UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2010
o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission File Number: 000-10065

ADVANCE NANOTECH, INC.

(Exact name of registrant as specified in its charter)

Delaware	20-1614256
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)

400 Rella Blvd, Suite 160, Montebello, NY	10901
(Address of principal executive offices)	(Zip Code)
(Registrant’s telephone number, including area code)
(212) 583-0080

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 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.

x Yes ¨ No

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

¨ Yes ¨ No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer	¨	Accelerated filer	¨

Non-accelerated filer	¨	Smaller reporting company	x
(Do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

¨ Yes x No

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date; 71,643,871 shares as of August 13, 2010.

TABLE OF CONTENTS

		Page (s)

PART I --	FINANCIAL INFORMATION

ITEM 1	FINANCIAL STATEMENTS

	Condensed Balance Sheet as of June 30, 2010 (unaudited) and December 31, 2009	1

	Condensed Statement of Operations for the three and six months ended June 30, 2010 and 2009 from inception (August 17, 2004) through June 30, 2010 (unaudited)	2

	Condensed Statement of Stockholders’ Equity from January 1, 2010 through June 30, 2010 (unaudited)	3

	Condensed Statement of Cash Flows for the six months June 30, 2010 and 2009 and from inception (August 17, 2004) through June 30, 2010 (unaudited)	4

	Notes to Financial Statements (unaudited)	6

ITEM 2	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	22

ITEM 3	QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	23

ITEM 4T	CONTROLS AND PROCEDURES	24

PART II --	OTHER INFORMATION	24

ITEM 1	LEGAL PROCEEDINGS	24

ITEM 1A	RISK FACTORS	24

ITEM 2	UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS	24

ITEM 3	DEFAULTS UPON SENIOR SECURITIES	24

ITEM 4	(Removed and Reserved)	24

ITEM 5	OTHER INFORMATION	25

ITEM 6	EXHIBITS	25

	SIGNATURES	26

ADVANCE NANOTECH, INC.
(A Development stage Company)
CONDENSED BALANCE SHEETS

	June 30,			December 31,
	2010			2009
	(unaudited)
ASSETS
Current assets:
Cash and cash equivalents	$	141,080		$	4,473
Accounts receivable, net		-			43,151
Accounts receivable, related party		-			520,264
Prepaid and other current assets		22,890			27,890
Total current assets		163,970			595,778

Property, plant and equipment, net		589			4,983

Other assets:
Investments		1,474,460			1,034,966

Total assets	$	1,639,019		$	1,635,727

LIABILITIES AND STOCKHOLDERS' DEFICIT
Current liabilities:
Accounts payable	$	347,601		$	384,939
Accrued expenses and other		922,962			585,069
Convertible notes payable, current portion		6,356,200			-
Capital lease obligation, current portion		-			5,318
Total current liabilities		7,626,763			975,326

Long term debt:
Convertible notes payable, long term portion		983,500			7,420,950
Warrant liability		1,446,016			588,816
Derivative liability		884,780			418,357

Total liabilities		10,941,059			9,403,449

Stockholders' deficit:
Preferred stock; $0.001 par value; 25,000,000 shares authorized; 0 shares issued and outstanding		-			-
Common stock; $0.001 par value; 200,000,000 shares authorized; 69,033,502 and 60,613,314 shares issued and outstanding as of June 30, 2010 and December 31, 2009, respectively		69,034			60,613
Additional paid in capital		22,766,625			22,371,186
Deficit accumulated during development stage		(32,143,046	)		(30,204,650	)
Accumulated other comprehensive income (loss)		5,347			5,129
Total shareholders' deficit		(9,302,040	)		(7,767,722	)

Total liabilities and shareholders' deficit	$	1,639,019		$	1,635,727

The accompanying notes are an integral part of these unaudited condensed financial statements

ADVANCE NANOTECH, INC.
(A Development Stage Company)
CONDENSED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
(unaudited)

	Three months ended June 30,						Six months ended June 30,						From Date of Inception (August 17, 2004) Through
	2010			2009			2010			2009			June 30, 2010
Operating expenses:
Selling, general and administrative		370,589			550,152			471,692			1,049,347			25,452,484
Total operating expenses		370,589			550,152			471,692			1,049,347			25,452,484

Loss from operations		(370,589	)		(550,152	)		(471,692	)		(1,049,347	)		(25,452,484	)

Other income (expense)
Interest income		146			140			250			140			243,281
Grant income		-			-			-			-			198,831
Gain on sale of investment		-			-			-			-			937,836
Gain on forgiveness of accounts payable and other income		-			-			-			-			641,393
Income from investments		140,334						439,494			-			7,185,724
Other income (expense)		(18,302	)		(195	)		(6,204	)		-			1,739,132
Interest expense		(245,209	)		(325,007	)		(391,595	)		(474,543	)		(2,747,481	)
Gain (loss) on change in fair value of warrant liability		(1,360,458	)		181,839			(1,323,623	)		(1,580,074	)		12,008,436
Accrued late registration rights cost		(75,471	)		(108,337	)		(185,026	)		(217,892	)		(3,070,740	)

Net (loss) before provision for income taxes		(1,929,549	)		(801,712	)		(1,938,396	)		(3,321,716	)		(8,316,072	)

Income taxes (benefit)		-			-			-			-			-

Net (loss) from continuing operations and non controlling interest		(1,929,549	)		(801,712	)		(1,938,396	)		(3,321,716	)		(8,316,072	)

Non controlling interest		-			-			-			-			5,331,364

Net (loss) from continuing operations		(1,929,549	)		(801,712	)		(1,938,396	)		(3,321,716	)		(2,984,708	)

(Loss) from discontinued operations		-			(245,412	)		-			(520,447	)		(29,158,338	)

NET ( LOSS) ATTRIBUTABLE TO ADVANCE NANOTECH, INC.	$	(1,929,549	)	$	(1,047,124	)	$	(1,938,396	)	$	(3,842,163	)	$	(32,143,046	)

Net (loss) per common stock (basic and fully diluted):
Continuing operations	$	(0.03	)	$	(0.01	)	$	(0.03	)	$	(0.06	)
Discontinued operations	$	-		$	(0.00	)	$	-		$	(0.01	)
Total	$	(0.03	)	$	(0.01	)	$	(0.03	)	$	(0.07	)

Weighted average shares outstanding (basic)		67,902,336			56,481,379			64,989,318			55,715,610

Net loss	$	(1,929,549	)	$	(1,047,124	)	$	(1,938,396	)	$	(3,842,163	)	$	(37,474,410	)
Foreign currency gain (loss)		218			687,923			218			687,923			5,129

Comprehensive loss		(1,929,331	)		(359,201	)		(1,938,178	)		(3,154,240	)		(37,469,281	)
Comprehensive income attributable to non controlling interest		-			442,511			-			334,475			5,331,364
Comprehensive loss attributable to Advance Nanotech, Inc.	$	(1,929,331	)	$	801,712	)	$	(1,938,178	)	$	(3,488,715	)	$	(32,137,917	)

The accompanying notes are an integral part of these unaudited condensed financial statements

ADVANCE NANOTECH, INC.
(A Development Stage Company)
CONDENSED STATEMENT OF STOCKHOLDERS' DEFICIT
From January 1, 2010 through June 30, 2010
(unaudited)

ADVANCE NANOTECH, INC.

													Deficit
													Accumulated
	Preferred Stock				Common Stock				Additional Paid in		Other Comprehensive		During Development			Non controlling		Total Stockholders'
	Shares		Amount		Shares		Amount		Capital		Income		Stage			Interest		Deficit
Balance, January 1, 2010		-	$	-		60,613,314	$	60,613	$	22,371,186	$	5,129	$	(30,204,650	)	$	-	$	(7,767,722	)
Common stock issued in exchange for accrued interest		-		-		5,337,135		5,338		245,531		-		-			-		250,869
Common stock issued as compensation		-		-		2,758,053		2,758		133,983		-		-			-		136,741
Common stock issued in exchange for convertible debt		-		-		325,000		325		15,925		-		-			-		16,250
Foreign currency gain		-		-		-		-		-		218		-			-		218
Net income		-		-		-		-		-		-		(1,938,396	)		-		(1,938,396	)
Balance, June 30, 2010		-	$	-		69,033,502	$	69,034	$	22,766,625	$	5,347	$	(32,143,046	)	$	-	$	(9,302,040	)

The accompanying notes are an integral part of these unaudited condensed financial statements

ADVANCE NANOTECH, INC.
(A Development Stage Company)
CONDENSED STATEMENTS OF CASH FLOWS
(unaudited)

							From Date of
							Inception (August 17,
	Six months ended June 30,						2004) Through
	2010			2009			June 30, 2010
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss attributable to continuing operations	$	(1,938,396	)	$	(3,321,716	)	$	(2,984,708	)
Loss from discontinued operations		-			(520,447	)		(29,158,338	)
Adjustments to reconcile net loss to cash flows used in operating activities:
Depreciation and amortization		4,394			7,055			166,403
Reserve for bad debts		43,151			-			43,151
Change in fair value of warrant and reset liabilities		1,323,623			1,580,074			(12,008,436	)
Common stock issued for services rendered		177,346			43,000			2,900,441
Common stock issued as compensation		-			55,370			1,905,228
Common stock issued for interest on notes		145,893			214,292			224,532
Common stock issued on conversion of notes		(65,000	)		179,250			180,800
Fair value of vested options issued to employees		-			-			2,426,618
Fair value of warrants issued for services		-			-			412,899
Fair value of warrants issued for short term note		-			262,674			-
Accrued late registration rights penalties		-			-			2,447,496
Gain on sale of investment		-			-			(937,836	)
Forgiveness of accounts payable		-			-			(641,393	)
Changes in operating assets and liabilities:
Increase in prepayments and other		5,000			(20,660	)		5,000
Inventory					-
Decrease (increase) in accounts receivable		520,264			23,380			563,415
Decrease in grants receivable					-			-
Increase (decrease) in accounts payable		27,033			(40,850	)		411,972
Increase (decrease) in accrued expenses		337,893			-			922,962
Net cash used in continuing operating activities		581,201			(1,538,578	)		(33,119,794	)
Net cash used in (provided by) discontinued operating activities		-			1,276,060			1,076,499
Net cash used in operating activities		581,201			(262,518	)		(32,043,295	)

CASH FLOWS FROM INVESTING ACTIVITIES:
Gain on deconsolidation of subsidiaries		-			-			(5,102,644	)
Cash disposed with deconsolidation		-			-			(18,646	)
Purchase of property, plant and equipment		-						(153,653	)
Development of patent technology		-						(646,501	)
Loss (income) from investments		(439,494	)		-			498,860
Non controlling interest		-			-			5,939,912
Net cash (used in) provided by investing activities		(439,494	)		-			517,328

CASH FLOWS FROM FINANCING ACTIVITIES:
Capital lease obligations, net		(5,318	)		(4,195	)		(35,362	)
Proceeds from issuance of common stock, net		-			-			22,321,193
Proceeds from issuance of short term notes		-			657,970			1,300,000
Repayments of short term notes		-			-			(300,000	)
Proceeds from issuance of convertible debentures		-			(179,250	)		10,151,423
Financing fees from issuance of convertible debentures		-			(46,000	)		(1,464,182	)
Financing fees on merger shares issued		-			-			(425,000	)
Net cash provided by financing activities from continuing operations		(5,318	)		428,525			31,548,072
Net cash provided by financing activities of discontinued operations		-			-			1,246,766
Net cash provided by financing activities		(5,318	)		428,525			32,794,838


Effect of exchange rates on cash and cash equivalents		218			(148,937	)		(1,127,791	)

Net increase (decrease) in cash and cash equivalents		136,607			17,070			141,080

Cash and cash equivalents, beginning of period		4,473			32,940			-
Cash and cash equivalents, end of period	$	141,080		$	50,010		$	141,080

The accompanying notes are an integral part of these unaudited condensed financial statements

ADVANCE NANOTECH, INC.
(A Development Stage Company)
CONDENSED STATEMENTS OF CASH FLOWS
(unaudited)

					From Date of
					Inception (August 17,
	Six months ended June 30,				2004) Through
	2010		2009		June 30, 2010
Supplemental disclosures of cash flow information:
Cash paid for interest and income taxes	$	-	$	32,934	$	438,987
Common stock issued for services rendered	$	177,346	$	43,000	$	4,742,901
Common stock issued for interest on convertible notes	$	210,264	$	214,291	$	387,020
Conversion of amounts due on related party credit facility to common stock	$	-	$	-	$	1,500,000
Convertible note issued in repayment of loan/accounts payable/accrual	$	-	$	-	$	956,000
Stock options issued to employees	$	-	$	-	$	2,426,618
Warrants issued for services	$	-	$	-	$	412,899
Warrants issued in connection with private placement	$	-	$	262,675	$	3,774,516
Conversion of convertible notes payable to common shares	$	81,250	$	179,250	$	446,300
Forgiveness of accounts payable	$	-	$	-	$	(641,393	)
Accrued late registration costs	$	185,025	$	217,892	$	2,742,076

The accompanying notes are an integral part of these unaudited condensed financial statements

ADVANCE NANOTECH, INC.

(A DEVELOPMENT STAGE COMPANY)

NOTES TO CONDENSED FINANCIAL STATEMENTS

JUNE 30, 2010

(Unaudited)

NOTE 1 – NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES

A summary of the significant accounting policies applied in the presentation of the accompanying unaudited condensed financial statements follows:

Basis of Presentation

The accompanying unaudited condensed financial statements of Advance Nanotech, Inc., (the “Company”), have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements.

In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. The results from operations for the six month period ended June 30, 2010, are not necessarily indicative of the results that may be expected for the year ended December 31, 2010. The unaudited condensed financial statements should be read in conjunction with the December 31, 2009 financial statements and footnotes thereto included in the Company’s SEC Form 10-K.

Nature of Operations

On March 3, 1980, Advance Nanotech, Inc. (the “Company) was incorporated under the laws of the state of Colorado under the name of Colorado Gold & Silver, Inc. subsequently changing its name to Dynamic I-T, Inc. and to Artwork & Beyond, Inc. in January 2004. On October 1, 2004, the Company acquired all the issued and outstanding common stock of Advance Nanotech Holdings, Inc. in exchange for 99% of the outstanding common stock of the Company and simultaneously changed the Company’s name to Advance Nanotech Inc. (a Colorado corporation). On June 16, 2006, Advance Nanotech, Inc. (a Colorado corporation) merged into its newly-formed, wholly owned subsidiary, Advance Nanotech, Inc. (a Delaware Corporation) in order to reincorporate under the laws of the state of Delaware.

The Company is in the development stage as defined by Accounting Standards Codification subtopic 915-10, Development Stage Entities ("ASC 915-10") and is seeking to assist its minority-owned subsidiary, Owlstone Nanotech, Inc. (“Owlstone”) in the commercialization of novel chemical sensor products based on its proprietary and innovative gas sensing technology. To date, the Company has not generated sales revenues, has incurred expenses and has sustained losses. Consequently, its operations are subject to all the risks inherent in the establishment of a new business enterprise. For the period from inception through June 30, 2010, the Company has accumulated a deficit through its development stage of $32,143,046.

ADVANCE NANOTECH, INC.

(A DEVELOPMENT STAGE COMPANY)

NOTES TO CONDENSED FINANCIAL STATEMENTS

JUNE 30, 2010

(Unaudited)

NOTE 1 – NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (continued)

Dissolution of subsidiaries

During the year ended December 31, 2009, the Company dissolved the following inactive subsidiaries:

·	Advance Nanotech, Limited
·	Nanofed Limited
·	Cambridge Nanotechnology Limited
·	Bio-Nano Sensium Limited

·	Nano Solutions Limited
·	Advance Display Technologies plc
·	Advance Homeland Security plc
·	Advance Nanotech (Singapore) Pte Ltd.

The operations and cash flows of these subsidiaries have been eliminated from the accounts of the Company’s ongoing operations and major classes of assets and liabilities related thereto have been segregated. The losses from discontinued operations, including the impairment of certain assets of discontinued operations, have been reflected in the financial statements of this annual report.

Deconsolidation

In November and December 2009, Owlstone Nanotech Inc. (“Owlstone”), a previous majority owned subsidiary, sold shares of its common stock in private placements to qualified investors reducing the Company’s ownership interest from 82.17% to 37.81%, and subsequently to 32.57% as of June 30, 2010. As such, the Company deconsolidated Owlstone as of October 31, 2009, the date a controlling financial interest was lost. Operations and cash flows of Owlstone for the period of control (from January 1, 2009 through October 31, 2009), and from date of acquisition of Owlstone through October 31, 2009 have been eliminated from the accounts of the Company’s continuing operations.

In accordance with Accounting Standards Codification subtopic 810-10, Consolidation, the Company recognized a gain on re-measurement of investment of subsidiary of $6,746,230 comprised of the difference between the carrying value of the investment in Owlstone Nanotech, Inc and the pro rata fair value of the investment of Owlstone after Owlstone sold shares of its common stock.

Estimates

The preparation of the financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect certain reported amounts and disclosures. Accordingly, actual results could differ from those estimates.

ADVANCE NANOTECH, INC.

(A DEVELOPMENT STAGE COMPANY)

NOTES TO CONDENSED FINANCIAL STATEMENTS

JUNE 30, 2010

(Unaudited)

NOTE 1 – NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (continued)

Revenue Recognition

The Company recognizes revenue in accordance with Accounting Standards Codification subtopic 605-10, Revenue Recognition (“ASC 605-10”) which requires that four basic criteria must be met before revenue can be recognized: (1) persuasive evidence of an arrangement exists; (2) delivery has occurred; (3) the selling price is fixed and determinable; and (4) collectability is reasonably assured. Determination of criteria (3) and (4) are based on management's judgments regarding the fixed nature of the selling prices of the products delivered and the collectability of those amounts. Provisions for discounts and rebates to customers, estimated returns and allowances, and other adjustments are provided for in the same period the related sales are recorded.

ASC 605-10 incorporates Accounting Standards Codification subtopic 605-25, Multiple-Element Arraignments (“ASC 605-25”). ASC 605-25 addresses accounting for arrangements that may involve the delivery or performance of multiple products, services and/or rights to use assets. The effect of implementing 605-25 on the Company's financial position and results of operations was not significant.

Cash and Cash Equivalents

For purposes of the Statements of Cash Flows, the Company considers all highly liquid debt instruments purchased with a maturity date of three months or less to be cash equivalents.

Fair Value of Financial Instruments

In the first quarter of fiscal year 2008, the Company adopted Accounting Standards Codification subtopic 820-10, Fair Value Measurements and Disclosures (“ASC 820-10”). ASC 820-10 defines fair value, establishes a framework for measuring fair value, and enhances fair value measurement disclosure. ASC 820-10 delays, until the first quarter of fiscal year 2009, the effective date for ASC 820-10 for all non-financial assets and non-financial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually). The adoption of ASC 820-10 did not have a material impact on the Company’s financial position or operations. Refer to Footnote 11 for further discussion regarding fair valuation.

Property and Equipment

Property and equipment are stated at cost. When retired or otherwise disposed, the related carrying value and accumulated depreciation are removed from the respective accounts and the net difference less any amount realized from disposition, is reflected in earnings. For financial statement purposes, property and equipment are recorded at cost and depreciated using the straight-line method over their estimated useful lives of 3 to 5 years.

Expenditures for repair and maintenance which do not materially extend the useful lives of property and equipment are charged to operations. When property or equipment is sold or otherwise disposed of, the cost and related accumulated depreciation are removed from the respective accounts with the resulting gain or loss reflected in operations. Management periodically reviews the carrying value of its property and equipment for impairment

ADVANCE NANOTECH, INC.

(A DEVELOPMENT STAGE COMPANY)

NOTES TO CONDENSED FINANCIAL STATEMENTS

JUNE 30, 2010

(Unaudited)

NOTE 1 – NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (continued)

Long-Lived Assets

The Company has adopted Accounting Standards Codification subtopic 360-10, Property, Plant and Equipment (“ASC 360-10”). ASC 360-10 requires that long-lived assets and certain identifiable intangibles held and used by the Company be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Events relating to recoverability may include significant unfavorable changes in business conditions, recurring losses, or a forecasted inability to achieve break-even operating results over an extended period. The Company evaluates the recoverability of long-lived assets based upon forecasted undiscounted cash flows. Should impairment in value be indicated, the carrying value of intangible assets will be adjusted, based on estimates of future discounted cash flows resulting from the use and ultimate disposition of the asset. ASC 360-10 also requires assets to be disposed of be reported at the lower of the carrying amount or the fair value less costs to sell.

Income Taxes

The Company has adopted Accounting Standards Codification subtopic 740-10, Income Taxes (“ASC 740-10”) which requires the recognition of deferred tax liabilities and assets for the expected future tax consequences of events that have been included in the financial statement or tax returns. Under this method, deferred tax liabilities and assets are determined based on the difference between financial statements and tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. Temporary differences between taxable income reported for financial reporting purposes and income tax purposes are insignificant.

At June 30, 2010, the significant components of the deferred tax assets (liabilities) are summarized below:

Net operating loss carry forwards expiring in 2029	$	32,000,000

Tax Asset		14,080,000
Less valuation allowance		(14,080,000	)

Balance	$	—

Net Loss per Share

The Company has adopted Accounting Standards Codification subtopic 260-10, Earnings Per Share (“ASC 260-10”) which specifies the computation, presentation and disclosure requirements of earnings per share information. Basic earnings per share have been calculated based upon the weighted average number of common shares outstanding. Stock options and warrants have been excluded as common stock equivalents in the diluted losses per share because they are either anti-dilutive, or their effect is not material.

ADVANCE NANOTECH, INC.

(A DEVELOPMENT STAGE COMPANY)

NOTES TO CONDENSED FINANCIAL STATEMENTS

JUNE 30, 2010

(Unaudited)

NOTE 1 – NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (continued)

Stock based compensation

The Company adopted Accounting Standards Codification subtopic 718-10, Compensation (“ASC 718-10”) which requires all share-based payments to employees, including grants of employee stock options, to be recognized in the income statement based on their fair values. Pro-forma disclosure is no longer an alternative. This statement does not change the accounting guidance for share based payment transactions with parties other than employees provided in ASC 718-10. The Company implemented AC 718-10 on January 1, 2006 using the modified prospective method.

As more fully described in Note 10 below, the Company granted stock options over the years to employees of the Company under its 2008 Equity Incentive Plan. The Company did not grant non-qualified stock options to purchase common stock during the three month periods ended June 30, 2010 and 2009 under the 2008 Equity Incentive Plan.

As of June 30, 2010, there were outstanding employee stock options to purchase 11,481,331 shares of common stock, all shares of which were vested.

Concentrations of Credit Risk

Financial instruments and related items, which potentially subject the Company to concentrations of credit risk, consist primarily of cash, cash equivalents and trade receivables. The Company places its cash and temporary cash investments with high credit quality institutions. At times, such investments may be in excess of the FDIC insurance limit.

Fair Value of Financial Instruments

Accounting Standards Codification subtopic 825-10, Financial Instruments (“ASC 825-10”) requires disclosure of the fair value of certain financial instruments. The carrying value of cash and cash equivalents, accounts payable and short-term borrowings, as reflected in the balance sheets, approximate fair value because of the short-term maturity of these instruments.

Comprehensive Income (Loss)

The Company adopted Accounting Standards Codification subtopic 220-10, Comprehensive Income (“ASC 220-10”) which establishes standards for the reporting and displaying of comprehensive income and its components. Comprehensive income is defined as the change in equity of a business during a period from transactions and other events and circumstances from non-owners sources. It includes all changes in equity during a period except those resulting from investments by owners and distributions to owners. ASC 220-10 requires other comprehensive income (loss) to include foreign currency translation adjustments and unrealized gains and losses on available for sale securities.

ADVANCE NANOTECH, INC.

(A DEVELOPMENT STAGE COMPANY)

NOTES TO CONDENSED FINANCIAL STATEMENTS

JUNE 30, 2010

(Unaudited)

NOTE 1 – NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (continued)

Reliance on Key Personnel and Consultants

As of June 30, 2010, the Company has no full-time employees and no part-time employees. Additionally, there are approximately 4 consultants performing various specialized services. The Company is heavily dependent on the continued active participation of these key consultants. The loss of any of the key consultants could significantly and negatively impact the business until adequate replacements can be identified and put in place.

Recent Accounting Pronouncements

In May 2010, the FASB (Financial Accounting Standards Board) issued Accounting Standards Update 2010-19 (ASU 2010-19), Foreign Currency (Topic 830): Foreign Currency Issues: Multiple Foreign Currency Exchange Rates. The amendments in this Update are effective as of the announcement date of March 18, 2010. The Company does not expect the provisions of ASU 2010-19 to have a material effect on the financial position, results of operations or cash flows of the Company.

In April 2010, the FASB (Financial Accounting Standards Board) issued Accounting Standards Update 2010-17 (ASU 2010-17), Revenue Recognition-Milestone Method (Topic 605): Milestone Method of Revenue Recognition. The amendments in this Update are effective on a prospective basis for milestones achieved in fiscal years, and interim periods within those years, beginning on or after June 15, 2010. Early adoption is permitted. If a vendor elects early adoption and the period of adoption is not the beginning of the entity’s fiscal year, the entity should apply the amendments retrospectively from the beginning of the year of adoption. The Company does not expect the provisions of ASU 2010-17 to have a material effect on the financial position, results of operations or cash flows of the Company.

There were various other updates recently issued, most of which represented technical corrections to the accounting literature or application to specific industries and are not expected to a have a material impact on the Company's consolidated financial position, results of operations or cash flows.

NOTE 2 – GOING CONCERN MATTERS

The accompanying unaudited condensed financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. As shown in the accompanying unaudited condensed consolidated financial statements during six months ended June 30, 2010, the Company incurred net losses attributable to common shareholders of $1,938,396, incurred net losses attributable to common shareholders of $32,143,046 from its inception on August 17, 2004 through June 30, 2010 and used $32,043,295 in cash for operating activities from its inception through June 30, 2010. These factors among others raise substantial doubt that the Company will be unable to continue as a going concern for a reasonable period of time.

The Company's existence is dependent upon management's ability to refinance or restructure its existing indebtedness, and/or to develop profitable operations. The Company’s principal asset is its 32.57% non-controlling stake in Owlstone. The value of the Company’s stake in Owlstone, among other factors, is directly related to Owlstone’s ability to successfully commercialize its technologies. Owlstone’s efforts are principally focused on the development of chemical sensing products using its proprietary technology and there can be no assurance that Owlstone’s efforts will be successful. The accompanying statements do not include any adjustments that might result should the Company be unable to continue as a going concern.

ADVANCE NANOTECH, INC.

(A DEVELOPMENT STAGE COMPANY)

NOTES TO CONDENSED FINANCIAL STATEMENTS

JUNE 30, 2010

(Unaudited)

NOTE 2 – GOING CONCERN MATTERS (continued)

Our 8% senior secured convertible notes (the “Notes”) come due in December of 2010 with respect to $3,732,200 in principal amount and in 2011 with respect to an additional $3,607,500 in principal amount. We do not have the cash or other assets to repay the Notes. Our only significant asset is our shares in Owlstone and the value of those shares, based on the price recently paid by private investors in Owlstone, is less than the principal amount of the indebtedness. Furthermore, our Owlstone shares have been pledged as security for the payment of the Notes. Without a substantial increase in the value of the Owlstone shares, we deem it unlikely that a lender would be willing to lend us the funds needed to repay the Notes. Accordingly, if we are unable to negotiate an extension of the maturity of the Notes or otherwise come to terms with the holders of the Notes acceptable to the Company, we may have to seek protection from creditors under the bankruptcy laws. If so, the prospects for the Company and its stockholders will be severely limited.

NOTE 3 - RELATED PARTY RECEIVABLES

Related party receivables are comprised of advances to Owlstone Nanotech, Inc., a former majority-owned subsidiary. The advances are informal and payable on demand. As of June 30, 2010, there we no related party receivables outstanding.

NOTE 4 – INVESTMENT

As described in Note 1 above, Owlstone Nanotech, Inc., a previous majority owned subsidiary, sold shares of its common stock in private placements to qualified investors reducing the Company’s ownership interest from 82.17% to 32.57%. As such, the Company deconsolidated Owlstone Nanotech, Inc as of October 2009, the date a controlling financial interest was lost.

In accordance with Accounting Standards Codification subtopic 810-10, Consolidation, the Company recognized a gain on re-measurement of investment of subsidiary as of December 31, 2009 of $6,746,230 comprised of the difference between the carrying value of the investment in Owlstone Nanotech, Inc and the pro rata fair value of the investment after the sale of the subsidiary’s common stock. The Company accounts for its investment in Owlstone Nanotech, Inc using the equity method of accounting. Component changes in the equity investment of Owlstone Nanotech, Inc. are as follows:

Carrying value of investment of Owlstone Nanotech, Inc. at deconsolidation	$	(5,710,746	)
Adjustment of investment in Owlstone Nanotech, Inc to fair value at October 31, 2009		6,746,230
Pro rata income (loss) of Owlstone Nanotech, Inc. from November 1, 2009 to December 31, 2009 (equity method)		(518	)
Balance, investment in Owlstone Nanotech, Inc. as of December 31, 2009		1,034,966
Pro rata loss of Owlstone Nanotech, Inc. from January 1, 2010 to June 30, 2010		(229,398	)
Adjustment in carrying value due to sale by subsidiary of common stock to qualified investors		668,892
Balance, investment in Owlstone Nanotech, Inc. as of June 30, 2010	$	1,474,460

The Company did not evaluate for impairment, and the fair value of the equity-method investment is not estimated, since there were no identified events or changes in circumstances that may have a significant adverse effect on the fair value of the investment and the Company determined, in accordance with ASC 825-10, that it is not practicable to estimate the fair value of the investment.

ADVANCE NANOTECH, INC.

(A DEVELOPMENT STAGE COMPANY)

NOTES TO CONDENSED FINANCIAL STATEMENTS

JUNE 30, 2010

(Unaudited)

NOTE 5 – CONVERTIBLE NOTES PAYABLE

In a series of transactions on December 19 and 21, 2007 and February 15 and September 4, 2008, we issued and sold our 8% senior secured convertible notes (the “Notes”) in the aggregate principal amount of $7,846,000 and warrants (the “Warrants”) to purchase in the aggregate 15,692,000 shares of our common stock, par value $.001 per share (the “Common Stock”) for $.30 per share. The Notes mature on the date that is three years from the date of issuance and are convertible into shares of Common Stock at a price of $0.25 per share. The Notes constitute our senior indebtedness and provide that we can not incur other indebtedness (excluding an additional $3,000,000 in debt, certain credit facility lines and trade payables incurred in the ordinary course of business) without the consent of the Note holders. The notes are secured by all of tangible and intangible assets including the equity interest in our previously majority owned subsidiary. The Warrants are exercisable for a period of five years from the date of issuance. The Notes and Warrants are subject to “full ratchet” anti-dilution provisions calling for repricing in the event the Company sells any shares at a price less than the conversion price of the Notes or the exercise price of the Warrants.

In connection with the issuance and sale of the Notes and Warrants, the Company paid to certain placement agents in the aggregate approximately $600,000 in cash. The Company issued warrants to purchase in the aggregate 2,342,000 shares of Common Stock for $0.30 per share. The warrants are exercisable for a period of five years from the date of issuance.

The Company was obligated to pay to the holders of the Notes a penalty of $88,219 for failure to secure within prescribed time limits registration of the shares issuable upon conversion of the Notes and the exercise of the Warrants with the Securities and Exchange Commission.

As of June 30, 2010, the fair value of the warrant liability for the investor warrants and the placement agent warrants issued in connection with the sale of the total $7,846,000 convertible note offering was revalued using the Black-Scholes option pricing model with the following assumptions: no dividend yield, risk-free interest rate of 0.61% to 1.60%, the contractual life of 2.48-3.25 years and volatility of 162.17%. In accordance with Accounting Standards Codification subtopic 815-40, the estimated fair value of the investor warrants and the placement agent warrants, in the amount of $1,446,016 was recorded as a liability. The Company recognized a non-cash loss of $857,200 for this revaluation for the six month period ending June 30, 2010, which correlates to the fluctuation in the Company’s share price of its common stock for the period.

Effective January 1, 2009, with the effectiveness of certain provisions of ASC 815-40 requiring bifurcation of any reset provisions embedded within our convertible notes and warrants, the Company determined the fair value of the embedded reset provision as of January 1, 2009 was $1,552,420 using the Black-Scholes option pricing model with the following assumptions: no dividend yield, risk-free interest rate of 0.88%, the contractual life of between 1.97 – 2.67 years and volatility of 196%. See Note 7 below.

NOTE 6 – WARRANT LIABILITY

As described in Note 5, the Company issued warrants in conjunction with the sale of convertible notes. These warrants contain certain reset provisions. Therefore, in accordance with ASC 815-40, the Company reclassified the fair value of the warrant from equity to a liability as of January 1, 2009. Subsequent to the reclassification, the Company is required to adjust to fair value the warrant as an adjustment to current period operations.

ADVANCE NANOTECH, INC.

(A DEVELOPMENT STAGE COMPANY)

NOTES TO CONDENSED FINANCIAL STATEMENTS

JUNE 30, 2010

(Unaudited)

NOTE 6 – WARRANT LIABILITY (continued)

The Company estimated the fair value at January 1, 2009 of the warrants issued in connection with the convertible notes to be $1,150,224 using the Black-Scholes formula assuming no dividends, a risk-free interest rate of 2.69%, expected volatility of 196%, and expected warrant remaining life of between 4.25 to 5 years. Since the warrants have reset provisions, pursuant to ASC 815-40, the Company has recorded the fair value of the warrants as a derivative liability. Until conversion and expiration of the reset provisions of the warrants, changes in fair value were recorded as non-operating, non-cash income or expense at each reporting date.

The fair values of the warrants of $1,446,016 at June 30, 2010 were determined using the Black Scholes Option Pricing Model with the following assumptions: no dividends, a risk-free interest rate of 0.61% to 1.00%, expected volatility of 162.17%, and expected warrant remaining life of between 2.48 to 3.25 years.

As of the date of the financial statements, the Company believes an event under the contract that would create an obligation to settle in cash or other current assets is remote and has classified the obligation as a long term liability.

NOTE 7 – DERIVATIVE LIABLITIY

As described in Note 5, the Company issued convertible notes that contain certain reset provisions. Therefore, in accordance with ASC 815-40, the Company determined the fair value of the reset provision of $1,552,413 on January 1, 2009 (the effectiveness of certain provisions of ASC 815-40) using the Black-Scholes formula assuming no dividends, a risk-free interest rate of 0.88%, expected volatility of 196%, and expected life of 1.97 to 2.67 years. Since the convertible notes contain reset provisions, pursuant to ASC 815-40, the Company has recorded the fair value of the reset provision as a derivative liability. Until expiration of the reset provisions of the convertible notes, changes in fair value were recorded as non-operating, non-cash income or expense at each reporting date.

The fair value of the reset provision of $884,780 at June 30, 2010 was determined using the Black Scholes Option Pricing Model with the following assumptions:

Dividend yield:		-0-	%
Volatility		162.17	%
Risk free rate:	0.18% to 0.32		%

For the period ending June 30, 2010, the Company adjusted the recorded fair values of the warrants and derivative liability to market resulting in net, non cash, non-operating loss of $466,423.

NOTE 8 - STOCKHOLDERS' EQUITY

Common stock

On February 12, 2008, the Company increased the number of authorized shares of the Company's common stock from 75,000,000 to 200,000,000. At June 30, 2010 and December 31, 2009, there were 69,033,502 and 60,613,314 shares of the Company’s $0.001 par value common stock outstanding, respectively.

ADVANCE NANOTECH, INC.

(A DEVELOPMENT STAGE COMPANY)

NOTES TO CONDENSED FINANCIAL STATEMENTS

JUNE 30, 2010

(Unaudited)

NOTE 8 - STOCKHOLDERS' EQUITY (continued)

Common stock

During 2008, the Company granted 1,834,546 shares of common stock to various employees and non-employee consultants and directors pursuant to the 2008 Plan and certain contractual employment agreements. The grants vested immediately upon grant. The Company estimated that the fair market value of these stock grants was approximately $233,000.

During 2009, the Company granted 1,380,100 shares of common stock to various employees and non-employee consultants and directors pursuant to the 2008 Plan and certain contractual employment agreements. The grants vested immediately upon grant. The Company estimated that the fair market value of these stock grants was approximately $105,766.

During 2009, the Company issued 717,000 shares of common stock in exchange for convertible notes of $179,250.

During 2009, the Company issued an aggregate of 4,925,755 shares of common stock as payment of accrued interest of $504,027.

During the six months ended June 30, 2010, the Company issued an aggregate of 5,337,135 shares of common stock as payment of accrued interest of $250,869.

During the six months ended June 30, 2010, the Company granted 2,758,053 shares of common stock to various employees and non-employee consultants and directors pursuant to the 2008 Plan and certain contractual employment agreements. The grants vested immediately upon grant. The Company estimated that the fair market value of these stock grants was approximately $136,741.

During the six months ended June 30, 2010, the Company issued 325,000 shares of common stock in exchange for convertible notes of $81,250.

Preferred stock

On June 19, 2006, the Company created a class of "blank check" preferred stock, par value $0.001 per share, consisting of 25,000,000 shares. The term "blank check" preferred stock refers to stock for which the designations, preferences, conversion rights, and cumulative, relative, participating, optional or other rights, including voting rights, qualifications, limitations or restrictions thereof, are determined by the Board of Directors (“Board”). As such, the Board will be entitled to authorize the creation and issuance of 25,000,000 shares of preferred stock in one or more series with such limitations and restrictions as may be determined in the sole discretion of the Board, with no further authorization by stockholders required for the creation and issuance of the preferred stock. Any preferred stock issued would have priority over the common stock upon liquidation and might have priority rights as to dividends, voting and other features. Accordingly, the issuance of preferred stock could decrease the amount of earnings and assets allocable to or available for distribution to holders of common stock and adversely affect the rights and powers, including voting rights, of the common stock. As of June 30, 2010, there were no shares of preferred stock issued or outstanding.

ADVANCE NANOTECH, INC.

(A DEVELOPMENT STAGE COMPANY)

NOTES TO CONDENSED FINANCIAL STATEMENTS

JUNE 30, 2010

(Unaudited)

NOTE 9 – OPTIONS, WARRANTS AND STOCK AWARDS

Restricted stock, stock options and warrants issued to non-employees are recorded at their fair value as determined in accordance with Accounting Standards Codification subtopic 718-10, Compensation-Stock Compensation (“ASC 718-10”) and recognized over the related service period.

Warrants

The following tables summarize disclosure information regarding warrants:

Exercise Price		Number Outstanding		Warrants Outstanding Weighted Average Remaining Contractual Life (years)		Weighted Average Exercise price		Number Exercisable		Warrants Exercisable Weighted Average Exercise Price
$	0.30		22,030,671		2.62	$	0.30		22,030,671	$	0.30
	2.00		19,300		0.49		2.00		19,300		2.00
	2.07		36,232		0.52		2.07		36,232		2.07
Total			22,086,203		2.09	$	0.30		22,086,203	$	0.30

Transactions involving the Company’s warrant issuance are summarized as follows:

	Number of Shares			Weighted Average Price Per Share
Outstanding at December 31, 2008		20,712,849		$	0.32
Granted		2,346,671			0.30
Exercised		—			—
Canceled or expired		(60,000	)		(1.94	)
Outstanding at December 31, 2009		22,999,520			0.30
Granted		—			—
Exercised		—			—
Canceled or expired		(913,317	)		(0.64	)
Outstanding at June 30, 2010		22,086,203		$	0.30

During the year ended December 31, 2009, the Company issued 1,416,669 bridge investor warrants and 96,667 placement agent warrants in relation to the Senior Secured Note offering. The fair value of the 1,513,336 warrants issued was estimated using the Black-Scholes option pricing model with the following assumptions: no dividend yield, risk-free interest rate of between 1.7%-2.84%, the contractual life of 3.0 years and volatility of 227%.

ADVANCE NANOTECH, INC.

(A DEVELOPMENT STAGE COMPANY)

NOTES TO CONDENSED FINANCIAL STATEMENTS

JUNE 30, 2010

(Unaudited)

NOTE 9 – OPTIONS, WARRANTS AND STOCK AWARDS (continued)

Warrants (continued)

During the year ended December 31, 2009, the Company issued 833,335 bridge investor warrants in relation to the Bridge Notes offering during the period. The fair value of the 833,335 warrants issued was estimated using the Black-Scholes option pricing model with the following assumptions: no dividend yield, risk-free interest rate of between 2.44%, the contractual life between 2.9-3.0 years and volatility of 233%.

Employee Options

On August 28, 2008, the Board of Directors of Advance Nanotech, Inc. adopted the Advance Nanotech, Inc. 2008 Equity Incentive Plan (the "2008 Plan"). The aggregate number of shares of Common Stock that may be issued under the Plan is 40,462,293, and such shares are reserved for issuance out of the authorized but previously unissued Shares. Employees, service providers and non-employee directors of the Company and its affiliates are eligible to receive stock options, restricted stock, performance awards and other stock- or performance-based awards. Incentive stock options may be granted only to employees. The 2008 Plan will continue until the earlier of the termination of the 2008 Plan by the board of directors or ten years after the effective date.

The 2008 Plan is currently being administered by the Company's compensation committee made up on two non-executive directors. The compensation committee may determine the specific terms and conditions of all Awards (as defined in the 2008 Plan) granted under the 2008 Plan, including, without limitation, the number of shares subject to each Award, the price to be paid for the shares and the vesting criteria, if any. The compensation committee has discretion to make all determinations necessary or advisable for the administration of the 2008 Plan.

As of June 30, 2010, there were 23,550,640 shares that had not been issued under the 2008 Plan.

The Company accounts for employee stock option grants in accordance with ASC 718-10 which establishes standards for the accounting for transactions in which an entity exchanges its equity instruments for goods or services. ASC 718-10 requires a public entity to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award. That cost will be recognized over the period during which an employee is required to provide service in exchange for the award - the requisite service period (usually the vesting period). No compensation cost is recognized for equity instruments for which employees do not render the requisite service.

ADVANCE NANOTECH, INC.

(A DEVELOPMENT STAGE COMPANY)

NOTES TO CONDENSED FINANCIAL STATEMENTS

JUNE 30, 2010

(Unaudited)

NOTE 9 – OPTIONS, WARRANTS AND STOCK AWARDS (continued)

Options (continued)

The following tables summarize disclosure information regarding stock options:

Exercise Price		Number Outstanding		Options Outstanding Weighted Average Remaining Contractual Life (years)		Weighted Average Exercise price		Number Exercisable		Options Exercisable Weighted Average Exercise Price
$	0.25		11,340,343		8.26	$	0.25		11,340,343	$	0.25
	2.03		120,000		0.53		2.03		120,000		2.03
	3.50		20,000		0.53		3.50		20,000		3.50
	60.00		238		0.95		60.00		238		60.00
	80.00		250		0.34		80.00		250		80.00
	160.00		500		0.17		160.00		500		160.00
Total			11,481,331		6.82	$	0.28		11,481,331	$	0.28

Transactions involving the Company’s option issuance are summarized as follows:

	Number of Shares			Weighted Average Price Per Share
Outstanding at December 31, 2008		11,622,845		$	0.39
Granted		—			—
Exercised		—			—
Canceled or expired		(21,514	)		(10.64	)
Outstanding at December 31, 2009		11,601,331			0.30
Granted		—			—
Exercised		—			—
Canceled or expired		(120,000	)		(2.03	)
Outstanding at June 30, 2010		11,481,331		$	0.30

ADVANCE NANOTECH, INC.

(A DEVELOPMENT STAGE COMPANY)

NOTES TO CONDENSED FINANCIAL STATEMENTS

JUNE 30, 2010

(Unaudited)

NOTE 10 — FAIR VALUE

ASC 825-10 defines fair value as the price that would be received from selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. When determining the fair value measurements for assets and liabilities required or permitted to be recorded at fair value, the Company considers the principal or most advantageous market in which it would transact and considers assumptions that market participants would use when pricing the asset or liability, such as inherent risk, transfer restrictions, and risk of nonperformance. ASC 825-10 establishes a fair value hierarchy that requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. ASC 825-10 establishes three levels of inputs that may be used to measure fair value:

Level 1 - Quoted prices in active markets for identical assets or liabilities.

Level 2 - Observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets with insufficient volume or infrequent transactions (less active markets); or model-derived valuations in which all significant inputs are observable or can be derived principally from or corroborated by observable market data for substantially the full term of the assets or liabilities.

Level 3 - Unobservable inputs to the valuation methodology that are significant to the measurement of fair value of assets or liabilities.

To the extent that valuation is based on models or inputs that are less observable or unobservable in the market, the determination of fair value requires more judgment. In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, for disclosure purposes, the level in the fair value hierarchy within which the fair value measurement is disclosed is determined based on the lowest level input that is significant to the fair value measurement.

Items recorded or measured at fair value on a recurring basis in the accompanying consolidated financial statements consisted of the following items as of June 30, 2010:

	Total			Quoted Prices in Active Markets for Identical Instruments Level 1		Significant Other Observable Inputs Level 2		Significant Unobservable Inputs Level 3 (A)
Liabilities
Warrant liability		(1,446,016	)		-		-		(1,446,016	)
Reset derivative		(884,780	)		-		-		(884,780	)
Total	$	(2,330,796	)	$	-	$	-	$	(2,330,796	)

(A)	Fair value is estimated based on internally-developed models or methodologies utilizing significant inputs that are unobservable from objective sources.

Level 3 Liabilities comprised of our bifurcated reset provision contained within our convertible notes and the fair value of issued warrants with reset provisions.

ADVANCE NANOTECH, INC.

(A DEVELOPMENT STAGE COMPANY)

NOTES TO CONDENSED FINANCIAL STATEMENTS

JUNE 30, 2010

(Unaudited)

NOTE 10 — FAIR VALUE (continued)

The following table provides a summary of changes in fair value of the Company’s Level 3 financial liabilities as of June 30, 2010:

Six Months Ended June 30, 2010
	Warrant Liability			Reset Derivative
Balance, December 31, 2009	$	588,816		$	418,357
Total (gains) losses
Mark-to-market at June 30, 2010:
- Convertible debt Reset Derivative					466,423
- Warrants issued in connection with debt		857,200
Transfers in and/or out of Level 3		—			—

Balance, June 30, 2010	$	1,446,016		$	884,780

Total (losses) gains for the period included in earnings relating to the liabilities held at June 30, 2010	$	(857,200	)	$	(466,423	)

NOTE 11- COMMITMENTS AND CONTINGENCIES

Lease

As of June 30, 2010, the Company had the following lease commitments:

	Operating		Capital
Year ending December 31,	Leases		Leases
2010		24,806
2011		24,806
2012
2013
Thereafter

Amounts representing interest		-

Total principal payments	$	49,612	$

We do not own any interest in real property. We lease 2,450 square feet of office space in Montebello, New York for our corporate headquarters, the majority of which is subleased on a month-to-month basis to Owlstone. We believe that our leased space is adequate to meet our business needs for the foreseeable future and that, if such space were to become unavailable, we would be able to acquire other space that would be adequate for our business needs at comparable rent.

ADVANCE NANOTECH, INC.

(A DEVELOPMENT STAGE COMPANY)

NOTES TO CONDENSED FINANCIAL STATEMENTS

JUNE 30, 2010

(Unaudited)

NOTE 11- COMMITMENTS AND CONTINGENCIES (continued)

Employment and Consulting Agreements

The Company has consulting agreements with outside contractors, certain of whom are also Company officers, directors and stockholders. The Agreements are generally month to month.

Defined Contribution Plan

The Company has a defined contribution 401(k) Plan whereby the Company can make discretionary matches to employee contributions. The Company has not made any contributions to the 401(k) Plan as of June 30, 2010.

Litigation

From time to time, we may become involved in various lawsuits and legal proceedings which arise in the ordinary course of business. However, litigation is subject to inherent uncertainties, and an adverse result in these or other matters may arise from time to time that may harm our business. Except as described below, we are currently not aware of any such legal proceedings that we believe will have, individually or in the aggregate, a material adverse affect on our business, financial condition or operating results.

On February 16, 2010, Alpha Capital Anstalt, one of the holders of the Company’s 8% Senior Secured Convertible Notes, instituted a lawsuit in the Supreme Court of the State of New York against Advance Nanotech and Owlstone claiming that Owlstone’s issuance and sale of its common stock in November of 2009 constituted a breach of the Company’s covenants contained in the subscription agreement between the Company and the plaintiff. The lawsuit seeks unspecified monetary damages, a declaratory judgment, a permanent injunction, punitive damages, costs and interest. The Company believes there is no merit to the case.

By action titled Jack J. Grynberg and Pricaspian Development Corporation (Texas) v. Advance Nanotech, Inc. instituted in 2007 in the Supreme Court of the State of New York, County of New York, the plaintiffs asserted breach of contract and three other causes of action that were subsequently dismissed seeking certain damages from the registrant and others based upon a claim that the registrant had failed to file a timely Form SB-2 registration statement with the Securities and Exchange Commission. The registrant's motion for summary judgment was granted, the plaintiffs have filed an appeal and the registrant filed its opposition to the appeal on August 11, 2010.

We are not aware of any other pending or threatened litigation against us that we expect will have a materially adverse effect on our business, financial condition, liquidity, or operating results.

NOTE 12 - SUBSEQUENT EVENTS

In accordance with FASB ASC 855, “Subsequent Events,” the Company has evaluated subsequent events through August 13, 2010, the date of filing.

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Unless otherwise noted, the terms "Advance Nanotech", the "Company", "we", "us", and "our" refer to the ongoing business operations of Advance Nanotech, Inc.

Overview and Plan of Operations

Our efforts are principally focused on refinancing or restructuring our current indebtedness and assisting in the development of Owlstone, our principal asset, in which we own a non-controlling interest of 32.57%. Owlstone’s efforts are principally focused on the development of chemical sensing products using its proprietary technology.

Material Changes in Financial Condition

At June 30, 2010, the Company had a total of approximately $141,080 of cash and cash equivalents after collections of an intercompany receivable from Owlstone of approximately $517,000. Based upon the Company’s current cash and cash equivalents on hand, the Company’s continued ability to operate is dependent upon obtaining additional funds, or finding a suitable merger candidate. The Company is presently pursuing various options to generate additional funds, including, among others, financing on a senior secured basis and raising additional capital through the sale of securities. If the Company is unable to generate sufficient cash flow through these means or obtain additional financing through other means to support its operations and meet its obligations, the Company will be forced to consider the further restructuring of its operations, disposition of various assets, seeking protection from its creditors, or cessation of operations and liquidation.

Our 8% senior secured convertible notes (the “Notes”) come due in December of 2010 with respect to $3,732,200 in principal amount and in 2011 with respect to an additional $3,607,500 in principal amount. We do not presently have the cash or other assets to repay the Notes. Our only significant asset is our shares in Owlstone and the value of those shares, based on the price recently paid by private investors in Owlstone, is less than the principal amount of the indebtedness. Furthermore, our Owlstone shares have been pledged as security for the payment of the Notes. Without a substantial increase in the value of the Owlstone shares, we deem it unlikely that a lender would be willing to lend us the funds needed to repay the Notes. Accordingly, if we are unable to negotiate an extension of the maturity of the Notes or otherwise come to terms with the holders of the Notes acceptable to the Company, we may have to seek protection from creditors under the bankruptcy laws. If so, the prospects for the Company and its stockholders will be severely limited.

The Company is actively exploring various debt and equity financing transactions. Although the Company is exploring all opportunities to improve its financial condition within the next several months, there is no assurance that these programs will be successful.

Results of Operations

Three months ended June 30, 2010 as compared with three months ended June 30, 2009:

Advance Nanotech has no revenues or operations other than those attributed to its non-controlling ownership interest in Owlstone and Advance Nanotech does not control the distribution of any Owlstone dividends. However, Advance Nanotech has expenditures associated with being a public company.

The Company had a loss from operations of $1,929,549 for the three months ended June 30, 2010, compared to $1,047,124 for the comparable period in 2009, representing an increase of $882,425, or approximately 85%. The changes of which are described below.

General and administrative expenses for the three months ended June 30, 2010 compared to the three months ended June 30, 2009 were $370,589 and $550,152, respectively, representing a decrease of $179,563, or 33%. General and administrative expenses for the three months ended June 30, 2010 decreased primarily due to the reduction in salaries and benefits and related support services.

The Company recognized a non-cash loss for the three months ended June 30, 2010 and a non-cash gain for the three months ended June 30, 2009 of $(1,360,458) and $181,839, respectively, for the change in fair value of the warrant liability driven by the increase in the price of the Company’s common stock.

For 2010, other income included recognized non-cash income from Owlstone of $140,334 where we treat our investment under the equity method of accounting. Other and interest income decreased by $18,101 for the same period in 2010 compared to 2009. Cash decreased throughout 2010 as a result of the expenses related to being a public company. All of our cash reserves had been invested in liquid securities at large financial institutions.

Interest expense for the three months ended June 30, 2010 and 2009 was $245,209 and $325,007, respectively, representing a decrease of $79,798 from 2009. In addition, the Company recognized a non-cash late registration cost of $75,471 and $108,337 for three months ended June 30, 2010 and 2009, respectively.

Six months ended June 30, 2010 as compared with six months ended June 30, 2009:

The Company had a loss from operations of $1,938,396 for the six months ended June 30, 2010, compared to $3,842,163 for the comparable period in 2009, representing a decrease of $1,903,767, or approximately 50%. The changes of which are described below.

General and administrative expenses for the six months ended June 30, 2010 compared to the six months ended June 30, 2009 were $471,692 and $1,049,347, respectively, representing a decrease of $577,655, or 55%. General and administrative expenses for the six months ended June 30, 2010 decreased primarily due to the reduction in salaries and benefits and related support services.

The Company recognized a non-cash loss for the six months ended June 30, 2010 and a non-cash loss for the six months ended June 30, 2009 of $(1,323,623) and $(1,580,074), respectively, for the change in fair value of the warrant liability driven by changes in the price of the Company’s common stock.

For 2010, other income included recognized non-cash income from Owlstone of $439,494 where we treat our investment under the equity method of accounting. Other and interest income decreased by $6,094 for the same period in 2010 compared to 2009. Cash decreased throughout 2010 as a result of the expenses related to being a public company. All of our cash reserves had been invested in liquid securities at large financial institutions.

Interest expense for the six months ended June 30, 2010 and 2009 was $391,595 and $474,543, respectively, representing a decrease of $82,948 from 2009. In addition, the Company recognized a non-cash late registration cost of $185,026 and $217,892 for three months ended June 30, 2010 and 2009, respectively.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Not Applicable

ITEM 4. CONTROLS AND PROCEDURES

Evaluation of disclosure controls and procedures

As of June 30, 2010, our management carried out an evaluation, under the supervision and with the participation of our Principal Executive Officer ("PEO") and Principal Financial Officer ("PFO"), of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 ("Exchange Act"). Disclosure controls are controls and procedures that are designed to ensure that information required to be disclosed in our reports filed under the Exchange Act, such as this Form 10-Q, is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company's management, including its principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure. Based on that evaluation, our Principal Executive Officer and Principal Financial Officer have concluded that our disclosure controls and procedures are effective in timely alerting them to material information required to be included in our periodic Securities and Exchange Commission filings

ITEM 4(T). CONTROLS AND PROCEDURES

Changes in Internal Control over Financial Reporting

During the second quarter of 2010, there were no changes in our internal control over financial reporting which have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II - OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS.

No reportable events.

ITEM 1A. RISK FACTORS.

Not applicable.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.

On May 3, 2010, the Company issued 1,000,000 shares of common stock to a consultant for services to the Company. On July 2, 2010, the Company issued 600,000 shares of common stock to another consultant for services to the Company. The issuance of the shares was exempt from the registration requirements of the Securities Act of 1933, as amended, pursuant to Section 4(2) thereof and Rule 506 of Regulation D promulgated thereunder.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES.

None.

ITEM 4. (Removed and Reserved).

None.

ITEM 5. OTHER INFORMATION.

None

ITEM 6. EXHIBITS.

(a) Financial Statements, Financial Statement Schedules and Exhibits.

(1) See Index to Financial Statements located on page i.

(2) Financial Statement Schedules: None

(3) Exhibits

Exhibit No.		Document Description

31.1+		Certification of Principal Executive Officer pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act, as amended.

31.2+		Certification of Principal Financial Officer pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act, as amended.

32+		Certification by Principal Executive Officer and Principal Financial Officer pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

+	Filed herewith.

SIGNATURES

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


August 13, 2010	ADVANCE NANOTECH, INC.

	By:	/s/ Jon Buttles
		Jon Buttles
		Principal Executive Officer

Advance Nanotech, Inc. 10-Q