Edgar Filing: PROTON LABORATORIES INC

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

FORM 10-KSB

[X] Annual Report Under Section 13 or 15(d) of the Securities Exchange Act of
1934 for the Fiscal 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: 000-31883

PROTON LABORATORIES, INC.
(Name of small business issuer in its charter)

Washington 91-2022700
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)

1135 Atlantic Avenue, Suite 101
Alameda, CA 94501
(Address of principal executive offices) (Zip Code)

(510) 865-6412
Issuer's telephone number

Securities registered under Section 12(b) of the Act:

Title of Each Class: Name of exchange on which registered:
None. None.

Securities registered under Section 12(g) of the Act:
Common Stock, $0.0001 par value
(Title of class)

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 Securities 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. [X]

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

Registrant's revenues for its most recent fiscal year: $328,200.

The aggregate market value of the common stock held by non-affiliates of
the registrant on April 11, 2006 based on the last price which was $0.39 per
share on April 11, 2006 was $2,415,894. On April 11, 2006, the closing bid
price on our common stock on the OTCBB was $0.39.

On April 11, 2006, the registrant had outstanding 14,622,500 shares of
Common Stock, $0.0001 par value per share.

Transitional Small Business Disclosure Format: Yes [ ] No [X]

TABLE OF CONTENTS

PART I PAGE

Item 1 Description of Business 4

Item 2. Description of Property 13

Item 3. Legal Proceedings 13

Item 4. Submission of Matters to a Vote of Security Holders 13

PART II

Item 5. Market for Common Equity Related Stockholder
Matters and Small Business Issuer Purchases of Equity
Securities 13

Item 6. Management's Discussion and Analysis 16

Item 7. Financial Statements 19 and F-1

Item 8. Changes In and Disagreements with Accountants
On Accounting and Financial Disclosure 19

Item 8A. Controls and Procedures 19

Item 8B. Other Information 20

PART III

Item 9. Directors and Executive Officers of the Registrant, 20
Promoters and Control Persons; Compliance with Section 16(a) of the
Exchange Act

Item 10. Executive Compensation 22

Item 11. Security Ownership of Certain Beneficial Owners and
Management and Related Stockholder Matters 24

Item 12. Certain Relationships and Related Transactions 25

Item 13. Exhibits 26

Item 14. Principal Accountant Fees and Services 26

SIGNATURES 28
FINANCIAL STATEMENTS F-1 and 19
EXHIBITS 28

Item 1 Description of Business

INTRODUCTION

Our executive offices are located at: Proton Laboratories, Inc., 1135
Atlantic Avenue, Suite 101, Alameda, CA 94501, tel. (510) 865-6412, fax: (510)
865-9385. Our Web site is www.protonlabs.com.

Our growth is dependent on attaining profit from our operations and our
raising capital through the sale of stock or debt. There is no assurance that we
will be able to raise any equity financing or sell any of our products at a
profit.

Our stock is traded on the OTCBB. Our trading symbol is "PLBI."

OUR BUSINESS--THE BACKGROUND OF FUNCTIONAL WATER

Our business is the marketing of residential and commercial "functional
water systems." "Functional water" is water that has been processed through an
electrolytic ion separation process or electrolysis process and has a wide array
of functional properties due to its unique characteristics. Our functional water
systems restructure tap water into one type of water that is alkaline in
concentration and one type of water that is acidic in concentration. We believe
that the functional water systems that we market will have applications in a
large variety of industries, such as corporate agriculture, organic agriculture,
food processing, medicine and dentistry, dermatology, heavy industry, mining,
environmental clean-up, product formulations and beverages.

We are an exclusive importer and master distributor of functional water
systems that are manufactured by Matsushita Electric Corporation of America. We
utilize functional water intellectual property under licensing agreements. We
supply consumer products related to functional water. We consult on projects
utilizing functional water. We facilitate knowledge about functional water
between the manufacturer and industry, and we act as educators about the
benefits of functional water. We are a provider of systems that produce
functional water, also called "electrolyzed water" or "functional electrolyzed
water." Functional water is water that has been restructured through the process
of electrolysis. Electrolysis forces a separation to occur in the electrolytes
that are present in the water molecules. Through the process of creating
functional water, regular tap water can be restructured into two separate types
of water. For instance, tap water can be restructured into one type of water
that is alkaline in concentration and one type of water that is acidic in
concentration.

We believe that water with these unique functional properties is desirable
for a number of reasons. Water with smaller clusters of molecules has a lower
surface tension. With a lower surface tension, water may have improved
hydrating, permeating and solubility properties. These properties may enhance
the overall functional effectiveness of water. The separation of the alkaline
and acidic properties found in water provides the water with functional
abilities. For example, functional acidic water has disinfecting abilities to
meet a wide array of disinfecting requirements in food processing procedures.
Functional alkaline water makes an excellent drinking water due to improved
hydration.

OUR BUSINESS--SYSTEMS AND MARKETS

We market functional water systems to the residential and commercial
markets. For the residential market, we market functional water systems that are
used to produce a health-beneficial, alkaline-concentrated drinking water. For
the commercial market, we market commercial-grade functional water systems that
are used in applications ranging from food preparation to hospital disinfection.
Our goal is to take our functional water technology and market it throughout
North America.

Our business model envisions us as: a supplier of technology for functional
water applications; a supplier of hardware for functional water systems; a
provider of intellectual property for functional water systems under licensing
agreements; a supplier of consumer functional water products; consultants to
industries requiring functional water; facilitators between Japanese functional
water manufacturers and industrial users in the U.S.A.; and educators of
academia, government and industry on the benefits of functional water.

OUR BUSINESS--SCIENCE

"Functional water" is a term that has been assigned to a new category of
water. Functional water has a wide array of functional properties due to its
unique characteristics. We believe the uses for this type of water are far
reaching, since we are identifying new applications and uses for functional
water on an ongoing basis. Functional water systems are capable of producing the
following types of functional water:

Ionic-Structured Water. Ionic-structured water is electrolyzed drinking
water that is alkaline-concentrated and utilizes smaller molecular clusters than
regular water for improved hydration and solubility. Ionic structured water is
smooth to the palate.

Electro-Structured Water. Electro-structured water is water that is
anti-microbial in nature and may be effective against virus, bacteria, fungus,
mildew and spores. This water may have a wide array of disinfectant uses.

Derma-Structured Water. Derma-structured water is electrolyzed low pH water
that has astringent and disinfecting properties and may have a wide array of
cosmetic, dermatological and post-plastic surgery applications that may minimize
infections and scarring and expedite healing.

FUNCTIONAL WATER RESEARCH IN ACADEMIA

The process to produce functional water was developed by Scottish inventor
Michael Faraday in Boston, Massachusetts in 1834. In 1929, the value of
electrolytic water separation to produce water with functional properties was
realized in Japan. Japanese researchers have since taken this process, created a
wide array of functional waters and have introduced this technology to food
processing, hospital disinfection, wound care, agriculture, organic agriculture
and food safety in Japan. During recent years, functional water applications
have been studied by universities in the U.S.A. and Canada. For example, in a
University of Georgia study published in the Journal of Food Protection in 1999
entitled "Inactivation of Escherichia coli O157:H7 and Listeria monocytogenes on
Plastic Kitchen Cutting Boards by Electrolyzed Oxidizing Water," the immersion
of plastic kitchen cutting boards in electrolyzed oxidizing water was found to
be an effective method for inactivating food-borne pathogens such as E. coli.
Other studies at the University of Georgia have looked at the efficacy of
electrolyzed oxidizing water for inactivating E. coli, Salmonella and Listeria
and have determined that such water may be a useful disinfectant. A University
of Georgia study entitled "Antimicrobial effect of electrolyzed water for
inactivating Campylobacter jejuni during poultry washing" demonstrated that
electrolyzed water is not only effective in reducing the populations of C.
jejuni on chicken, but also may be effective in the prevention of
cross-contamination of processing environments.

OUR BUSINESS--FUNCTIONAL WATER SYSTEMS

Residential Systems. The residential countertop, functional water systems
produce water that scientists believe contains more wellness and
health-beneficial properties than regular tap water (see, "Electrolyzed-Reduced
Water Scavenges Active Oxygen Species and Protects DNA from Oxidative Damage,"
Biochemical and Biophysical Research Communications, Vol. 234, No. 1, pp.
269-274 (1997); and, Hanaoka, K., "Antioxidant Effects Of Reduced Water Produced
By Electrolysis Of Sodium Chloride Solutions," 31 Journal of Applied
Electrochemistry 1307-1313 (2001)). Generally, the residential countertop system
sits next to the kitchen faucet, and through the use of a diverter, allows tap
water to be routed through the system. The water is then processed through a
charcoal filter where chlorine and sediments are removed. The filtered water
then proceeds to the electrolysis chamber that is made up of electrodes and
membranes. A positive and negative electrical charge is passed through the
electrodes. The minerals that are found in the filtered water are attracted to
opposite electrodes. For example, the alkaline minerals (minerals with
positive(+) properties that include calcium, magnesium, sodium, manganese, iron
and potassium) are attracted to the negatively charged (-) electrode. The acidic
minerals (minerals with negative (-) properties include nitric acid, sulfuric
acid and chlorine) are attracted to the positively-charged (+) electrode.
Through this mineral separation process, two separate types of water are formed,
which are water with alkaline-concentrated minerals, and water with
acidic-concentrated minerals. Each type of water is held in a separate chamber
in the residential countertop system. The alkaline-concentrated water may be
consumed for drinking and cooking purposes, while the acidic-concentrated water
may be used in a topical, astringent medium.

Commercial Systems. We are in preparation to market commercial functional
water systems to the food processing, medical and agricultural industries. The
system for the food processing industry includes: (1) a hand disinfectant system
for proper hand washing, and (2) an anti-microbial water production system for
general sterilization and disinfectant needs. We also intend to market similar
systems to the medical industry. For the agricultural industry, we intend to
sell functional water systems to organic food growers who desire to use
functional water to replace the use of pesticides, fungicides, herbicides and
chemical fertilizers. Our commercial functional water systems produce
approximately one gallon per minute of electrolyzed alkaline and acidic waters.
For the food processing industry, the alkaline water may be used as an effective
medium for removing pesticides from agricultural products, while the acidic
water may be used as anti-microbial water. For the hospital industry, the
alkaline water may be used as an effective medium in removing protein buildup
from surfaces, while the acidic water may be used as anti-microbial water. For
the organic agricultural industry, the alkaline water may be used for plant

growth and as a solid nutrient, while the acidic water may be used as a
substitute for fungicides, pesticides, herbicides and sporicides.

OUR BUSINESS--MARKETING STRATEGY

Our objectives are:

- To create a revenue stream through our marketing of residential
systems. These sales may be made through independent distributors,
network marketing, infomercials, mail order, retail sales and direct
sales generated through word-of-mouth referrals.

- To create a revenue stream through the sale of disinfectant systems to
the food processing industry.

- To create a revenue stream through licensing agreements based upon a
wide array of applications for functional water that will be targeted
to specific industries. For example, electrolyzed water may be used in
the beverage industry to extract flavors from their natural sources,
such as extracting tea from tea leaves for use in bottled iced tea.
Electrolyzed water may also be used in the formulation of
nutraceutical-type dietary supplement products in the health-food and
dietary supplement industries.

To continue the development of functional water applications for industries
that are currently dependent upon chemicals as a processing medium. In addition
to the food processing, medical and agricultural markets, we intend to develop
market-driven applications for functional water, provide the science to these
applications, publish the developments in scientific and industrial circulars
and perform consulting functions to industries that can benefit from functional
water. We intend to hire engineers from Japan to design, engineer and assemble
prototypes of functional water systems that are built for specific industrial
needs. We believe that by performing these functions ourselves, we will have all
of the necessary tools to become a leading provider of functional water
technology.

OUR BUSINESS--GOVERNMENT REGULATIONS

Our functional water systems are, or may be, subject to regulation by a
variety of federal, state and local agencies, including the Consumer Product
Safety Commission (CPSC") and the Food and Drug Administration ("FDA").

Our hand disinfectant functional water system may be subject to pre-market
approval by the FDA under Title 21 of the Code of Federal Regulations. We would
expect such an approval process to take approximately 90 days after filing with
the FDA, although there is no assurance that we will be able to obtain
pre-market approval from the FDA. We have not made any applications to the FDA
yet. We have engaged the consulting services of Environ Health Associates Inc.
to assist us with our FDA application for the hand disinfectant. We anticipate
filing the FDA application in the near future. Environ Health Associates Inc. is
familiar with a modern food safety procedure known as Hazard Analysis and
Critical Control Point ("HACCP"). HACCP is a food safety procedure that focuses
on identifying and preventing hazards that could cause food-borne illnesses. We
believe that complying with the HACCP procedure may assist us in getting FDA
approval, since the FDA generally encourages retailers to apply HACCP-based food
safety principles, along with other recommended practices.

At such time as we may obtain FDA approval for the hand disinfectant, we
then would request that the system be tested by Underwriter's Laboratories and
the National Sanitation Foundation.

OUR BUSINESS--MARKETING AND DISTRIBUTION

We intend to develop systems for the following markets:

- Hand disinfection for the food processing, fast food, medical, dental,
personal care and general health care industries.

- Residential, countertop drinking water electrolysis systems.

- Commercial functional water systems, such as metal mining and
refining, wine grape mildew treatment, wine aging control, potato
maintenance treatment, and the formulation of dietary supplement
products.

Hand Disinfection. After we obtain FDA approvals for the hand disinfection
system, we plan to introduce the device and what we believe to be its
operational simplicity, user-friendliness, high efficacy and affordability,
through industrial circulars where hand disinfection is of a primary concern. We
also intend to arrange with a leasing company to lease the hand disinfectant
system to the fast food industry. A large part of our marketing efforts will be
directed to educating our target markets about functional water. We plan to
write and publish articles through industrial media, disinfection forums, trade
shows and documentary-type films that may be aired through CNN, PBS and Voice of

America introducing a new and novel method for hand disinfection. We intend to
handle all inquiries through a toll-free number.

We plan to hire a public relations company that provides the news media
with documentary videos for the purpose of educating the public on the
technology, processes and applications that we market. The videos will cover the
following subjects:

- The use of functional electrolyzed water for food safety.

- The use of functional electrolyzed water for effective disinfection in
hospitals and clinical settings.

- The use of functional electrolyzed water for agriculture and organic
agriculture.

- The use of functional electrolyzed water as a wellness medium.

Residential Countertop Units. The first step towards the marketing and
distribution of residential countertop units is to develop a national product
distribution program through network marketing, mail order catalogs sales,
infomercials, independent distributor channels and word of mouth sales. Since we
understand that the demographics in these sales channels is predominately
composed of females in the age groups of 35-60, we intend to concentrate on this
market segment. The second step in the marketing and distribution of residential
countertop units is to introduce a simplified, lower price-point system that
will be introduced through retail outlets under a series of private labels.

Commercial Functional Water Systems. In addition to marketing the
residential countertop systems, we plan to develop marketing plans for
commercial systems. We may enter into agreements with companies to act as
distributors of our functional water systems. We may also grant exclusive rights
to companies to use our systems in specific industries for specific applications
in exchange for royalties.

We presently have 12 product distributors. We are presently seeking 108
additional product distributors.

OUR BUSINESS--COMPETITION

Our competitors include several entry-level importers of systems from Japan
and Korea. We believe that we have several distinctive advantages over
entry-level distributors:

We and our consultants, who are scientists, business people and advisers,
are individuals who have helped pioneer the understanding, documentation,
representation and structuring of the technology and its relevance to the U.S.A.
during the past nine-year period through various companies and organizations.
These consultants are the leaders in the U.S.A. in the knowledge and
representation of functional water.

We have been able to create a strong platform of specialists to advance
functional water technology in the U.S.A., which would be difficult for others
to replicate due to our high level of focused commitment and dedication.

We have close working relationships with our Japanese counterparts which
have been developed and nurtured over the past ten-year period. These members
are highly respected within the Japanese electrolysis community and attend
annual conferences as invited speakers.

We have excellent working relationships with the Japanese manufacturers and
we are often relied upon to provide international perspectives to be used in the
refinement of their scientific, design and engineering thought processes to
create products that will be accepted on a global basis.

With our knowledge, experience and foresight into the electrolyzed water
industry, we are well-positioned to branch out on our own without reliance on
Japanese manufacturing, if necessary.

We have strategically positioned ourselves as the "go to" organization for
technology, hardware and informational support for the public.

Although the majority of competitors are small resellers, the one
significant competitor that we have is named Hoshizaki U.S.A., which is an
established U.S.A.-based Japanese company that has a substantial market presence
in refrigeration and icemakers. We expect that we may face additional
competition from new market entrants and current competitors as they expand
their business models, but we do not believe that any real strong competitors
are imminent for the foreseeable 3 to 4 year period, other than Hoshizaki U.S.A.

To be competitive, we must assemble a strategic marketing and sales
infrastructure. Our success will be dependent on our ability to become a
formidable marketing and sales entity based upon the technology we have and our

ability to aggressively introduce this technology and its far-reaching benefits
through documentary videos and other methods of public relations.

EMPLOYEES

We currently have 3 full-time employees all of whom are in management
positions. None of our employees is subject to a collective bargaining
agreement. We believe that our employee relations are good.

OTHER DEVELOPMENTS

We have done preliminary field testing in the wine industry with respect to
the control of mildew on wine grapes in vineyards. Mildew on wine grapes is a
serious grapevine fungal disease. The tendency for mildew to grow on wine grapes
occurs, for example, in areas of Napa Valley where foggy conditions prevail. If
mildew is found on the wine grapes, then spraying with dusty sulfur is done.
Spraying with dusty sulfur will generally eliminate and control the mildew on
grapes. If this fungus is ignored, the wine grapes may spoil. However, the
long-term effects of sulfur exposure is unknown. The use of low pH functional
water may remove mildew

We have done preliminary field testing in the potato growing industry with
respect to potato maintenance during storage. Our preliminary review of this use
of functional water indicates better potato maintenance during storage. We plan
to continue this preliminary test using an automated functional water sprayer.

We have done preliminary testing in the mining and refining industry with
respect to the effect of the use of functional water on heap leaching and
refining of precious metals.

We obtained, through a sublicense from Edward Alexander at no cost to us,
the North American rights to manufacture and distribute an electrolyzed
water-based antioxidant dietary supplement developed by MIZ Corporation, a
Japanese company specializing in advanced uses of electrolyzed water. We plan to
sell this product to the fitness, sports and wellness markets.

We have been developing a proprietary process allowing for electrolysis to
be applied to wine. The primary objective for this application is to allow for a
wine maker to have direct control over the aging process of wine such that it
allows a wine maker to shorten, complement or, if desired, bypass the wine aging
process. The test results that were achieved showed promise in creating the
"optimal" wine through a controlled process which provides a smooth texture to
the wine along with an enhancement to the various active properties of the wine.

We plan to file an FDA application for our hand disinfectant system and our
surface disinfectant system.

In February 2005, MIZ Company, a Japanese company that owns four U.S.
patents whose subject matter is the electrolysis of water, assigned a 50%
ownership interest in those four patents to Mr. Alexander in consideration of
consulting services provided to MIZ Company by Mr. Alexander. Mr. Alexander has
agreed to allow us to exploit the four patents on a royalty-free basis. Since
MIZ Company and Mr. Alexander each has an ownership interest in the four
patents, either Mr. Alexander or the Japanese company could grant licenses to
others to use the four patents, and the Japanese company could exploit the four
patents by itself.

Our functional currency is the U.S. dollar.

Our independent auditors made a going concern qualification in their report
dated March 29, 2006, which raises substantial doubt about our ability to
continue as a going concern.

Equity Line of Credit. Effective November 28, 2005, we entered into an
Investment Agreement, which is an equity line of credit ("ELOC"), with Dutchess
Private Equities Fund, LP ("Dutchess"). The maximum amount of money that the
ELOC may provide to us over a 36 month period beginning January 2006, is
$10,000,000. We may periodically deliver new issue registered shares of our
common stock to Dutchess who then delivers cash to us based on a fluctuating
price per share of our common stock. We are not obligated to request the entire
$10,000,000. Since draw downs on the equity line of credit can occur at a
maximum rate of one draw down per week for $100,000 (or other amount using an
alternative calculation [which may be higher or lower than $100,000], each week
that we do not make a draw down raises the possibility that over the life of the
ELOC, we may not receive the entire $10 million. The actual aggregate number of
shares that we may issue pursuant to the Investment Agreement is not
determinable as it is based on the market price of our common stock from time to
time and how much funding we desire from time to time. We have registered and
reserved 50 million shares for this transaction We have not made any draw downs
on the equity line of credit as April 11, 2006.

We can commence drawing down at our discretion. For an equal amount of
funding from time to time pursuant to the ELOC, the number of shares we would
issue to Dutchess would be greater

during times of our stock price being low, and conversely so during times when
our stock price is high. Pursuant to the ELOC, we are subject to penalties if we
fail to deliver stock to Dutchess after we request a draw down from the ELOC. We
have engaged USEuro Securities to act as our placement agent in connection with
the ELOC.

Pursuant to the ELOC, we are subject to late fees if we fail to deliver
stock to Dutchess after requesting a draw down from the ELOC. These late fees
vary based on the number of undelivered shares, if any.

Item 2. Description of Property

We lease approximately 4,000 square feet of office and storage space
located at 1135 Atlantic Avenue, Suite 101, Alameda, CA 94501, for a lease
payment of approximately $6,000 per month. Under this lease, we are required to
pay a percentage of the property taxes, insurance and maintenance. The lease
expires in July 2006 and we anticipate renewing the lease at that time. We
believe this space is adequate for our current needs, and that additional space
is available to us at a reasonable cost, if needed.

Item 3. Legal Proceedings

We are not a plaintiff or defendant in any litigation, nor is any
litigation threatened against us.

Item 4. Submission of Matters to a Vote of Security Holders

None.

Item 5. Market for Common Equity Related Stockholder Matters and Small Business
Issuer Purchases of Equity Securities

Our stock is traded on the OTCBB. Our trading symbol is "PLBI." The
following table sets forth the quarterly high and low bid price per share for
our common stock. These bid and asked price quotations reflect inter-dealer
prices, without retail mark-up, mark-down or commission, and may not represent
actual prices. Our fiscal year ends on December 31.

COMMON STOCK PRICE RANGE

YEAR AND QUARTER HIGH LOW
--------------------------------

2005:
-----

First Quarter $1.55 $0.37
Second Quarter $0.48 $0.32
Third Quarter $0.40 $0.20
Fourth Quarter $0.34 $0.14

2004:
-----

First Quarter $2.45 $0.60
Second Quarter $2.30 $0.90
Third Quarter $1.15 $0.30
Fourth Quarter $2.90 $0.35

-------------------------

On Apri1 11, 2006, the closing price of our stock was $0.390.

On April 11, 2006, we had outstanding 14,622,500 shares of common stock.

On April 11, 2006, we had approximately 92 shareholders of record which
includes shares held directly by shareholders and shares beneficially owned by
shareholders who have deposited their shares into an account at a broker-dealer.
Such deposited shares into a brokerage account are accumulated in a nominee
account in the name of Cede, Inc. Cede, Inc. is the nominee account that most
broker-dealers use to deposit shares held in the name of the broker-dealer.
Cede, Inc. is counted as one record shareholder, even though it could represent
many beneficial shareholders who have deposited their shares into an account at
a broker-dealer.

We have not paid any cash dividends on our common stock and we do not
expect to declare or pay any cash dividends on our common stock in the
foreseeable future. Payment of any cash dividends will depend upon our future
earnings, if any, our financial condition, and other factors as deemed relevant
by the Board of Directors.

We have outstanding 8,000 shares of Series A Preferred Stock. We have no
outstanding options, warrants, convertible debt. Our Series A Preferred Stock
pays dividends.

SECURITIES AUTHORIZED FOR ISSUANCE UNDER
EQUITY COMPENSATION PLANS
Number of
securities to Number of securities
be issued remaining available
upon Weighted-average for future issuance
exercise of exercise price of under equity
outstanding outstanding compensation
options, options, plans (excluding
warrants and warrants and securities reflected
rights rights in column (a))

(a) (b) (c)

PLAN CATEGORY:

Equity compensation
plans approved by
security holders -0- n/a -0-

Equity compensation
plans not approved by
security holders (2) -0- n/a -0-

Total -0- n/a -0-

Item 6. Management's Discussion and Analysis

FORWARD-LOOKING STATEMENT

Certain statements contained herein, including, without limitation,
statements containing the words, "believes," "anticipates," "expects," and other
words of similar meaning, constitute "forward-looking statements" within the
meaning of Section 27A of the Securities Act of 1933, as amended, and Section
21E of the Securities Exchange Act of 1934, as amended. Such forward-looking
statements involve known and unknown risks, uncertainties and other factors
which may cause our actual results, performance or achievements, to be
materially different from any future results, performance, or achievements
expressed or implied by such forward-looking statements. Given these
uncertainties, readers are cautioned not to place undue reliance on such
forward-looking statements. In addition to the forward-looking statements
contained herein, the following forward-looking factors could cause our future
results to differ materially our forward-looking statements: competition,
funding, government compliance and market acceptance of our products.

INTRODUCTION

The following discussion and analysis of our financial condition and
results of operations should be read in conjunction with the audited financial
statements and accompanying notes and the other financial information appearing
elsewhere herein. The accompanying consolidated financial statements have been
prepared in conformity with accounting principles generally accepted in the
USA., which contemplate our continuation as a going concern.

We have incurred net losses of $981,674 in 2005 and $965,840 in 2004. We
had a working capital deficit of $871,723 at December 31, 2005 and $203,900 at
December 31, 2004. Loans from our president were required to fund operations.

Our independent auditors made a going concern qualification in their report
dated March 29, 2006, which raises substantial doubt about our ability to
continue as a going concern. The financial statements do not include any
adjustments relating to the recoverability and classification of recorded asset
amounts or amounts and classification of liabilities that might be necessary
should the Company be unable to continue in existence.

Our ability to continue as a going concern is dependent upon our ability to
generate sufficient cash flows to meet our obligations on a timely basis, to
obtain additional financing as may be required, and ultimately to attain
profitable operations. However, there is no assurance that profitable operations
or sufficient cash flows will occur in the future.

We are located in Alameda, California. Our business consists of the sales
and marketing of the industrial, environmental and residential systems
throughout the U.S.A. which alter the properties of water to produce functional
water. We act as an exclusive importer and master distributor of these products
to various companies in which uses for the product range from food processing to
retail water sales. We are working towards raising funds to expand our marketing
and revenues. We have spent considerable time negotiating with several overseas
corporations for the co-development of enhanced antioxidant beverages for
distribution into the overseas markets. In addition, we are working with
Canadian businesses to identify markets for various disinfection applications of
functional water, pending government approval. We are working on agricultural
applications of functional water. We are working on packaging for a spray-on
application of function water for pathogen counter-measures.

We: formulate intellectual properties under licensing agreements; supply
consumer products; consult on projects utilizing functional water; facilitate
usage, uses and users of functional water between manufacturer and industry; and
act as educators on the benefits of functional water. Our business has been
focused on marketing functional water equipment and systems.
Alkaline-concentrated functional water may have health-beneficial properties and
may be used for drinking and cooking purposes. Acidic-concentrated functional
water may be used as a topical, astringent medium.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

Our discussion and analysis of our financial condition and results of
operations is based upon our consolidated financial statements, which have been
prepared in accordance with generally accepted accounting principles. The
preparation of these financial statements requires us to make estimates and
judgments that affect the reported amounts of assets, liabilities, revenue and
expenses, and related disclosure of contingent assets and liabilities. On an

ongoing basis, we evaluate our estimates. We base our estimates on historical
experience and on various other assumptions that are believed to be reasonable
under the circumstances. These estimates and assumptions provide a basis for us
to make judgments about the carrying values of assets and liabilities that are
not readily apparent from other sources. Our actual results may differ from
these estimates under different assumptions or conditions, and these differences
may be material.

We recognize revenue when all four of the following criteria are met: (i)
persuasive evidence that an arrangement exists; (ii) delivery of the products
and/or services has occurred; (iii) the selling price is both fixed and
determinable and; (iv) collectibility is reasonably probable. Our revenues are
derived from sales of our industrial, environmental and residential systems
which alter the properties of water to produce functional water. We believe that
this critical accounting policy affects our more significant judgments and
estimates used in the preparation of our consolidated financial statements.

Our fiscal year end is December 31.

We have a joint research and development program with Weber Farms located
in Washington State. Weber Farms is family-owned with a long history of raising
and marketing quality potatoes, wheat and corn. In 1979, Weber Farms built a
fresh pack potato warehouse to ensure better quality and more oversight of the
marketing of open potatoes both to domestic and foreign markets. In 1997, a
state-of- the-art potato storage facility capable of storing 50,000 tons was
built. End uses of Weber Farm potatoes are generally in the areas of boxed and
bagged potatoes for retail stores, hash browns, French fires and other
retail-type products. We will work together in various areas where Proton's
electrolyzed water, with its unique efficacies, can be integrated into potato
production and post-harvesting processes. Understanding that Proton's water
brings about certain potato maintenance efficacies, environmental and worker
safety, on-site production abilities and cost efficiencies, both parties are
looking forward to a mutually rewarding relationship.

RESULTS OF OPERATIONS-YEARS ENDED DECEMBER 31, 2005 AND 2004.

We had revenue of $328,200 for the year ended December 31, 2005 Compared to
revenue of $379,989 for the year ended December 31, 2004 This was a decrease of
13%.

We had a net loss $981,674 for the year ended December 31, 2005 compared to
a net loss of $965,840 for the year ended December 31, 2005. This increase in
net loss was due primarily to an increase in interest cost.

Cash used by operating activities was $250,646 for the year ended December
31, 2005 compared to cash used by operating activities of $323,722 for the year
ended December 31, 2004. This decrease in cash used by operating activities was
due primarily to a decrease in cost of stock issued as compensation.

LIQUIDITY

As of December 31, 2005, we had cash on hand of $1,384. Our growth is
dependent on attaining profit from our operations and our raising of additional
capital either through the sale of stock or borrowing. There is no assurance
that we will be able to raise any equity financing or sell any of our products
to generate a profit.

During 2005, two of our shareholders advanced us an aggregate of $54,142.
These advances bear interest at 7% with principal and accrued interest. At
December 31, 2005, we owed the two shareholders an aggregate of $316,142,
compared to December 31, 2004 when we owed the two shareholders an aggregate of
$262,000. These amounts include loans made to us by them prior to 2005.

At December 31, 2005 and 2004, the accrued interest relating to stockholder
loans was $37,154 at December 31, 2005 and $15,946 at December 31, 2004.

During 2005, we accrued $60,000 as salaries payable to our majority
shareholders resulting in $135,091 of salaries payable at December 31, 2005.
This accrual includes salary accruals that we made prior to 2005.

In March 2005, we issued a note payable in the amount of $164,000. The note
was originally due in May 2005 and has been extended through May 31, 2006 and is
secured by inventory. The original terms of the loan provided for an interest
payment of $28,500 or 106% per annum. When the note was extended in May 2005,
the interest rate was amended to 30%. In October 2005, we obtained an additional
$4,500 from the same lender under the same terms. At December 31, 2005, the
outstanding balance of the note was $168,500 and $60,421 of interest had been
accrued. In addition, we issued 47,500 shares of common stock as additional
consideration for the loan which was recorded as a $27,075 loan cost and was
amortized over the original term of the note. The lender is Gary Taylor who is
our President.

In June 2005, we entered into an agreement with Mitachi, a Japanese
electronics component manufacturer, to aid in the production of enhanced
drinking water generators. Pursuant to this agreement, Mitachi agreed to pay us
25,000,000 Yen for engineering design, molding, tooling and preparation costs,
and the exclusive product distribution rights for China, Taiwan, and Japan.
Through December 31, 2005, Mitachi had paid to us 6,000,000 Yen (US $52,506) in
connection with this agreement. Since the project is not yet completed and no
units have been sold, this amount is classified as deferred revenue.

FUTURE CAPITAL REQUIREMENTS

Our growth is dependent on attaining profit from our operations, or our
raising additional capital either through the sale of stock or borrowing. There
is no assurance that we will be able to raise any equity financing or sell any
of our products at a profit.

Our future capital requirements will depend upon many factors, including:

- The cost to acquire equipment that we then would resell.

- The cost of sales and marketing.

- The rate at which we expand our operations.

- The results of our consulting business.

- The response of competitors.

Item 7. Financial Statements

The financial statements required by this item are set forth beginning on
page F-1.

Item 8. Changes In and Disagreements with Accountants On Accounting and
Financial Disclosure

None.

Item 8A. Controls and Procedures

(a) Evaluation of disclosure controls and procedures.

Based on their evaluation of our disclosure controls and procedures (as
defined in Rule 13a-15(e) under the Securities Exchange Act of 1934 (the
"Exchange Act")), our principal executive officer and principal financial
officer have concluded that as of the end of the period covered by this annual
report on Form 10-KSB such disclosure controls and procedures are effective to
ensure that information required to be disclosed by us in reports that we file
or submit under the Exchange Act is recorded, processed, summarized and reported
within the time periods specified in Securities and Exchange Commission rules
and forms.

(b) Changes in internal control over financial reporting.

Our management is responsible for establishing and maintaining adequate
control over our financial reporting.

During the year under report, there was no change in our internal control
over financial reporting that has materially affected, or is reasonably likely
to materially affect, our internal control over financial reporting.

The evaluation of our disclosure controls included a review of whether
there were any significant deficiencies in the design or operation of such
controls and procedures, material weaknesses in such controls and procedures,
any corrective actions taken with regard to such deficiencies and weaknesses and
any fraud involving management or other employees with a significant role in
such controls and procedures.

There have been no changes in our internal control over financial
reporting.

Item 8B. Other Information

None.

Item 9. Directors and Executive Officers of the Registrant, Promoters and
Control Persons; Compliance with Section 16(a) of the Exchange Act

EXECUTIVE OFFICERS AND DIRECTORS

Name Age Position
---------------------------------------------------------------------------------

Edward Alexander 54 Director, Chief Executive Officer,
Chief Financial Officer, and Secretary

Michael Fintan Ledwith 63 Director, Member of the Audit Committee

Gary Taylor 56 Director and President

Edward Alexander has been our Chairman, a Director, Chief Executive
Officer, Chief Financial Officer, and Secretary since 2002. He had been the
owner and president of Proton Laboratories, LLC from January, 2001 until its
merger with us. Proton Laboratories, LLC introduced an electrolytic water
separation technology that has many uses in industry, product formulations and
consumer products. From January 1997 to July 1998, Mr. Alexander served as owner
and president of Advanced H2O, LLC. In July 1998, Mr. Alexander formed Advanced
H2O, Inc. to specialize in bottled water production. Mr. Alexander continues to
serve as a consultant to Advanced H2O, Inc. Prior to 1997, Mr. Alexander served
as General Manager for Tomoe Incorporated and held various positions with
various divisions of the U.S. Navy Resale System. In February 2002, the
Securities and Exchange Commission accepted a settlement offer from Mr.
Alexander and imposed a cease and desist order against Mr. Alexander from
committing or causing any violation or future violation of Section 10(b) of the
Exchange Act and Rule 10b-5 thereunder. This order was imposed in connection
with a press release that Mr. Alexander was persuaded to release about Proton
Laboratories, LLC by a business associate whom Mr. Alexander trusted at the
time.

Michael Ledwith has been our Director since 2002. He has been a member of
the Audit Committee since June 2004. He has been semi-retired from daily
business activities since 1998. He was Professor of Systematic Theology at the
Pontifical University of Maynooth in Ireland from 1976 to 1994. He was later
Dean of the Faculty, Head of Department and Editor of "The Irish Theological
Quarterly." He was later appointed as a Consulting Editor of the renowned
international review "Communio" and still serves in that capacity. He was
appointed Vice-President of the University in 1980, re-appointed in 1983, and
was appointed President in 1985. He served as Chairman of the Committee of Heads
of the Irish Universities and was a Member of the Governing Bureau of the
European University Presidents' Federation (CRE). He retired from his
Professorship on September 30, 1996 and has since continued to pursue his
interest in research, writing, and lecturing in the field of actualizing human
potential. Since November 2001 he has been a partner in World of Star Stuff,
which markets whole food products.

On June 3, 2005, Gary Taylor was appointed as a Director and President. We
granted 131,600 shares of common stock to Mr. Taylor in connection with this
appointment. Since 1998, Mr. Taylor has been the CEO of The Moore Company which
provides consulting for product distribution and third party logistical
services.

COMMITTEES OF THE BOARD OF DIRECTORS

We do not have any nominating, or compensation committees of the Board, or
committees performing similar functions.

In December 2003, our Board adopted our Audit Committee Charter (the
"Charter") which established our Audit Committee. The Board of Directors has
selected Michael Ledwith, our only independent Director, to be on the Audit
Committee. Mr. Ledwith is not a financial expert. We have determined Mr.
Ledwith's independence using the definition of independence set forth in NASD
Rule 4200-(14). We have not yet been able to recruit an independent director who
is also a financial expert.

The primary purpose of the Audit Committee is to oversee our financial
reporting process on behalf of the Board of Directors. The Audit Committee will
meet privately with our Chief Accounting Officer and with our independent public
accountants and evaluate the responses by the Chief Accounting Officer both to
the facts presented and to the judgments made by our independent accountants.
The Charter establishes the independence of our Audit Committee and sets forth

the scope of the Audit Committee's duties. The Purpose of the Audit Committee is
to conduct continuing oversight of our financial affairs. The Audit Committee
conducts an ongoing review of our financial reports and other financial
information prior to filing them with the Securities and Exchange Commission, or
otherwise providing them to the public. The Audit Committee also reviews our
systems, methods and procedures of internal controls in the areas of: financial
reporting, audits, treasury operations, corporate finance, managerial, financial
and SEC accounting, compliance with law, and ethical conduct. A majority of the
members of the Audit Committee will be independent directors. The Audit
Committee is objective, and reviews and assesses the work of our independent
accountants and our internal audit department. The Audit Committee will review
and discuss the matters required by SAS 61 and our audited financial statements
for the year ended December 31, 2004 with our management and our independent
auditors. The Audit Committee will receive the written disclosures and the
letter from our independent accountants required by Independence Standards Board
No. 1, and the Audit Committee will discuss with the independent accountant the
independent accountant's independence.

MEETINGS OF THE BOARD OF DIRECTORS

The Board of Directors did not hold meetings during the year ended December
31, 2004, but did act by consent on four occasions. There is no family
relationship between or among any of our directors and executive officers.

SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE

Section 16(a) of the Exchange Act requires our officers, directors and
persons who beneficially own more than 10% of our common stock to file reports
of ownership and changes in ownership with the SEC. These reporting persons also
are required to furnish us with copies of all Section 16(a) forms they file. To
the best of our knowledge, all persons required to file reports under Section
16(a) of the Exchange Act have done so in a timely manner.

CODE OF ETHICS

We have a Code of Ethics that applies to our principal executive officer
and our principal financial officer. We undertake to provide to any person,
without charge, upon request, a copy of our Code of Ethics. You may request a
copy of our Code of Ethics by mailing your written request to us. Your written
request must contain the phrase "Request for a Copy of the Code of Ethics of
Proton Laboratories, Inc." Our address is: Proton Laboratories, Inc., 1135
Atlantic Avenue, Suite 101, Alameda, CA 94501.

SHAREHOLDER NOMINEES FOR DIRECTOR AND SHAREHOLDER COMMUNICATIONS WITH DIRECTORS

The deadline for stockholders to submit proposals to be considered for
inclusion in the Proxy Statement for the 2007 Annual Meeting of Stockholders is
October 31, 2006. If you have any proposals that you would like to be included
in the Proxy Statement for the 2007 Annual Meeting of Stockholders, including
nominees for Director, kindly mail them to us. We encourage our shareholders to
communicate with our Directors by mail addressed to any Director or to all
Directors. Our address is: Proton Laboratories, Inc., 1135 Atlantic Avenue,
Suite 101, Alameda, CA, 94501. We will not screen such communications.

Item 10. Executive Compensation

Executive Compensation

The following table sets forth certain information as to our highest paid
officers and directors. No other compensation was paid to any such officers or
directors other than the compensation set forth below.

Annual Compensation Long-Term Compensation
Awards Pay-Outs
Securities
Name and Other Under-
All Restricted lying
Principal Annual Stock Options LTIP Other
Position Year Salary Bonus Compensation Award(s) SARs Payouts Compensation

Edward
Alexander
CEO, CFO

$ $ $ $ # $
2005(1) 60,000 -0- -0- -0- -0- -0- -0-

2004 (2) 62,400 -0- -0- -0- -0- -0- -0-
2003 (3) 62,400 -0- -0- -0- -0- -0- -0-

--------------------------------
(1) Mr. Alexander's services were valued at $60,000 which was recorded as
accrued wages.

(2) Mr. Alexander received $2,400 as cash compensation. We determined that the
value of his services was $62,400, of which $60,000 was recorded as accrued
wages.

(3) Mr. Alexander received $2,400 as cash compensation. We determined that the
value of his services was $62,400, of which $45,000 was recorded as
additional paid-in capital and $15,000 was recorded as accrued wages.

OUTSTANDING STOCK OPTIONS

We have not granted any options to purchase common stock and we do not have
any outstanding options to purchase common stock.

COMPENSATION OF DIRECTORS

Our directors do not receive cash compensation for their services as
directors or members of committees of the Board of Directors.

EMPLOYEE STOCK OPTION PLANS

We do not have nay Stock and Stock Option Plan at this time.

NO EMPLOYMENT AGREEMENT

We do not have any employment agreements with any employees.

SECURITIES AUTHORIZED FOR ISSUANCE UNDER
EQUITY COMPENSATION PLANS

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

(a) (b) (c)

PLAN CATEGORY:

Equity compensation
plans approved by
security holders -0- n/a -0-

Equity compensation
plans not approved by
security holders (2) -0- n/a -0-

Total -0- n/a -0-

SECURITIES AUTHORIZED FOR ISSUANCE UNDER
EQUITY COMPENSATION PLANS

(a) (b) (c)

PLAN CATEGORY:

Equity compensation
plans approved by
security holders -0- n/a -0-

Equity compensation
plans not approved by
security holders (2) -0- n/a -0-

Total -0- n/a -0-

Item 11. Security Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters

The following table sets forth certain information concerning the number of
shares of common stock owned beneficially as of April 11, 2006, by: (i) each
person (including any group) known by us to own more than five percent (5%) of
any class of our voting securities, (ii) each of our directors and executive
officers, and (iii) and our officers and directors as a group. Unless otherwise
indicated, the shareholders listed possess sole voting and investment power with
respect to the shares shown. As of April 11, 2006, we had 14,622,500 shares of
common stock outstanding.

Name Amount of Shares Class of Percentage
and Address Beneficially Owned Securities of Class
------------------------------------------------------------------------------------

Edward Alexander
1135 Atlantic Avenue, Suite 101
Alameda, CA 94501 8,224,000 Common Stock 58%

Gary Taylor
333 S.E. 2ND AVE.
PORTLAND OR 97214 156,400 Common Stock 1%

Michael Fintan Ledwith
6610 Churchill Rd. SE
Tenino, WA 98589 -0- Common Stock -0-%

Executive Officers
As A Group(3 Persons) 8,380,400 Common Stock 59%

We are not aware of any arrangements that could result in a change of
control.

Item 12. Certain Relationships and Related Transactions

We have a policy that our business affairs will be conducted in all
respects by standards applicable to publicly held corporations and that we will
not enter into any future transactions and/or loans between us and our officers,
directors and 5% shareholders unless the terms are: (a) no less favorable than
could be obtained from independent third parties, and (b) will be approved by a
majority of our independent and disinterested directors. In our view, all of the
transactions described below meet this standard.

During the year ended December 31, 2004, Edward Alexander advanced to us
the amount of $178,000 in cash. This advance accrues interest at the rate of 7%
per annum and is due on various dates through September 2006.

At December 31, 2005, the aggregate balance we owe on loans from
shareholders is $316,142. All of these loans accrues interest at the rate of 7%
per annum and are due on various dates through September 2006. At December 31,
2005, the aggregate accrued interest on these loans was $37,154.

During 2005, two of our shareholders advanced us an aggregate of $54,142.
These advances bear interest at 7% with principal and accrued interest.

During 2004, we obtained, through a sublicense from Edward Alexander, at no
cost to us, the North American rights to manufacture and distribute an
electrolyzed water-based antioxidant dietary supplement developed by MIZ
Corporation, a Japanese company specializing in advanced uses of electrolyzed
water. We plan to sell this product to the fitness, sports and wellness markets.

Item 13. Exhibits

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

31.1 Certification pursuant to Section 13a-14 of CEO

31.2 Certification pursuant to Section 13a-14 of CFO

32.1 Certification pursuant to Section 1350 of CEO

32.2 Certification pursuant to Section 1350 of CFO

Item 14. Principal Accountant Fees and Services

OUR INDEPENDENT ACCOUNTANT

In 2005, our Board of Directors selected as our independent accountant the
CPA firm of Hansen, Barnett & Maxwell, a Professional Corporation ("HBM") of
Salt Lake City, Utah. HBM audited our financial statements for the years ended
December 31, 2005 and 2004. Our Audit Committee approved 100% of the work of
HBM.

1. AUDIT FEES

For the two years ended December 31, 2005 and 2004, HBM billed us the
aggregate amount of $24,096 and $14,458, respectively, for professional
services rendered for their audits of our annual financial statements for
those years and their reviews of our quarterly financial statements for
those years. We were not billed for professional services from any other
accounting firm for audits or reviews done in 2005 and 2004.

2. AUDIT-RELATED FEES

For the two years ended December 31, 2005 and 2004, we were billed $5,029
and $1,073, respectively, by HBM for audit-related fees.

3. TAX FEES

For the two years ended December 31, 2005 and 2004, we were not billed by
HBM for any tax fees.

4. ALL OTHER FEES

For the two years ended December 31, 2005 and 2004, we were not billed by
HBM for any other professional services.

5(I). PRE-APPROVAL POLICIES

Our Audit Committee does not pre-approve any work of our independent
auditor, but rather approves independent auditor engagements before each
engagement.

5(II). PERCENTAGE OF SERVICES APPROVED BY OUR AUDIT COMMITTEE

There were no services performed by our independent auditor of the type
described in Items 9(e)(2) through 9(e)(4) of Schedule 14A. Our Audit
Committee considers that the work done for us by HBM is compatible with
maintaining HBM's independence.

6. AUDITOR'S TIME ON TASK

At least 50% of the work expended by HBM on our 2005 audit was attributed
to work performed by HBM's full-time, permanent employee

SIGNATURES

In accordance with Section 13 or 15(d) of the Exchange Act, the registrant
caused this FORM 10-KSB to be signed on its behalf by the undersigned, thereunto
duly authorized in Alameda, California.

PROTON LABORATORIES, INC.

April 13, 2006 By: /s/ Edward Alexander
Edward Alexander
Director, Chief Executive Officer, President and
Chief Financial Officer

In accordance with the Exchange Act, this FORM 10-KSB has been signed below
by the following persons on behalf of the registrant and in the capacities and
on the dates indicated.

April 13, 2006 By: /s/ Edward Alexander
Edward Alexander
Director, Chief Executive Officer and
Chief Financial Officer

April 13, 2006 By: /s/ Michael Fintan Ledwith
Michael Fintan Ledwith
Director

April 13, 2006 By: /s/ Gary Taylor
Gary Taylor
Director and President

PROTON LABORATORIES, INC.

REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
AND
CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2005 AND 2004

HANSEN, BARNETT & MAXWELL
A Professional Corporation
CERTIFIED PUBLIC ACCOUNTANTS

PROTON LABORATORIES, INC.
TABLE OF CONTENTS

PAGE

Report of Independent Registered Public Accounting Firm F-2

Consolidated Balance Sheets - December 31, 2005 and 2004 F-3

Consolidated Statements of Operations for the years ended December 31, 2005 and 2004 F-4

Consolidated Statements of Stockholders' Deficit for the years ended December 31, 2004
and 2005 F-5

Consolidated Statements of Cash Flows for the years ended December 31, 2005 and 2004 F-6

Notes to Consolidated Financial Statements F-7

HANSEN, BARNETT & MAXWELL
A Professional Corporation REGISTERED WITH THE PUBLIC COMPANY
CERTIFIED PUBLIC ACCOUNTANTS ACCOUNTING OVERSIGHT BOARD
5 Triad Center, Suite 750
Salt Lake City, UT 84180-1128 [GRAPHIC OMITTED]
Phone: (801) 532-2200 an independent member of
Fax: (801) 532-7944 BAKER TILLY
www.hbmcpas.com INTERNATIONAL

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and the Stockholders
Proton Laboratories, Inc. and subsidiaries

We have audited the consolidated balance sheets of Proton Laboratories, Inc. as
of December 31, 2005 and 2004, and the related consolidated statements of
operations, stockholders' deficit and cash flows for the years ended December
31, 2005 and 2004. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.

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

In our opinion the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of Proton
Laboratories as of December 31, 2005 and 2004, and the results of their
consolidated operations and their cash flows for the years ended December 31,
2005 and 2004, in conformity with accounting principles generally accepted in
the United States of America.

The accompanying consolidated financial statements have been prepared assuming
that the Company will continue as a going concern. As discussed in Note 2 to the
consolidated financial statements, the Company has an accumulated deficit, has
suffered reoccurring losses from operations, has negative working capital, and
has required loans from the Company's majority shareholder to fund operations.
These factors raise substantial doubt about the Company's ability to continue as
a going concern. Management's plans in regards to these matters are also
described in Note 2. The consolidated financial statements do not include any
adjustments that might result from the outcome of this uncertainty.

HANSEN, BARNETT & MAXWELL

Salt Lake City, Utah
March 29, 2006

F-2

PROTON LABORATORIES, INC
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2005 AND 2004

2005 2004
---------------------------------------------------------------------------------------------

ASSETS
CURRENT ASSETS
Cash $ 1,384 $ 14,412
Accounts receivable, less allowance for doubtful accounts of
$16,522 and $16,522, respectively 21,927 10,633
Inventory 32,861 34,097
---------------------------------------------------------------------------------------------
TOTAL CURRENT ASSETS 56,172 59,142
---------------------------------------------------------------------------------------------
PROPERTY AND EQUIPMENT
Furniture and fixtures 19,709 18,438
Equipment and machinery 161,833 95,039
Leasehold improvements 11,323 10,995
Deposit on equipment - 64,500
Accumulated depreciation (45,820) (19,160)
---------------------------------------------------------------------------------------------
NET PROPERTY AND EQUIPMENT 147,045 169,812
---------------------------------------------------------------------------------------------
DEPOSITS 6,131 5,000
---------------------------------------------------------------------------------------------
TOTAL ASSETS $ 209,348 $ 233,954
---------------------------------------------------------------------------------------------
LIABILITIES AND STOCKHOLDERS' DEFICIT
CURRENT LIABILITIES
Accounts payable $ 168,378 $ 134,780
Accrued expenses 252,769 110,562
Deferred revenue 52,506 -
Preferred dividends payable 9,600 3,200
Stockholder loans, current portion 444,642 84,000
---------------------------------------------------------------------------------------------
TOTAL CURRENT LIABILITIES 927,895 332,542
---------------------------------------------------------------------------------------------
STOCKHOLDER LOANS, NET OF CURRENT PORTION 40,000 178,000
---------------------------------------------------------------------------------------------
STOCKHOLDERS' DEFICIT
Series A convertible preferred stock, 400,000 shares authorized
with a par value of $0.0001; 8,000 issued and outstanding,
liquidation preference of $80,000. 80,000 80,000
Undesignated preferred stock, 19,600,000 shares authorized with a
par value of $0.0001; no shares issued or outstanding - -
Common stock, 100,000,000 common shares authorized with a par
value of $0.0001; 14,270,100 and 12,975,000 shares issued and
outstanding, respectively 1,429 1,299
Additional paid in capital 1,856,601 1,350,616
Accumulated deficit (2,696,577) (1,708,503)
---------------------------------------------------------------------------------------------
TOTAL STOCKHOLDERS' DEFICIT (758,547) (276,588)
---------------------------------------------------------------------------------------------
TOTAL LIABILITIES AND STOCKHOLDERS' DEFICIT $ 209,348 $ 233,954
---------------------------------------------------------------------------------------------

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

F-3

PROTON LABORATORIES, INC
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR YEARS ENDED DECEMBER 31, 2005 AND 2004

2005 2004
-------------------------------------------------------------------------------------------

SALES $ 328,200 $ 379,989

COST OF GOODS SOLD 246,630 263,395
-------------------------------------------------------------------------------------------

GROSS PROFIT 81,570 116,594
-------------------------------------------------------------------------------------------

SELLING, GENERAL AND ADMINISTRATIVE EXPENSES (including
equity-based expenses of $459,040 and $618,349, respectively) 954,834 1,065,595
-------------------------------------------------------------------------------------------

LOSS FROM OPERATIONS (873,264) (949,001)
-------------------------------------------------------------------------------------------

OTHER INCOME AND (EXPENSE)
Loss on disposal of property and equipment - (1,648)
Interest income 186 20
Interest expense (108,596) (15,211)
-------------------------------------------------------------------------------------------
NET OTHER EXPENSE (108,410) (16,839)
-------------------------------------------------------------------------------------------

NET LOSS (981,674) (965,840)

PREFERRED STOCK DIVIDEND (6,400) (3,200)
-------------------------------------------------------------------------------------------

LOSS APPLICABLE TO COMMON SHAREHOLDERS $ (988,074) $ (969,040)
-------------------------------------------------------------------------------------------

BASIC AND DILUTED LOSS PER
COMMON SHARE $ (0.07) $ (0.08)
-------------------------------------------------------------------------------------------

BASIC AND DILUTED WEIGHTED AVERAGE
SHARES OUTSTANDING 13,720,209 11,525,510
-------------------------------------------------------------------------------------------

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

F-4

PROTON LABORATORIES, INC
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' DEFICIT
FOR THE YEARS ENDED DECEMBER 31, 2004 AND 2005

PREFERRED STOCK COMMON STOCK ADDITIONAL
--------------- -------------------- PAID IN ACCUMULATED
SHARES AMOUNT SHARES AMOUNT CAPITAL DEFICIT TOTAL
-----------------------------------------------------------------------------------------------------------------------

BALANCE - DECEMBER 31, 2003 - - 11,250,000 1,126 536,440 (739,463) (201,897)
-----------------------------------------------------------------------------------------------------------------------
Sale of preferred stock 8,000 80,000 - - - - 80,000
Issuance of shares for legal services - - 100,000 10 39,990 - 40,000
Issuance of shares for consulting services - - 1,345,000 135 578,214 - 578,349
Issuance of common stock for cash - - 280,000 28 195,972 - 196,000
Dividends accrued - - - - - (3,200) (3,200)
Net loss for the period - - - - - (965,840) (965,840)
-----------------------------------------------------------------------------------------------------------------------
BALANCE - DECEMBER 31, 2004 8,000 80,000 12,975,000 1,299 1,350,616 (1,708,503) (276,588)
Issuance of shares for interest expense - - 47,500 5 27,070 - 27,075
Issuance of shares to director - - 131,600 13 52,627 - 52,640
Issuance of shares for consulting services - - 1,016,000 102 406,298 - 406,400
Issuance of shares for cash - - 100,000 10 19,990 - 20,000
Dividends accrued - - - - - (6,400) (6,400)
Net loss for the period - - - - - (981,674) (981,674)
-----------------------------------------------------------------------------------------------------------------------
BALANCE - DECEMBER 31, 2005 8,000 $80,000 14,270,100 $ 1,429 $ 1,856,601 $(2,696,577) $(758,547)
-----------------------------------------------------------------------------------------------------------------------

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

F-5

PROTON LABORATORIES, INC
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 2005 AND 2004

2005 2004
----------------------------------------------------------------------

CASH FLOWS FROM OPERATING ACTIVITIES
----------------------------------------------------------------------
Net loss $(981,674) $(965,840)
Adjustments to reconcile net loss to cash used
in operating activities:
Depreciation 26,660 9,814
Bad debt expense - 6,430
Loss on disposal of property and equipment - 1,648
Common stock issued for services 459,040 618,349
Amortization of loan costs 27,075 -
Changes in operating assets and liabilities
Accounts receivable (11,294) 7,520
Inventory 1,236 (33,674)
Deffered revenue 52,506 -
Accounts payable 33,598 (62,796)
Accrued expenses 142,207 94,827
----------------------------------------------------------------------
NET CASH FROM OPERATING ACTIVITIES (250,646) (323,722)
----------------------------------------------------------------------

CASH FLOWS FROM INVESTING ACTIVITIES
Refund of deposit 5,000 -
Cash paid for deposit (6,131) -
Purchases of property and equipment (3,893) (120,289)
----------------------------------------------------------------------
NET CASH FROM INVESTING ACTIVITIES (5,024) (120,289)
----------------------------------------------------------------------

CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from sale of common stock 20,000 196,000
Proceeds from sale of preferred stock - 80,000
Proceeds from stockholder loans 222,642 178,000
----------------------------------------------------------------------
NET CASH FROM FINANCING ACTIVITIES 242,642 454,000
----------------------------------------------------------------------

NET INCREASE (DECREASE) IN CASH (13,028) 9,989
CASH AT BEGINNING OF PERIOD 14,412 4,423
----------------------------------------------------------------------
CASH AT END OF PERIOD $ 1,384 $ 14,412
----------------------------------------------------------------------

NON-CASH INVESTING AND FINANCING ACTIVITIES:
Transfer of inventory to equipment $ 64,500 $ 27,377
Issuance of common stock for loan costs $ 27,075 $ -
Accrual of preferred stock dividends $ 6,400 $ -

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

F-6

PROTON LABORATORIES, INC.
NOTES TO FINANCIAL STATEMENTS

NOTE 1 - ORGANIZATION AND BASIS OF PRESENTATIONS

ORGANIZATION- Proton Laboratories, LLC. (Proton) was incorporated on February
16, 2000 in the State of California. Proton did not begin its operations until
January 1, 2001. On January 1, 2001, Proton's sole owner contributed inventory
and property and equipment to the Company.

BentleyCapitalCorp.com Inc. (Bentley) was incorporated in the State of
Washington, U.S.A. on March 14, 2000. On November 15, 2002, Proton entered into
an Agreement and Plan of Reorganization with Bentley whereby the Company merged
with and into VWO I Inc. (VWO), a wholly owned subsidiary of Bentley (the
"Merger"). In April 2004 the subsidiary changed its name to Water Science, Inc.

For financial statement purposes Proton is considered the parent corporation and
originally elected to maintain BentleyCapitalCorp.com, Inc as its business name.
In December 2003 the Company's board elected to change its name to Proton
Laboratories, Inc., and hereafter collectively referred to as the "Company".

CONSOLIDATION POLICY - The accompanying consolidated financial statements
reflect the financial position of and operations for Proton as of and for the
years ended December 31, 2005 and 2004. All significant intercompany
transactions have been eliminated in consolidation.

NATURE OF OPERATIONS - The Company's operations are located in Alameda,
California. The core business of the Company consists of the sale and
marketing of the Company's industrial, environmental and residential systems
throughout the United States of America which alter the properties of water to
produce functional water. The Company acts as an exclusive importer and master
distributor of these products to various companies in which uses for the product
range from food processing to retail water sales. Additionally, the Company
formulates intellectual properties under licensing agreements, supplies consumer
products, consults on projects utilizing functional water, facilitates between
manufacturer and industry and acts as educators on the benefits of functional
water.

NOTE 2 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

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, disclosure of contingent assets and
liabilities and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.

FINANCIAL INSTRUMENTS -The Company is subject to concentration of credit risk
with respect to sales primarily in the functional water industry and sales to a
significant customer and purchases from a significant vendor. Accounts
receivable are generally unsecured. The Company normally obtains payments from
customers prior to delivery of the related products. Otherwise, the Company does
not require collateral for accounts receivable.

The carrying value of the note payable approximates fair value based on it
bearing interest at a rate which approximates market rates. The amount reported
as inventory is considered to be a reasonable approximation of its fair value.
The fair value estimates presented herein were based on market information
available to management at the time of the preparation of the financial
statements.

BUSINESS CONDITION - The accompanying consolidated 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. The Company has incurred net losses of $981,674 and $965,840 for
the years ended December 31, 2005 and 2004, respectively. The Company had a
working capital deficit of $871,723 and $203,900 at December 31, 2005 and 2004,
respectively.

F-7

PROTON LABORATORIES, INC.
NOTES TO FINANCIAL STATEMENTS

Loans from the Company's shareholders were required to fund operations. These
conditions raise a substantial doubt about the Company's ability to continue as
a going concern. The financial statements do not include any adjustments
relating to the recoverability and classification of recorded asset amounts or
amounts and classification of liabilities that might be necessary should the
Company be unable to continue in existence.

The Company is working towards raising public funds to expand its marketing and
revenues. The Company has spent considerable time in contracting with several
major overseas corporations for the co-development of enhanced antioxidant
beverages for distribution into the domestic and overseas markets. In addition,
the Company is working with its Canadian business associates to identify
institutional businesses to market various disinfection applications based upon
functional water, in some cases, pending government approval.

The Company's ability to continue as a going concern is dependent upon its
ability to generate sufficient cash flows to meet its obligations on a timely
basis, to obtain additional financing as may be required, and ultimately to
attain profitable operations. However, there is no assurance that profitable
operations or sufficient cash flows will occur in the future.

CASH AND CASH EQUIVALENTS - The Company considers all highly liquid instruments
purchased with a maturity of less than three months to be cash equivalents.

ACCOUNTS RECEIVABLE - Accounts receivable are recorded at the invoiced amount
and do not bear interest. The allowance for doubtful accounts is the Company's
best estimate of the amount of probable credit losses in the Company's existing
accounts receivable. The Company determines the allowance based on historical
write-off experience. Past due balances over 90 days and a specified amount are
reviewed individually for collectibility. Account balances are charged off
against the allowance after all means of collection have been exhausted and the
potential for recovery is considered remote. The Company does not have any
off-balance sheet credit exposure related to its customers.

INVENTORY - Inventory consists of purchased finished goods and is stated at the
lower of cost (using the first-in, first-out method) or market value.

PROPERTY AND EQUIPMENT - Equipment, and furniture and fixtures are stated at
cost. Depreciation is computed using the straight-line method over the estimated
useful lives of the assets. Estimated useful lives range from 3 to 7 years.
Depreciation expense for the years ended December 31, 2005 and 2004, was $26,660
and $9,814, respectively. Expenditures for maintenance, repairs, and renewals
are charged to expense as incurred. Expenditures for major renewals and
betterments that extend the useful lives of existing equipment are capitalized
and depreciated. On retirement or disposition of property and equipment, the
cost and accumulated depreciation are removed and any resulting gain or loss is
recognized in the statement of operations.

Long-lived assets are reviewed for impairment yearly. Recoverability of assets
to be held and used is measured by comparison of the carrying amount of an asset
to future net cash flows expected to be generated by the asset. If such assets
are considered to be impaired, the impairment to be recognized is measured by
the amount that the carrying amount of the assets exceeds the fair value of the
assets. Assets to be disposed of are reported at the lower of the carrying
amount or fair value less costs to sell. Based on the evaluation, no impairment
was considered necessary during the years ended December 31, 2005 or 2004.

INCOME TAXES - The Company recognizes an asset or liability for the deferred tax
consequences of all temporary differences between the tax bases of assets or
liabilities and their reported amounts in the financial statements. That will
result in taxable or deductible amounts in future years when the reported

F-8

PROTON LABORATORIES, INC.
NOTES TO FINANCIAL STATEMENTS

amounts of the assets or liabilities are recovered. These deferred tax assets
and or liabilities are measured using the enacted tax rates that will be in
effect when the differences are expected to reverse. Deferred tax assets are
reviewed periodically for recoverability and valuation allowances and
adjustments are provided as necessary.

ADVERTISING - The Company follows the policy of charging the cost of advertising
to expense as incurred. Advertising expense for the year ended December 31,
2005 and 2004 was $2,055 and $10,776, respectively.

CONCENTRATIONS OF RISK - Sales to major customers are defined as sales to any
one customer which exceeded 10% of total sales. The risk of loss of a major
customer subjects the Company to the possibility of decreased sales. Purchases
from major vendors are defined as inventory purchases from any one vendor which
exceeded 10% of total inventory purchases. The risk of loss of a major vendor
subjects the Company to the possibility of increased costs and not being able to
fulfill customer orders. See Note 7.

REVENUE RECOGNITION - The Company recognizes revenue when all four of the
following criteria are met: (i) persuasive evidence that arrangement exists;
(ii) delivery of the products and/or services has occurred; (iii) the selling
price is both fixed and determinable and; (iv) collectibility is reasonably
probable. The Company's revenues are derived from sales of their industrial,
environmental and residential systems which alter the properties of water to
produce functional water.

BASIC AND DILUTED LOSS PER COMMON SHARE - Basic loss per common share is
calculated by dividing net loss by the weighted-average number of common shares
outstanding. Diluted loss per common share is calculated by dividing net loss
by the weighted-average number of Series A convertible preferred shares and
common shares outstanding to give effect to potentially issuable common shares
except during loss periods when those potentially issuable shares are
anti-dilutive. Potential common shares from convertible preferred stock have
not been included as they are anti-dilutive.

NEW ACCOUNTING STANDARDS - In November 2004, the FASB issued SFAS No. 151,
Inventory Costs, which is an amendment of ARB No. 43. SFAS No. 151 requires
idle facility expenses, freight, handling costs and wasted material (spoilage)
costs to be recognized as current-period charges. It also requires that
allocation of fixed production facilities. SFAS No. 151 will be effective for
the Company beginning January 1, 2006 and resulting adjustments will be made on
prospective basis. The Company does not anticipate that the adoption of this
standard will have a significant impact on its business, results of operations
or financial position.

In December 2004, the FASB issued SFAS No. 123 (revised 2004), "Share-Based
Payment," which is an amendment to SFAS No. 123, "Accounting for Stock-Based
Compensation." This new standard eliminates the ability to account for
share-based compensation transactions using Accounting Principles Board (APB)
No. 25, "Accounting for Stock Issued to Employees" (APB 25) and requires such
transactions to be accounted for using a fair-value-based method and the
resulting cost recognized in the Company's financial statements. This new
standard is effective for interim and annual periods beginning after June 15,
2005. The Company has evaluated SFAS No. 123 as revised and intends to implement
it for any future issuance of stock to employees.

In December 2004, the FASB issued SFAS Statement No. 153, "Exchanges of
Non-monetary Assets-an amendment of APB Opinion No. 29." This Statement amends
APB Opinion 29 to eliminate the exception for non-monetary exchanges of similar
productive assets and replaces it with a general exception for exchanges of
non-monetary assets that do not have commercial substance. A non-monetary
exchange has commercial substance if the future cash flows of the entity are
expected to change significantly as a result of the exchange. The Statement will
be effective in January 2006. The Company does not expect that the adoption of
SFAS No. 153 will have a material impact on its Consolidated Financial
Statements.

F-9

PROTON LABORATORIES, INC.
NOTES TO FINANCIAL STATEMENTS

In May 2005, the FASB issued SFAS No. 154, Accounting Changes and Error
Corrections - a replacement of APB Opinion No. 20 and FASB Statement No. 3.
SFAS No. 154 applies to all voluntary changes in accounting principle or when an
accounting pronouncement does not include specific transition provisions and
changes the requirements for the accounting for and reporting of a change in
accounting principle. This statement requires retrospective application to
prior periods' financial statements of changes in accounting principle, unless
it is impracticable to determine either the period specific effects or the
cumulative effect of the change. The Company implemented this standard on
January 1, 2006 and will not have a material impact to the company.

Reclassifications - The financial statements for the prior period have been
reclassified to be consistent with the current period financial statement
presentation. These reclassifications had no effect on net income.

NOTE 3 - RELATED PARTY TRANSACTIONS

Stockholder loans as of December 31, 2005 and 2004 consisted of the following:

2005 2004
-----------------------------------------------------------------------------------------
Note payable to president; principal and interest due May 2006;
interest is accrued at 30% per annum; secured by inventory $168,500 $ -

Note payable to CEO and majority shareholder; principal and
interest currently due; interest is accrued at 7% per annum;
unsecured. 84,000 84,000

Note payable to CEO and majority shareholder; principal and
interest currently due; interest is accrued at 7% per annum;
unsecured. 125,000 125,000

Note payable to CEO and majority shareholder; principal and
interest due April 2006; interest is accrued at 7% per annum;
unsecured. 40,000 40,000

Note payable to CEO and majority shareholder; principal and
interest due September 2006; interest is accrued at 7% per annum;
unsecured. 13,000 13,000

Note payable to CEO and majority shareholder; principal and
interest due September 2007; interest is accrued at 7% per annum;
unsecured. 14,142 -

Note payable to shareholder; principal and interest due January 2007;
interest is accrued at 7% per annum; unsecured. 40,000 -
-----------------------------------------------------------------------------------------

TOTAL STOCKHOLDER LOANS 484,642 262,000

Less: Current Portion 444,642 84,000
-----------------------------------------------------------------------------------------

TOTAL STOCKHOLDER LOANS - LONG TERM $ 40,000 $178,000
-----------------------------------------------------------------------------------------

F-10

PROTON LABORATORIES, INC.
NOTES TO FINANCIAL STATEMENTS

The following table shows the schedule of principal payments under shareholder
loans as of December 31, 2005:

YEAR ENDING DECEMBER 31, PAYMENTS
------------------------- ---------
2006 $ 444,642
2007 40,000
---------
$ 484,642
=========

The note payable to the president was issued in March 2005 in the amount of
$164,000 and was originally due in May 2005. During 2005, the due date was
extended to May 2006. The original terms of the loan provided for an interest
payment of $28,500 or 106% per annum. The interest rate for the extension period
is 30% on the original principal balance. In October 2005, the Company obtained
an additional $4,500 from the same lender under the same terms. In addition,
the Company issued the lender 47,500 shares of common stock, which was recorded
as a $27,075 loan cost and was amortized over the original term of the note.

At December 31, 2005 and 2004, the accrued interest relating to stockholder
loans was $97,575 and $15,946, respectively

During the years ended December 31, 2005 and 2004, the Company accrued $60,000
as salaries payable to the Company's CEO, resulting in $135,091 and $75,091 of
salaries payable at December 31, 2005 and 2004, respectively.

NOTE 4 - INCOME TAXES

There was no provision for or benefit from income tax for any period. The
components of the net deferred tax asset at December 31, 2005 and 2004 are as
follows:

2005 2004
=======================================================

Net operating loss carryforward $ 654,778 $ 416,124
Bad debt reserve 6,381 6,381
Accrued salaries 52,172 29,000
Less: valuation allowance (713,331) (451,505)
-------------------------------------------------------
NET DEFERRED TAX ASSET $ - $ -
=======================================================

For tax reporting purposes, the Company has net operating loss carry forwards in
the amount of $1,888,518 which will begin expiring in 2022.

The following is a reconciliation of the amount of tax benefit that would result
from applying the federal statutory rate to pretax loss with the benefit from
income taxes for the years ended December 31, 2005 and 2004:

2005 2004
=====================================================================

Benefit at statutory rate $(231,769) $(328,836)
Non-deductible expenses 1,436 2,589
Change in valuation allowance 261,826 370,419
State tax benefit, nete of federal tax effect (31,493) (44,622)
---------------------------------------------------------------------
NET BENEFIT FROM INCOME TAXES $ - $ -
=====================================================================

F-11

PROTON LABORATORIES, INC.
NOTES TO FINANCIAL STATEMENTS

NOTE 5 - PREFERRED STOCK

During May 2004, the Company designated 400,000 shares of the preferred stock as
Series A convertible preferred stock.

The holders of Series A convertible preferred stock are entitled to a cumulative
dividend of 8% per year in cash payable in arrears.

The holders of Series A convertible preferred stock may convert any or all of
their shares plus all accrued dividends on the preferred stock into common stock
at any time. Each share of preferred stock may be converted into 5 shares of
common stock. The holder will receive one share of common stock for $2 of
accrued dividends.

Upon the liquidation, dissolution or winding up of the Company, holders of
Series A convertible preferred stock, are entitled to receive, out of legally
available assets, a liquidation preference of $10 per share, plus an amount
equal to any unpaid dividends through the payment date, before any payment or
distribution was made to holders of common stock. The holders of Series A
convertible preferred stock are not entitled to vote.

During July 2004, the Company issued 8,000 shares of preferred stock for
$80,000. At December 31, 2005 and 2004, dividends payable was $9,600 and $3,200,
respectively.

NOTE 6 - COMMON STOCK

During the year ended December 31, 2005, the Company issued 131,600 shares of
its common stock to a director for compensation of services. The shares were
valued at $52,640 based on the market value of the Company's stock on the date
of issuance.

In June 2005, the Company issued 1,016,000 of its common stock to consultants
for services. The shares were valued at $406,400 based on the market value of
the Company's stock on the date of issuance.

In August 2005, the Company sold 100,000 shares of restricted common stock at a
sale price of $0.20 per share for total consideration of $20,000 in cash.

In December 2003, the Company's shareholders approved the 2004 Stock and Stock
Option Plan effective January 1, 2004 whereby up to 500,000 shares may be
granted, optioned or sold. The plan is for its key employees and directors who
contribute materially to the success and profitability of the Company as well as
attracting other key employees and directors. In November 2004, 400,000 common
shares were issued pursuant to this plan, resulting in $172,000 in consulting
expense. These shares were valued using the per share fair value of the
Company's common stock on the date of issuance.

During September 2004, the Company issued 100,000 shares of common stock for
$40,000 of legal services. These shares were valued using the per share fair
value of the Company's common stock on the date of issuance.

In November 2004, the Company's board of directors approved the 2004 Marketing
Consultant Stock Plan whereby up to 945,000 common shares may be granted,
optioned or sold. The plan is for its consultants, key employees, and directors
who contribute materially to the success and profitability of the Company as
well as attracting other key employees and directors. In November 2004,
945,000 shares were issued under this plan resulting in $406,349 of consulting
and employee expense valued using the per share fair value of the Company's
common stock on the date of issuance.

F-12

PROTON LABORATORIES, INC.
NOTES TO FINANCIAL STATEMENTS

NOTE 7 - COMMITMENTS

PRODUCTION AGREEMENT - In June 2005, the Company entered into an agreement with
Mitachi, a Japanese electronics component manufacturer, to aid in the production
of enhanced drinking water generators. Pursuant to this agreement, Mitachi
agreed to pay the Company 25,000,000 Yen for engineering design, molding,
tooling and preparation costs, and the exclusive product distribution rights for
China, Taiwan, and Japan. As of December 31, 2005, Mitachi had paid 6,000,000
Yen, or $52,506, for the above mentioned distribution rights. Since the project
is not yet completed and no units have been sold, this amount is classified as
deferred revenue.

EQUITY LINE - In November 2005, the Company entered into an equity line
agreement with a private investor (the "Equity Line Investor"). Under the
equity line, the Company had the right to draw up to $10,000,000 from the Equity
Line Investor. The Company was entitled to draw funds and to "put" to the
Equity Line Investor shares of the Company's Class A common stock in lieu of
repayment of the draw.

For the year ended December 31, 2005, the Company had not drawn funds under the
equity line. The Company has paid the Equity Line Investor $10,000 as a
documentation fee for the equity line, which is to be netted against funds
drawn. Due to no funds being drawn and the Company's intentions to not draw on
the equity line, this documentation fee has been expensed during the year ended
December 31, 2005.

OPERATING LEASES - The Company currently leases office and storage space from a
third party. On July 1, 2005, the Company entered into a lease agreement to pay
monthly lease payments of $6,131 until June 30, 2006 and $6,335 from July 1,
2006 through June 30, 2007.

Future minimum lease payments under operating lease obligations as of December
31, 2005, were as follows:

Year Ending December 31,
2006 $ 74,796
2007 38,010
--------------------------------------------
Total $112,806
--------------------------------------------

Rent expense for the years ended December 31, 2005 and 2004 was $45,649 and
$33,678, respectively.

MAJOR CUSTOMER - During the year ended December 31, 2005, sales to five
customers accounted for 39% of total sales. As of December 31, 2005, $4,573 was
due from these customers. During the year ended December 31, 2004, sales to
three customers accounted for 37% of total sales. As of December 31, 2004,
there were no amounts due from these customers.

MAJOR VENDOR - During the year ended December 31, 2005, purchases from four
vendors accounted for 96% of total inventory purchases. As of December 31,
2005, amounts due to these vendors accounted for 35% of accounts payable.
During the year ended December 31, 2004, purchases from three vendors accounted
for 96% of total inventory purchases. As of December 31, 2004, amounts due to
these vendors accounted for 54% of accounts payable.

NOTE 8 - SUBSEQUENT EVENT

In March 2006 the Company issued 352,400 shares of common stock for payment of
legal fees. The value of the shares issued was $81,052, based on a market price
on date of issuance of $0.23. $40,526 of this amount is related to services
rendered during the year ended December 31, 2005 and is included as part of
accounts payable in the accompanying financial statements.

F-13