tax assets and
liabilities for both the expected impact of differences between the financial
statements and tax basis of assets and liabilities, and for the expected future
tax benefit to be derived from tax loss and tax credit carry forwards. SFAS No.
109 additionally requires the establishment of a valuation allowance to reflect
the likelihood of realization of deferred tax assets.

For the year ended December 31, 2005 and 2004, no provision for income taxes has
been provided for, as a result of continued net operating losses. The Company is
subject to certain state and local taxes based on capital. The state and local
taxes based on capital were immaterial for each of the years ended December 31,
2005 and 2004.

F-15

WATER CHEF, INC.
(A Development Stage Company Commencing January 1, 2002)

NOTES TO FINANCIAL STATEMENTS
Continued

The effective tax rate differs from the statutory rate of 34% due to the
increase of the valuation allowance.

The Company has net operating loss carry-forwards for federal income tax
purposes totaling approximately $17,822,000 at December 31, 2005. These
carry-forwards expire between the years 2009 through 2025. Utilization of these
loss carry-forwards may be limited under Internal Revenue Code Section 382. The
deferred tax asset arising from the net operating loss carry-forwards has been
offset by a corresponding valuation allowance.

The valuation allowance relates to the federal and state net operating losses
for which utilization in future periods is uncertain. The ultimate realization
of deferred tax assets is dependent upon the generation of future taxable income
during the periods in which those temporary differences become deductible. The
Company considers projected future taxable income and tax planning strategies in
making this assessment. Based on projections for future taxable income over the
periods that the deferred tax assets are deductible, the Company believes it is
more likely than not that the Company will not realize the benefits of these
deductible differences in the near future and therefore a full valuation
allowance of $6,950,000 is provided. The valuation allowance increased
approximately $50,000 during 2005 related to increased net operating losses.

14. MAJOR CUSTOMERS

15. COMMITMENTS AND CONTINGENCIES

In January 1, 2004, the Company entered into a 5 year employment agreement with
its Chief Executive Officer ("Employee"). The Company agreed to pay to the
Employee for the services to be rendered a base salary at an annual rate of
three hundred and fifty thousand dollars. The Company granted to its employee a
five-year option for 5,000,000 shares of the Company's outstanding common stock
for an option price of $.25 per share. The option will vest in fifty equal,
consecutive monthly increments of 100,000 shares each on the first day of each
month beginning with January of 2004 and ending with February of 2008. Those
options were converted to stock appreciation rights in November 2004. As of
December 31, 2005, approximately $442,400 was owed and is included on the
balance sheet as part of accrued compensation.

In March 9, 2004, the Company extended for two additional years the consulting
agreement with a director. The Company agreed to increase his monthly payment to
$10,000 per month. The Company also gave him the right to purchase one million
shares of the Company's common stock at a price of $0.25 per share, such right
to vest at the rate of 50% per year. Those options were converted to stock
appreciation rights in November 2004. For each of the years ended December 31,
2005 and 2004, the Company has incurred a charge of $120,000, which has been
included in the statement of operations as part of selling general and
administrative costs. In addition, the director earned approximately $25,000 of
director fees.

16. CREDIT RISK

The Company maintains its cash in accounts with major financial institutions in
the United States. From time to time, these balances may exceed the amounts of
insurance provided on such deposits. As of December 31, 2005, the Company has a
credit risk exposure of approximately $153,700.

17. SUBSEQUENT EVENTS

On March 14, 2006, the shareholders of the Company approved an increase in the
authorized capital stock of the Company from 200 million shares to 350 million
shares, comprised of 340 million shares of common stock and 10 million shares of
preferred stock.

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