Notes to Financial Statements

Notes 1- GENERAL

The Company

Probe Manufacturing Industries, Inc. was incorporated on July 7, 1995. On April 21, 2005, the Company was re-domiciled from California to Nevada, and changed its name to Probe Manufacturing, Inc.  Probe Manufacturing, Inc. (the “Company” or “Probe”) is a leading provider of advanced electronics manufacturing services, or EMS, to original equipment manufacturers, or OEMs, primarily in the medical device, aerospace, industrial, instrumentation and alternative fuel, segments. This includes end-to-end manufacturing solutions ranging from engineering to manufacturing of printed circuit board assembly, cable assembly, enclosures, complete system integration and testing, as well as global order fulfillment. To provide for long term sustainability and growth, the Company is now leveraging its manufacturing and commercializing competencies, combined with product knowledge to develop its own proprietary products in alternative fuel technologies.  The two major sectors in alternative energy are electricity generation and transportation.   Our research and development efforts have been focused on these two sectors.  Our transportation focus is on power electronics, and controllers which enable vehicles to operate on clean alternative fuels. Our power generation focus is on Hydrogen and distributed power generators and solar power.   Probe Manufacturing's headquarters are located in Lake Forest, California.  

Going Concern

The financial statements have been prepared on a going concern basis, which contemplates continuity of operations, realization of assets and liquidation of liabilities in the normal course of business. The Company had a net profit of $121,260 and a working capital surplus of $62,135 and improved their total stockholders deficit by $164,165 for the six months ended, June 30, 2008.  However, the Company still had shareholder deficit of $(108,875) as of June 30, 2008. Therefore the ability of the Company to operate as a going concern is still dependent upon its ability (1) to obtain sufficient debt and/or equity capital and/or (2) to continue generating positive cash flow from operations.

Management is taking the following steps to address this situation. The Company continues to improve operational efficiencies by: re-negotiating direct material cost with all of our suppliers and setting up Managed inventory Solutions, such as bonded inventory levels and auto-release programs with our major suppliers, whereby they maintain stock at their facilities and deliver “Just-in-Time”.  This will improve the utilization of our lines of credit with suppliers and maintains inventory at its lowest value point. However from time to time inventory levels may increase temporarily, due to scheduling issues and acquisition of new customers and/or products. The company continues to negotiate its lines of credit with agreements that have more attractive terms, as well as increasing our credit lines with suppliers.  The company continues to increase revenue with customers that are a better fit and   growing the business with our existing customers by offering more value added services. The Company is focusing   on a more stable customer base in areas such as medical device, aerospace, and alternative fuel industries that have a better chance of maintaining their manufacturing in Southern California instead of moving it to low cost and offshore regions. To ensure long term sustainability of the Company, we’re allocating more resources to develop proprietary technology within the alternative energy industry while continuing to operate our EMS business.

The future success of the Company is likely dependent on its ability to attain additional capital to support growth and ultimately, upon its ability to continue profitable operations.  There can be no assurance that the Company will be successful in obtaining such financing, or that it will continue to generate sufficient positive cash flow from operations.  The successful outcome of these or any future activities cannot be determined at this time and there is no assurance that if achieved, the Company will have sufficient funds to execute its business plans. The financial statements do not include any adjustments relating to the recoverability and classification of asset carrying amounts or the amount and classification of liabilities that might result should the Company be unable to continue as a going concern.

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NOTE 2 – BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:

The interim financial information included herein is unaudited; however, such information reflects all adjustments which are, in the opinion of management, necessary for a fair presentation of the Company’s financial position, results of operations, changes in stockholders’ equity (deficit) and cash flows for the interim periods.  All such adjustments are of a normal, recurring nature.  The results of operations for the first six months of the year are not necessarily indicative of the results of operations which might be expected for the entire year.  

The accompanying financial statements of the Company have been prepared in accordance with the instructions to Form 10-Q and, therefore, omit or condense certain footnotes and other information normally included in financial statements prepared in accordance with generally accepted accounting principles.  It is suggested that these condensed financial statements should be read in conjunction with the Company's financial statements and notes thereto included in the Company's audited financial statements on Form 10-K/A as amended for the fiscal year ended December 31, 2007.

The Company follows United States Generally Accepted Accounting Principles. Certain of the principles involve selection among alternatives and choices of methods, which are described in the footnotes to the Company’s reviewed financial statements.  

Cash and Cash Equivalents

The Company maintains the majority of its cash accounts at a commercial bank. The total cash balance is insured by the Federal Deposit Insurance Corporation (“FDIC”) up to $100,000 per commercial bank. For purposes of the statement of cash flows the Company considers all cash and highly liquid investments with initial maturities of one year or less to be cash equivalents.

Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States 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 the reported amounts of revenue and expenses during the reporting period. Such estimates may be materially different from actual financial results. Significant estimates include the recoverability of long-lived assets, the collection of accounts receivable and valuation of inventory and reserves.

Accounts Receivable

The Company grants credit to its customers located within the United States of America; and does not require collateral. The Company’s ability to collect receivables is affected by economic fluctuations in the geographic areas and industries served by the Company.

Reserves for un-collectable amounts are provided, based on past experience and a specific analysis of the accounts.  Although the Company expects to collect amounts due, actual collections may differ from the estimated amounts. As of June 30, 2008, the Company had a reserve for potentially un-collectable accounts of $35,212.

Five (5) customers accounted for approximately 84% of accounts receivable at June 30, 2008.  The Company’s trade accounts primarily represent unsecured receivables.  Historically, the Company’s bad debt write-offs related to these trade accounts have been insignificant.

Inventory

Inventories are valued at the lower of weighted average cost or market value.   Our industry experiences changes in technology, changes in market value and availability of the raw materials, as well as changing customer demand.  The Company makes provisions for estimated excess and obsolete inventories based on regular audits and cycle counts of our on-hand inventory levels and forecasted customer demands and at times additional provisions are made.  Any inventory write offs are charged to the reserve account. For the three months ended, March 31, 2008 the company wrote off $60,034 of excess inventory against the reserve.  As of June 30, 2008, the Company had a reserve for potentially obsolete inventory of $240,457.  

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Property and Equipment

Property and equipment are stated at cost. Assets held under capital leases are recorded at lease inception at the lower of the present value of the minimum lease payments or the fair market value of the related assets.  The Company follows the practice of capitalizing property and equipment purchased over $5,000.  The cost of ordinary maintenance and repairs is charged to operations. Depreciation and amortization are computed on the straight-line method over the following estimated useful lives of the related assets:

Furniture and fixtures

3 to 7 years

Equipment

7 to 10 years

Leasehold improvements

2 years (life of the lease)

Long –Lived Assets

The Company’s management assesses the recoverability of its long-lived assets by determining whether the depreciation and amortization of long lived assets over their remaining lives can be recovered through projected undiscounted future cash flows. The amount of long lived asset impairment if any, is measured based on fair value and is charged to operations in the period in which long lived assets impairment is determined by management. There can be no assurance however, that market conditions will not change or demand for the Company’s services will continue, which could result in impairment of long-lived assets in the future.

Revenue Recognition

Revenue from product and services are recognized at the time goods are shipped or services are provided to the customer, with an appropriate provision for returns and allowances. Terms are generally FOB Origination with the right of inspection and acceptance. The Company has not experienced a material amount of rejected or damaged product.

Fair Value of Financial Instruments

The carrying amount of accounts payable and accrued expenses are considered to be representative of their respective fair values because of the short-term nature of these financial instruments.

Other Comprehensive Income

The Company has no material components of other comprehensive income (loss) and accordingly, net loss is equal to comprehensive loss in all periods.

Net Profit / (Loss) per Common Share      

Basic profit / (loss) per share is computed on the basis of the weighted average number of common shares outstanding.  At June 30, 2008 the Company had outstanding common shares of 10,594,285, and 35,155 shares to be issued for officer compensation, for a total of 10,629,440 used in the calculation of basic earnings per share.  Basic Weighted average common shares and equivalents at June 30, 2008 were 10,531,361. As of June 30, 2008 the Company had outstanding warrants to purchase 4,749,110 additional common shares and options to purchase 511,345 additional common shares, which may dilute future earnings per share. Fully diluted weighted average common shares and equivalents at June 30, 2008 were 15,762,719.

Research and Development :

To ensure long term sustainability and growth of the Company we have started research and development towards growth markets of the future by investing in alternative energy technologies.  While we continue to operate our Electronics Manufacturing business, we are now directing more resources towards developing technologies in the alternative energy industry.  Our alternative energy research and development is focused on the alternative fuel industry as defined by the Energy Policy Act of 1992 (EPAct) including ethanol, natural gas, propane, hydrogen, bio-diesel, electricity and methanol. These fuels are being used worldwide in a variety of vehicle and power generator applications. We believe three independent market factors; economics, energy security/independence and environmental concerns are driving the growth of alternative energy technologies today and into the foreseeable future. 

Research and Development Costs incurred in association with the alternative fuels technology development (which include salaries and equipment) are expensed as incurred.  We expensed $36,250 in R&D during the three months ended June 30, 2008 and $119,574 for the six months ended June 30, 2008. We acquired a 125 kW natural gas

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distributed power generator and have converted it to run on hydrogen fuel. We will be performing validation testing for performance; and later for emission.  Emission testing will require additional funding.  This distributed power generator will have near zero carbon based emission and very low NOx emissions.  When completed, this hydrogen-fueled internal combustion engine will address two major needs:  power and near-zero emissions.  These engines serve as replacement engines for the industrial user who has been dependent upon a manufacturer of traditional gasoline or diesel-fueled industrial engines.  Our second research and development project involves an Engine Control Unit (ECU) to help convert gasoline cars to run on natural gas.  The Solaris project is in prototype stages, and will be 100% Probe’s proprietary technology.  Once completed this functionally advanced Electronics Controller Units (ECU) can operate under the hood, and will be appropriately priced for different vehicle type and markets. 

Segment Information      

Except as identified above in the research and development section, we operate primarily in a single operating segment providing printed circuit board and electronic assemblies.

Share Based Compensation   

The company has adopted the use of Statement of Financial Accounting Standards No. 123R, “Share-Based Payment” (SFAS No. 123R), which supersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees”, and its related implementation guidance and eliminates the alternative to use Opinion 25’s intrinsic value method of accounting that was provided in Statement 123 as originally issued. This Statement requires an entity to measure the cost of employee services received in exchange for an award of an equity instruments, which includes grants of stock options and stock warrants, based on the fair value of the award, measured at the grant date, (with limited exceptions). Under this standard, the fair value of each award is estimated on the grant date, using an option-pricing model that meets certain requirements. We use the Black- Scholes option-pricing model to estimate the fair value of our equity awards, including stock options and warrants. The Black-Scholes model meets the requirements of SFAS No. 123R; however the fair values generated may not reflect their actual fair values, as it does not consider certain factors, such as vesting requirements, employee attrition and transferability limitations. The Black-Scholes model valuation is affected by our stock price and a number of assumptions, including expected volatility, expected life, risk-free interest rate and expected dividends. We estimate the expected volatility and estimated life of our stock options at grant date based on historical volatility; however, due to the thinly traded nature of our stock, we have chosen to use an average of the annual volatility of like companies in our industry. For the “risk-free interest rate”, we use the Constant Maturity Treasury rate on 90 day government securities. The term is equal to the time until the option expires. The dividend yield is not applicable, as the company has not paid any dividends, nor do we anticipate paying them in the foreseeable future. The fair value of our restricted stock is based on the market value of our free trading common stock, on the grant date calculated using a 20 trading day average. At the time of grant, the share based-compensation expense is recognized in our financial statements based on awards that are ultimately expected to vest using historical employee attrition rates and the expense is reduced accordingly.  It is also adjusted to account for the restricted and thinly traded nature of the shares.  The expense is reviewed and adjusted in subsequent periods if actual attrition differs from those estimates. We re-evaluate the assumptions used to value our share-based awards on a quarterly basis and if changes warrant different assumptions, the share-based compensation expense could vary significantly from the amount expensed in the past. We may be required to adjust any remaining share-based compensation expense, based on any additions, cancellations or adjustments to the share based awards. The expense is recognized over the period during which an employee is required to provide service in exchange for the award—the requisite service period (usually the vesting period). No compensation cost is recognized for equity instruments for which employees do not render the requisite service.   For the year ended December 31, 2007 we recognized $97,537 of share based compensation which included $21,920 of expense, due to the issuance of our options and warrants. For the six months ended June 30, 2008 we recognized $42,893 of share based compensation which included $9,926 of expense, due to the issuance of our options and warrants, we also had $17,789 in non-vested expense to be recognized over the next three years.

Income Taxes

The Company accounts for income taxes under SFAS No. 109, which requires the asset and liability approach to accounting for income taxes.  Under this method, deferred tax assets and liabilities are measured based on differences between financial reporting and tax bases of assets and liabilities measured using enacted tax rates and laws that are expected to be in effect when differences are expected to reverse. The net profit for the six month

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period ended, June 30, 2008 of $121,260 is offset by previous losses.  As of June 30, 2008 the Company had a net operating loss carry forward of $362,432. The Company has not booked any deferred tax asset as a result.

NOTE 7 - CAPITAL LEASE SETTLEMENT OBLIGATIONS  

On July 9, 1997 and December 21, 1997, the Company entered into two lease agreements, with Crocker capital, which subsequently assigned the leases to The CIT Group.  In September 2004 the Company had outstanding balances of $457,604 and $556,293 on the two leases and was unable to make the monthly lease payments. As a

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result, the Company entered into a forbearance agreement with The CIT Group, with monthly payments of $7,500 and an early payment schedule as follows:

The CIT Group would release the Company and its guarantors if one of the following payments were made, less the total of all monthly payments made to that date:

$375,000 if paid by October 25, 2004

$425,000 if paid by December 25, 2004

$500,000 if paid by June 25, 2005

$550,000 if paid by December 25, 2005

$600,000 if paid by June 25, 2006

$650,000 if paid by December 25, 2006

$700,000 if paid by June 25, 2007

On June 1, 2007 an amended forbearance agreement was entered into:

1)

In consideration of CIT entering into this Addendum, Probe will pay CIT the sum of $7,500 on or before June 25, 2007, which was paid.

2)

Recital B is amended to state that as of June 25, 2007 Probe’s payment obligation to CIT totals $457,500.

3)

Section 2.3 of the Forbearance Agreement is amended to state that probe will pay CIT the amount of $457,500 in sixty-one (61) monthly installments of $7,500 each, commencing on July 25, 2007 and ending on July 25, 2012. If at any time Probe elects to pay in full the remaining balance, upon 30 day written notice, CIT will provide a payoff figure for the remaining balance using a present value rate of 7.0%.

4)

The Company imputed interest at 7% over the term of the payments, which resulted in a present value of $384,025 and $318,841 at June 30, 2007 and 2008 respectively.

5)

This resulted in a gain of $324,330 which had an effect on Net profit per common share of $.031 and Diluted Net Profit per common share of $.022.

6)

As of June 30, 2008 the outstanding balance was $318,842.

NOTE 8 – NOTES PAYABLE

Note Payable – secured by deed of trust, 12% interest, originally due on September 2006 to Ashford Capital Transition Fund I, LP, and was subsequently extended to March 2006. The balance of $456,000 was paid in full on March 10, 2006.  

Note Payable - dated March 10, 2006 – special use, line of credit in the amount of $90,000, unsecured, 12% interest paid in cash due May 10, 2007, payable to Ashford Capital, LLC.  This note was converted to a term note payable, with an effective date of June 30, 2006, unsecured, 12% interest rate, with a 36 month amortization, payments of $1,997 and a balloon payment of $33,068 on April 15, 2008. As of June 30, 2008 the outstanding balance was $31,782.  On April 15, 2008 we were unable to meet the balloon payment and the note is in default, as of June 30, 2008.

Note Payable – This Note was an operating line of credit, secured by the assets of the Company. Borrowings under this line of credit were at an interest rate of 20% (12% paid in cash and 8% paid in common stock in the Company) per annum, payable to Ed Lassiter.  This note was converted to a term note payable, with an effective date of June 30, 2006, un-secured, at 12% interest rate, with a 36 month amortization, monthly payments of $ $4,650 and a balloon payment of $77,014 on April 15, 2008.  As of June 30, 2008 the outstanding balance was $74,018 .  On April 15, 2008 we were unable to meet the balloon payment and the note is in default, as of June 30, 2008

Note Payable -- This Note was an operating line of credit, secured by the assets of the Company. Borrowings under this line of credit were at an interest rate of 20% (12% paid in cash and 8% paid in common stock in the Company) per annum, payable to William Duncan.  This note was converted to a term note payable, with an effective date of June 30, 2006, un-secured, at 12% interest rate, with a 36 month amortization, monthly payments of $1,661 and a balloon payment of $27,505 on April 15, 2008. As of June 30, 2008 the outstanding balance was $26,144. On April 15, 2008 we were unable to meet the balloon payment and the note is in default, as of June 30, 2008.

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Note Payable – This Note was an operating line of credit, secured by the assets of the Company.   Borrowings under this line of credit were at an interest rate of 20% (12% paid in cash and 8% paid in common stock in the Company) per annum, payable to Benner Exemption Trust.  This note was converted to a term note payable, with an effective date of June 30, 2006, un-secured, at 12% interest rate, with a 36 month amortization, payments of $4,650 and a balloon payment of $77,014 on April 15, 2008. As of June 30, 2008 the outstanding balance was $74,018. On April 15, 2008 we were unable to meet the balloon payment and the note is in default, as of June 30, 2008.

Note Payable – This note was an operating line of credit, secured by the assets of the Company.  Borrowings under this line of credit were at an interest rate of 20% (12% paid in cash and 8% paid in common stock in the Company) per annum, payable to Ashford Capital, LLC.  This note was converted to a term note payable, with an effective date of June 30, 2006, un-secured, at 12% interest rate, with a 36 month amortization, monthly payments of $3,321 and a balloon payment of $55,010 on April 15, 2008.  As of June 30, 2008 the outstanding balance was $52,871. On April 15, 2008 we were unable to meet the balloon payment and the note is in default, as of June 30, 2008.

Note Payable – This Note was an operating line of credit, secured by the assets of the Company.  Borrowings under this line of credit were at an interest rate of 15% per annum, payable to Hoa Mai.  This note was converted to a term note payable, with an effective date of June 30, 2006, un-secured, at 12% interest rate, with a 36 month amortization, monthly payments of $1,661 and a balloon payment of $27,505 on April 15, 2008.  As of June 30, 2008 the outstanding balance was $24,726.  The note was extended by 18 months, with an interest rate of 13% per annum.  The holder was also issued 1 series D Warrant for every $2.00 of outstanding note balance on that date.

Note Payable – Term note payable, with an effective date of April 23, 2006, payable to Hoa Mai at 15% interest rate, with a 12 month amortization, monthly payments of $ 2,166. As of June 30, 2008 the outstanding balance was $0.  

Note Payable – Note payable, with an effective date of February 1, 2008, payable to Hoa Mai at 15% interest rate per annum, due on April 30, 2008. As of June 30, 2008 the outstanding balance was $0.  

Note Payable – Note payable, with an effective date of February 8, 2008, payable to Linwood Goddard at 15% interest rate per annum, due on May 30, 2008. As of June 30, 2008 the outstanding balance was $0.  

Related Party – Notes payable

Note Payable - dated March 10, 2006  – related party, special use, line of credit in the amount of $45,000, unsecured, 20% interest (10% paid in Cash and 10% paid in Company stock),  due May 10, 2007.  This note was converted to a term note payable, with an effective date of June 30, 2006, un-secured, 12% interest rate, with a 36 month amortization, monthly payments of $1,001 and a balloon payment of $16,588 on April 15, 2008.  This note is payable to Kambiz Mahdi.  As of June 30, 2008 the outstanding balance was $15,943.  On April 15, 2008 we were unable to meet the balloon payment and the note is in default, as of June 30, 2008.

Note Payable - dated March 10, 2006 – related party, special use, line of credit in the amount of $45,000, unsecured, 20% interest (10% paid in Cash and 10% paid in Company stock),  due May 10, 2007.   This note was converted to a term note payable, with an effective date of June 30, 2006, un-secured, 12% interest rate, with a 36 month amortization, monthly payments of $1,001 and a balloon payment of $16,588 on April 15, 2008.  This note is payable to Reza Zarif.  As of June 30, 2008, the outstanding balance was $15,972. The note was extended by 18 months, with an interest rate of 13% per annum.  The holder was also issued 1 series D Warrant for every $2.00 of outstanding note balance on that date.

Note Payable – related party, unsecured, 20% interest (10% paid in Cash and 10% paid in Company stock) due on May 10, 2007, Payable to Kambiz Mahdi.  This note was converted to a term note payable, with an effective date of June 30, 2006, un-secured, At 12% interest rate, with a 36 month amortization, monthly payments of $7,871 and a balloon payment of $130,366 on April 15, 2008.   As of June 30, 2008 the outstanding balance was $124,055. On April 15, 2008 we were unable to meet the balloon payment and the note is in default, as of June 30, 2008.

Note Payable – related party, unsecured, 20% interest (10% paid in Cash and 10% paid in Company stock) due on May 10, 2007, Payable to Reza Zarif.  This note was converted to a term note payable, with an effective date of June

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30, 2006, un-secured, at 12% interest rate, with a 36 month amortization, monthly payments of $7,871 and a balloon payment of $130,366 on April 15, 2008. As of June 30, 2008 the outstanding balance was $126,759 .   The note was extended by 18 months, with an interest rate of 13% per annum.  The holder was also issued 1 series D Warrant for every $2.00 of outstanding note balance on that date.

Note Payable – related party.  This note was an operating line of credit, secured by the assets of the Company. Borrowings under this line of credit were at an interest rate of 20% (12% paid in cash and 8% paid in common stock in the Company) per annum, payable to Rufina Paniego.  This note was converted to a term note payable, with an effective date of June 30, 2006, un-secured, 12% interest rate, with a 36 month amortization, monthly payments of $2,491 and a balloon payment of $39,759 on April 15, 2008.  As of June 30, 2008 the outstanding balance was $42,893. The note was extended by 18 months, with an interest rate of 13% per annum.  The holder was also issued 1 series D Warrant for every $2.00 of outstanding note balance on that date.

 Note Payable – related party.  This note was an operating line of credit, secured by the assets of the Company.   Borrowings under this line of credit were at an interest rate of 20% (12% paid in cash and 8% paid in common stock in the Company) per annum, payable to eFund Capital Partners.  This note was converted to a term note payable, with an effective date of June 30, 2006, un-secured, at 12% interest rate, with a 36 month amortization, monthly payments of $4,982 and a balloon payment of $82,516 on April 15, 2008. As of June 30, 2008 the outstanding balance was $79,371. The note was extended by 18 months, with an interest rate of 13% per annum.  The holder was also issued 1 series D Warrant for every $2.00 of outstanding note balance on that date.

Note Payable – This is a related party term note payable. Borrowings under this term note were at an interest rate of 15%, with 12 months amortization, monthly payments of $2,256 payable to Rufina Paniego. As of June 30, 2008 the outstanding balance was $0.

Note Payable – This is a related party term note payable, with an effective date of February 11, 2008, payable to Rufina Paniego at 15% interest rate per annum, due on April 11, 2008. As of June 30, 2008 the outstanding balance was $0.  

Note Payable – related party. This is a term note payable, with an effective date of January 15, 2008, payable to Jeff Conrad, Esq. at a 12% interest rate, with a 30 month amortization and monthly payments of $1,162.  As of June 30, 2008 the outstanding balance was $27,659.

Note Payable – related party, with an effective date of April 30, 2008, payable to Rufina Paniego at 15% interest rate per annum, due on May 31, 2008. As of June 30, 2008 the outstanding balance was $24,600. The note is currently in default, as of June 30, 2008.

Other Long-Term Debt

1) We have settlement reached with I-Source, a supplier, with monthly payments of $2,500. As of June 30, 2008 the outstanding balance was $11,925. Payments continue through September, 2008.

2) We currently owe the Internal Revenue Service $44,963 for past tax liabilities.  We negotiated a settlement with the IRS and have entered into a payment plan with them in which we pay the IRS $3,000 per month.  All payments to date are current.  The balance is included in other long-term debt.

NOTE 9 – COMMITMENTS AND CONTIGENCIES

Operating Rental Leases

On September 11, 2006 we entered into a sublease agreement for 10,000 sq ft. of manufacturing space which includes office space with Quantum Fuel System Technologies Worldwide, Inc. On May 19, 2008 we entered into a new extension of the sublease agreement with an effective termination date of August 31, 2009. The facility is located at 25242 Arctic Ocean Drive, Lake Forest, CA 92630.  

Litigation

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The Company may be involved from time to time in various claims, lawsuits, and disputes with third parties, action involving allegations or discrimination or breach of contract actions incidental in the normal operations of the business.  

As of June 30, 2008 We believe that there are no other claims or litigation pending, the outcome of which could have a material adverse effect on our financial condition or operating results.  However, if litigation should arise and the company was to receive an unfavorable ruling, there is a possibility that it would have a material adverse impact on our financial condition, results of operations, or liquidity of the period in which the ruling occurs, or future periods.

While we are currently able to service any and all payment obligation to the creditors, if we are unable in the future to service any payments, anyone of the creditors may instigate foreclosure proceedings against us. If we are unable to satisfy our obligations, we could be forced into bankruptcy.

NOTE 10 – CAPITAL STOCK TRANSACTIONS

On April 21, 2005 the Company’s Board of Directors and shareholders approved the following capital stock transactions:

The Company re-domiciled in the state of Nevada, whereby increasing the number of authorized common shares to 200,000,000 and designating a par value of $.001 per share.

On May 25, 2006 the Company’s Board of Directors and shareholders approved the following capital stock transactions:

An amendment to the Articles of Incorporation of the Company authorizing a new series of Preferred stock, which shall be designated as Series C, and shall consist of 15,000 shares.  

Common Stock transactions:

From June 16, 2004 to April 1, 2005 the Company sold 2,221,250 shares of common stock through a Private Placement Memorandum at $.80 per Share to 49 individuals generating net proceeds of $1,777,000, of which 715,000 shares were sold in 2005, generating net proceeds of $572,000.

During 2005 the Company issued 31,118 shares of common stock, in lieu of interest payments at $.80 per share for a total of $24,894.

In February 2006 the Company issued 13,438 shares of common stock, in lieu of interest payments at $.80 per share for a total of $10,751.

In May 2006 the Company issued 16,336 shares of common stock, in lieu of interest payments at $.80 per share for a total of $13,094.

On May 25, 2006 the Company issued 500,000 shares of common stock at .10 cents (Market value of shares on that date), for a total of $50,000,  to compensate its directors for services through a stock grant pursuant to Form S-8 in the following amounts:

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In August 2006 the Company issued 30,254 shares of common stock, in lieu of interest payments at $.80 per share for a total of $24,205.

In August 2006 the Company issued 11,678 shares of common stock, in lieu of interest payments at $.80 per share for a total of $9,343.

In August 2006 the Company issued 4,205 shares of common stock for officer compensation at $.80 per share for a total of $3,365.

In August 2006 the Company accrued 47,260 shares of common stock for officer compensation at $.10 per share (fair market value at time of accrual) for a total of $4,726. These shares were issued on March 30, 2007.

In September 2006 the Company accrued 29,083 shares of common stock for officer compensation at $ .65 per share (fair market value at time of accrual) for a total of $18,904. These shares were issued on March 30, 2007.

.

In December 2006 the Company accrued 34,370 shares of common stock for officer compensation at $.55 per share (fair market value at time of accrual) for a total of $18,904.  These shares were issued on March 30, 2007.

In July 2006 the Company converted 12,500 shares from Preferred B to Preferred C, 14,040 shares.

In August 2006 the holders of preferred series C elected to convert 14,040 shares into 1,755,000   shares of common stock.

On August 14, 2006 the holders converted 440 shares of the Preferred Series A for 4,472,424 shares of the Company’s common stock.

On March 30, 2007 the Company issued 110,713 shares of common stock for officer compensation which were accrued but un-issued as of December 31, 2006.

On June 30, 2007 the company issued 78,363 shares of common stock for officer compensation for the first and second quarter of 2007.

On October 15, 2007 the company issued 47,260 shares of common stock for officer compensation for the 3rd quarter of 2007.

For the quarter ended December 31, 2007 the company accrued 157,533 shares of common stock for officer compensation, which were issued on February 11, 2008.

For the quarter ended March 31, 2008 the company accrued 37,808 shares of common stock for officer compensation, which were issued on April 12, 2008.

For the quarter ended June 30, 2008 the company accrued 35,515 shares of common stock for officer compensation, which were un-issued as of June 30, 2008.

On November 5, 2007 the company entered into a consulting services agreement with Global Capital Management (GCM), to provide investment banking services, for one year.  As a result we issued 425,000 warrants to purchase 425,000 shares of common stock at a price of .40 per share.  As a result we recognized share based compensation expense in the amount of $16,607 for the year ended December 31, 2007.

COMMON STOCK

Our Articles of Incorporation authorize us to issue 200,000,000 shares of common stock, par value $0.001 per share. As of March 31, 2008 and December 31, 2007 there were 10,556,477 and 10,398,944 shares of common stock issued and outstanding, respectively.  We also had 37,808 shares to be issued, for officer compensation which were accrued and un-issued as of March 31, 2008.  All outstanding shares of common stock are, and the common stock to be issued will be, fully paid and non-assessable.  Each share of our common stock has identical rights and privileges in every respect. The holders of our common stock are entitled to vote upon all matters submitted to a vote of our

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shareholders and are entitled to one vote for each share of common stock held. There are no cumulative voting rights.

The holders of our common stock are entitled to share equally in dividends and other distributions that our Board of Directors may declare from time to time out of funds legally available for that purpose, if any, after the satisfaction of any prior rights and preferences of any outstanding preferred stock. If we liquidate, dissolve or wind up, the holders of shares of common stock will be entitled to share ratably in the distribution of all of our assets remaining available for distribution after satisfaction of all our liabilities and our obligations to holders of our outstanding preferred stock.

PREFERRED STOCK

Our Articles of Incorporation authorize us to issue 10,000,000 shares of preferred stock.  We authorized 440 shares of Series A Convertible Preferred Stock and 20,000 shares of Series B Convertible Preferred Stock.  On May 25, 2006 the Articles of Incorporation were amended authorizing 15,000 shares Series C Convertible Preferred Stock.

As of August 20, 2006 all Preferred Stock has been converted into Common stock and there are no outstanding Preferred shares as of June 30, 2008.

Preferred Series A

Previously, there were 440 shares of Convertible A Preferred Stock outstanding, with a stated value of $1,000.  Each share is convertible into 0.1% percent of the shares of our common stock outstanding at the date of conversion, which shall convert upon election of the holder.  The holders of series A Preferred stock have the right to vote with the holders of common stock on any matter to which the common stock holders are entitled to vote and they are entitled to vote number of shares of common stock into which the series A Preferred Stock is convertible. If we are liquidated, distribute our assets, dissolve or wind-up, the holders of Convertible A Preferred Stock shall receive the greater of (i) $2,500 per share of Convertible A Preferred Stock they hold at the time of such liquidation, or (ii) their pro rata share of the total value of our assets and funds to be distributed, assuming the Convertible A preferred stock is converted to common stock.  On August 14, 2006 the holders converted 440 shares of the Preferred Series A for 4,544,188 shares of the Company’s common stock.

Preferred Series B

Previously there were 12,500 shares of Series B Convertible stock outstanding, with a stated value of $100. Each share of Series B Stock shall be converted into a number of shares of common stock that is equal to each share being divided by the average of the 3 lowest intraday bids in the twenty (20) days prior to conversion multiplied by 100 (1 divided by x, multiplied by 100), or 125 shares per Series B, whichever is greater.  The minimum conversion price which Series B shareholders shall convert their Series B shares to common stock shall be $0.10.  

Exchange of Preferred Series B to Preferred Series C

On May 25, 2006 the Board of Directors approved the exchange of Series B Convertible Preferred Stock for Series C No-Par, Convertible Preferred Stock for its Series B stockholders.  After the exchange took place Series B Convertible Preferred Stock was cancelled.  The Series C Convertible Preferred Stock carries the same rights as Series B Convertible Preferred Stock except that Series C Convertible Preferred Stock can be redeemed by the Company.  At any time, the Company may, in its sole discretion, redeem some or all of the outstanding shares of Series C Stock at a “Redemption Price” equal to the greater of $120.00 per share for the first year from the date of this certificate and after which the redemption price shall increase by twelve percent (12%) per year until all outstanding shares of Series C have been redeemed.  To redeem Series C Stock, the Company, at least five (5) days prior to the date on which it desires to redeem such stock (the “Redemption Date”), shall send the applicable holder of Series C Stock a notice of the redemption provided, however, that failure to give such notice or any defect therein or in the mailing thereof shall not affect the validity of the proceedings for the redemption of any shares of Series C Stock.  Such notice shall state:  (i) the redemption date; (ii) the redemption price; and (iii) the number of shares of Series C Stock to be redeemed.  Furthermore, the holders of Series C Convertible Preferred Stock shall receive one A Warrant and one B Warrant for every Ten (10) shares of common stock received from converting a share of Series C Convertible Preferred stock of the Company.  This series A and B Warrants are pursuant to the terms and conditions of the Company’s Series A and B warrant agreement as amended.

Preferred Series C

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Previously there were 14,040 shares of Convertible C Preferred Stock outstanding.   Originally as filed on May 25, 2006 each share of Series C Stock shall be converted into a number of shares of Common Stock that is equal to each share being divided by the average of the 3 lowest intraday bids in the twenty (20) days prior to conversion or $0.10, which ever is greater, multiplied by 100 (1 divided by x, multiplied by 100), or 125 shares per Series C, whichever is greater. However, on August 07, 2006 the terms of Series C were amended as follows: Each share of Series C stock shall be converted into a number of shares of Common Stock that is equal to each share divided $0.80 multiplied by 100 (1 divided by $0.80, multiplied by 100).

On August 14, 2006 the holders of Preferred Series C elected to convert their shares into common stock.  As a result 14,040 shares of Preferred Series C were converted into 1,755,000 shares of common stock.

Our Board of Directors has the authority to issue additional shares of preferred stock in one or more series, and fix for each series, the designation of and number of shares to be included in each such series. Our Board of Directors is also authorized to set the powers, privileges, preferences, and relative participating, optional or other rights, if any, of the shares of each such series and the qualifications, limitations or restrictions of the shares of each such series.

Unless our Board of Directors provides otherwise, the shares of all series of preferred stock will rank on parity with respect to the payment of dividends and to the distribution of assets upon liquidation. Any issuance by us of shares of our preferred stock may have the effect of delaying, deferring or preventing a change of our control or an unsolicited acquisition proposal. The issuance of preferred stock also could decrease the amount of earnings and assets available for distribution to the holders of common stock or could adversely affect the rights and powers, including voting rights, of the holders of common stock.

Warrants

Series A - Common Stock Warrants:

We currently have 407,625 Series A Warrants issued and outstanding.  Each warrant gives the holder the right to purchase 5 shares of common stock (2,038,125 total shares) at $1.00 per share.  The Series A Warrants expire on November 15, 2008.

Series B - Common Stock Warrants

We currently have 407,625 Series B Warrants issued and outstanding.  Each warrant gives the holder the right to purchase 5 shares of common stock (2,038,125 total shares) at $1.50 per share.  The Series B Warrants will expire on May 15, 2009.

Series C – Common Stock Warrants

We currently have 200,000 Series C Warrants issued and outstanding.  Each warrant gives the holder the right to purchase 1 shares of common stock (200,000 total shares) at $.80 per share.  The Series C Warrants expire on November 5, 2010.

Series D – Common Stock warrants

We currently have 572,860 Series D Warrants issued and outstanding.  Each warrant gives the holder the right to purchase 1 share of common stock (572,860 total shares) at $.40 per share. The Series D Warrants expire on November 5, 2012.

For the year ended December 31, 2007 we recognized $16,607 and for the six months ended June 30, 2008, we recognized $5,811 as share based compensation expense as a result of the issuance of Series D Warrants.

Warrants Activity for the Period and Summary of Outstanding Warrants

From June 16, 2004 to April 1, 2005 the Company sold 222,125 common stock units pursuant to a private placement memorandum at $8.00 per unit to 49 individuals generating net proceeds of $1,777,000.  Each Unit consists of ten (10) shares of common stock.  In addition, each unit entitles the holder to purchase a total of 10 shares of Probe Common Stock through the exercise of Warrants as follows: series A Warrants, for 5 shares at a price of $1.00 per share which would expire on November 16, 2005, which has been subsequently extended to November 15, 2008 and series B Warrants, for 5 shares at a price of $1.50 per share which would expire on May 16, 2005, which was subsequently extended to May 15, 2009.  As of June 30, 2007 no warrants were exercised.  

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On August 14, 2006 the holders of Preferred Series C elected to convert their shares into common stock.  As a result 14, 040 shares of Preferred Series C were converted into 1,755,000 shares of common stock.  Furthermore, the holders of Series C Convertible Preferred Stock shall receive one A Warrant and one B warrant for every Ten (10) shares of common stock received from converting a share of Series C convertible Preferred stock of the Company.  

On December 31, 2004 the company issued 100,000 shares of its common stock for services.  Each share of stock issued included two warrants, for a total of 200,000 common share equivalents, which were replaced with series C warrants created, approved and issued on November 5, 2007 by the board of directors.

On November 5, 2007 the company entered into a consulting services agreement with Global Capital Management (GCM), to provide investment banking services, for one year.  As a result we issued 425,000 warrants to purchase 425,000 shares of common stock at a price of .40 per share.  As a result we recognized share based compensation expense in the amount of $16,607 for the year ended December, 31, 2007.

On April 2, 2008 the following notes were converted and series D warrants were issued:

Note Payable – This Note was an operating line of credit, secured by the assets of the Company. Borrowings under this line of credit were at an interest rate of 15% per annum, payable to Hoa Mai.  This note was converted to a term note payable, with an effective date of June 30, 2006, un-secured, at 12% interest rate, with a 36 month amortization, monthly payments of $1,661 and a balloon payment of $27,505 on April 15, 2008.  As of June 30, 2008 the outstanding balance was $24,726.  The note was extended by 18 months, with an interest rate of 13% per annum.  The holder was also issued 1 series D Warrant for every $2.00 of outstanding note balance on that date.

Note Payable - dated March 10, 2006 – related party, special use, line of credit in the amount of $45,000, unsecured, 20% interest (10% paid in Cash and 10% paid in Company stock),  due May 10, 2007.   This note was converted to a term note payable, with an effective date of June 30, 2006, un-secured, 12% interest rate, with a 36 month amortization, monthly payments of $1,001 and a balloon payment of $16,588 on April 15, 2008.  This note is payable to Reza Zarif.  As of June 30, 2008, the outstanding balance was $15,972. The note was extended by 18 months, with an interest rate of 13% per annum.  The holder was also issued 1 series D Warrant for every $2.00 of outstanding note balance on that date.

Note Payable – related party.  This note was an operating line of credit, secured by the assets of the Company. Borrowings under this line of credit were at an interest rate of 20% (12% paid in cash and 8% paid in common stock in the Company) per annum, payable to Rufina Paniego.  This note was converted to a term note payable, with an effective date of June 30, 2006, un-secured, 12% interest rate, with a 36 month amortization, monthly payments of $2,491 and a balloon payment of $39,759 on April 15, 2008.  As of June 30, 2008 the outstanding balance was $42,893. The note was extended by 18 months, with an interest rate of 13% per annum.  The holder was also issued 1 series D Warrant for every $2.00 of outstanding note balance on that date.

Note Payable – related party.  This note was an operating line of credit, secured by the assets of the Company.   Borrowings under this line of credit were at an interest rate of 20% (12% paid in cash and 8% paid in common stock in the Company) per annum, payable to eFund Capital Partners.  This note was converted to a term note payable, with an effective date of June 30, 2006, un-secured, at 12% interest rate, with a 36 month amortization, monthly payments of $4,982 and a balloon payment of $82,516 on April 15, 2008. As of June 30, 2008 the outstanding balance was $79,371. The note was extended by 18 months, with an interest rate of 13% per annum.  The holder was also issued 1 series D Warrant for every $2.00 of outstanding note balance on that date.

Note Payable – related party, unsecured, 20% interest (10% paid in Cash and 10% paid in Company stock) due on May 10, 2007, Payable to Reza Zarif.  This note was converted to a term note payable, with an effective date of June 30, 2006, un-secured, at 12% interest rate, with a 36 month amortization, monthly payments of $7,871 and a balloon payment of $130,366 on April 15, 2008. As of June 30, 2008 the outstanding balance was $126,759 .   The note was extended by 18 months, with an interest rate of 13% per annum.  The holder was also issued 1 series D Warrant for every $2.00 of outstanding note balance on that date.

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A summary of warrant activity for the periods is as follows:

Note: The weighted average exercise price has been adjusted retroactively due to price decreases in the warrant strike prices.

STOCK OPTIONS

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On February 8, 2007 pursuant to the Company’s 2006 Qualified Incentive Option Plan which was adopted by the Company’s Board of Directors granted Company employees an incentive stock option to purchase up to 205,505 shares of common stock in the Company.  These options were granted at $.52 cents, the fair market value of the Company at the time of the grant. These options expire on February 8, 2017.

On February 8, 2007 the Company granted stock options to its key employees, to purchase up to 250,000 shares of the Company’s common stock, which was approved by the company’s Board of Directors.  These options were granted at $.52 cents, the fair market value of the Company at the time of the grant.  These options expire on February 8, 2017.   As of December 31, 2007 we had a reduction in the outstanding stock options of 37,841 as a result of employee termination and forfeiture of the options.  As a result the company recognized share-based compensation expense in the amount of $5,313 for the Year ended December 31, 2007 and $664 for the three months ended March 31, 2008, with a balance to be expensed over the next three years of $7,305.

On February 28, 2008 the Company granted stock options to a key employee, to purchase up to 100,000 shares of the Company’s common stock, which was approved by the company’s Board of Directors.  These options were granted at $.1 cents, the fair market value of the Company at the time of the grant.  These options expire on February 8, 2017.  

As of December 31, 2007 we had a reduction in the outstanding stock options of 37,082 as a result of employee termination and forfeiture of the options.  As a result the company recognized share-based compensation expense in the amount of $4,116 for the six months ended June 30, 2008, with a balance to be expensed over the next three years of $17,789.

Stock to be issued under option and warrant plans

Any shares issued under the existing option or warrant plans will come from the companies authorized but un-issued, un-registered shares.

NOTE 11 – RELATED PARTY TRANSACTIONS

Jeffrey Conrad provides legal services for the Company and receives a monthly retainer of $2,500 and is one of the Company directors.  Jeffrey Conrad is also a venture partner of eFund Capital Partners, LLC. Jeffrey Conrad does not have an equity stake in eFund Capital Partners, LLC.  eFund Capital Partners, LLC received their shares pursuant to an investment agreement with us in April of 2004. Total payments for the six months ended June 30, 2008 were $6,500.

On May 25, 2006 the holders of Series B Convertible Preferred Stock exchanged their stock for Series C Convertible Preferred Stock.  Pursuant to the exchange Reza Zarif, our CEO, received 4,500 shares of Series C; Kambiz Mahdi received 4,500 shares of series C; and eFund Capital Partners, LLC received 5,040 shares of series C.  As originally filed on May 25, 2006 each share of Series C Stock shall be converted into a number of shares of Common Stock that is equal to each share being divided by the average of the 3 lowest intraday bids in the twenty (20) days prior to conversion or $0.10, which ever is greater, multiplied by 100 (1 divided by x, multiplied by 100), or 125 shares per Series C, whichever is greater.  However, on August 07, 2006 the terms of Series C were amended as follows: Each share of Series C Stock shall be converted into a number of shares of Common Stock that is equal to each share being divided $0.80 multiplied by 100 (1 divided by $0.80, multiplied by 100).

For the 1 ^st quarter of 2006, the Company leased its 35,000 sq/ft facility for $19,700 per month from Kambiz Mahdi, Reza Zarif and Pacific Sail Bay Trust.   Kambiz Mahdi was the former Chief Executive Officer and a Director of the company.  Reza Zarif is the Chief Executive Officer and a Director of the company.   Pacific Sail Bay Trust is managed by Frank Kavanaugh.  Frank Kavanaugh is also the managing member of Ashford Capital, LLC, and the managing partner of Ashford Transition Fund, L.P.  Furthermore, Mr. Kavanaugh was a director of the company from July 2004 to December 2004; however, he is no longer a member of the Board of Directors. Total payments made for the year ended December 31, 2006 were $59,100.  This lease was terminated on March 7, 2006