ISONICS CORPORATION AND SUBSIDIARIES

Index to Financial Statements

Report of Independent Registered Public Accounting Firm
Consolidated Financial Statements
Consolidated Balance Sheets
Consolidated Statements of Operations
Consolidated Statements of Stockholders’ Equity
Consolidated Statements of Cash Flows
Notes to Consolidated Financial Statements

F-1

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors
Isonics Corporation
Golden, Colorado

We have audited the consolidated balance sheets of Isonics Corporation and subsidiaries (the “Company”) as of April 30, 2006 and 2005, and the related consolidated statements of operations, stockholders’ equity and cash flows for each of the two years in the period ended April 30, 2006. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. 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 provided a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Isonics Corporation and subsidiaries as of April 30, 2006 and 2005, and the results of their operations and their cash flows for each of the two years in the period ended April 30, 2006, in conformity with U.S. generally accepted accounting principles.

/s/ Hein & Associates LLP

Denver, Colorado
July 19, 2006

F-2

Isonics Corporation and Subsidiaries

CONSOLIDATED BALANCE SHEETS

(In thousands, except share amounts)

	April 30,
	2006			2005
ASSETS
CURRENT ASSETS:
Cash and cash equivalents	$	2,117		$	21,206
Accounts receivable (net of allowances of $67 and $59, respectively)	3,410			935
Inventories	1,077			1,550
Prepaid expenses and other current assets	1,142			153
Assets held for sale	560			—
Total current assets	8,306			23,844
LONG-TERM ASSETS:
Property and equipment, net	4,854			5,589
Goodwill	3,631			—
Intangible assets, net	491			241
Equity in net assets of investee	386			—
Other assets	195			1,507
Total long-term assets	9,557			7,337
TOTAL ASSETS	$	17,863		$	31,181
LIABILITIES AND STOCKHOLDERS’ EQUITY
CURRENT LIABILITIES:
Accounts payable	$	2,175		$	1,079
Accrued liabilities	1,606			1,033
Current portion of obligations under capital lease	14			44
Current portion of notes payable	786			672
Current portion of convertible debentures, net of discount	10,432			3,025
Total current liabilities	15,013			5,853
Obligations under capital lease, net of current portion	34			47
Notes payable, net of current portion	173			653
Convertible debentures, net of discount and of current portion	—			15,040
TOTAL LIABILITIES	15,220			21,593
STOCKHOLDERS’ EQUITY:
Preferred Stock; shares authorized: 2006—7,650,000; 2005—7,656,666
Series A Convertible Preferred Stock—no par value; shares issued and outstanding: 2006—zero; 2005—6,666; liquidation preference: 2006—zero; 2005—$10	—			5
Series D Convertible Preferred Stock—no par value; shares issued and outstanding: 2006—zero; 2005—800; liquidation preference: 2006—zero; 2005—$80	—			90
Series E Convertible Preferred Stock—no par value; shares issued and outstanding: 2006—zero; 2005—33,000; liquidation preference: 2006—zero; 2005—$3,300	—			3,938
Common stock—no par value; 75,000,000 shares authorized; shares issued and outstanding: 2006—42,071,119; 2005—27,696,800	57,061			28,401
Additional paid in capital	13,910			13,080
Deferred compensation	(24		)	(64		)
Accumulated deficit	(68,304		)	(35,862		)
Total stockholders’ equity	2,643			9,588
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY	$	17,863		$	31,181

See Notes to Consolidated Financial Statements.

F-3

Isonics Corporation and Subsidiaries

CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share amounts)

	Year Ended April 30,
	2006			2005
Revenues	$	23,716		$	10,105
Cost of revenues	22,729			12,841
Gross margin	987			(2,736		)
Operating expenses:
Selling, general and administrative	11,859			7,473
Impairment loss on assets held for sale	466			—
Impairment of goodwill and intangible assets	—			2,682
Research and development	5,293			1,271
Total operating expenses	17,618			11,426
Operating loss	(16,631		)	(14,162		)
Other income (expense):
Amortization of debt issuance costs	(1,260		)	(166		)
Debt conversion expense	(7,227		)	—
Interest and other income	301			117
Interest expense	(7,554		)	(1,000		)
Equity in net income of investee	30			—
Foreign exchange	—			34
Total other income (expense), net	(15,710		)	(1,015		)
Loss before income tax benefit	(32,341		)	(15,177		)
Income tax benefit	—			—
NET LOSS	(32,341		)	(15,177		)
DEEMED DIVIDEND ON PREFERRED STOCK	—			(1,206		)
DIVIDENDS ON SERIES E CONVERTIBLE PREFERRED STOCK	(101		)	(132		)
NET LOSS ATTRIBUTABLE TO COMMON STOCKHOLDERS	$	(32,442	)	$	(16,515	)
Net loss per common share—basic and diluted
Net loss per share attributable to common stockholders	$	(1.00	)	$	(.74	)
Shares used in computing per share information	32,410			22,383

See Notes to Consolidated Financial Statements.

F-4

Isonics Corporation and Subsidiaries

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

(In thousands, except share amounts)

	Preferred Stock					Common Stock			Additional Paid in			Deferred			Accumulated
	Shares		Amount			Shares	Amount		Capital			Compensation			Deficit			Total
Balances as of April 30, 2004	1,005,616		$	5,613		15,344,913	$	14,817	$	6,732		$	(104	)	$	(19,347	)	$	7,711
Exercise of common stock warrants	—		—			5,366,201	6,708		—			—			—			6,708
Cashless exercise of common stock warrants	—		—			363,719	45		(45		)	—			—			—
Common stock issued in legal settlement	—		—			4,257	20					—			—			20
Exercise of common stock options	—		—			93,000	111		—			—			—			111
Fair value of common stock issued for the acquisition of the assets of Encompass Materials Group, Ltd.	—		—			731,930	1,171		—			—			—			1,171
Issuance of Series E Convertible Preferred Stock and related common stock warrants	33,000		2,732			—	—		337			—			—			3,069
Deemed dividend on preferred stock	—		1,206			—	—		—			—			(1,206		)	—
Preferred stock dividends	—		—			—	—		—			—			(132		)	(132		)
Conversion of convertible preferred stock into common stock:
Series A	(957,000	)	(740		)	1,914,000	740		—			—			—			—
Series C	(9,000	)	(1,141		)	947,368	1,141		—			—			—			—
Series D	(32,150	)	(3,637		)	2,922,726	3,637		—			—			—			—
Fair value of common stock warrants issued to members of HSDC advisory board for services	—		—			—	—		669			—			—			669
Discount on convertible debentures due to issuance of detachable warrants and beneficial conversion feature	—		—			—	—		5,245			—			—			5,245
Fair value of common stock warrants issued to convertible debenture placement agent	—		—			—	—		142			—			—			142
Common stock issued under Employee Stock Purchase Program	—		—			8,686	11		—			—			—			11
Amortization of deferred compensation	—		—			—	—		—			40			—			40
Net loss	—		—			—	—		—			—			(15,177		)	(15,177		)
Balances as of April 30, 2005	40,466		4,033			27,696,800	28,401		13,080			(64		)	(35,862		)	9,588
Exercise of common stock warrants	—		—			1,012,511	1,367		—			—			—			1,367
Cashless exercise of common stock warrants	—		—			10,000	13		(13		)	—			—			—
Fair value of common stock warrants issued in legal settlements	—		—			—	—		110			—			—			110
Exercise of common stock options	—		—			419,115	356		—			—			—			356
Fair value of common stock issued for the acquisition of Protection Plus Security Corporation	—		—			706,527	1,228		—			—			—			1,228
Fair value of extension of warrant expiration dates	—		—			—	—		510			—			—			510
Common stock issued in payment of interest due on convertible debentures	—		—			451,604	949		—			—			—			949
Common stock issued in payment of principal due on convertible debentures	—		—			2,712,663	4,313		—			—			—			4,313
Conversion of convertible debentures into common stock	—		—			6,206,897	16,227		—			—			—			16,227
Preferred stock dividends	—		—			—	—		—			—			(101		)	(101		)
Conversion of convertible preferred stock into common stock:
Series D	(800	)	(90		)	72,727	90		—			—			—			—
Series E	(33,000	)	(3,938		)	2,661,290	3,938		—			—			—			—
Redemption of Series A Convertible Preferred Stock	(6,666	)	(5		)	—	—		(5		)	—			—			(10		)
Fair value of common stock warrants issued for services	—		—			—	—		228			—			—			228
Fair value of common stock issued for services	—		—			100,000	140		—			—			—			140
Common stock issued under Employee Stock Purchase Program	—		—			20,985	39		—			—			—			39
Amortization of deferred compensation	—		—			—	—		—			40			—			40
Net loss	—		—			—	—		—			—			(32,341		)	(32,341		)
Balances as of April 30, 2006	—		$	—		42,071,119	$	57,061	$	13,910		$	(24	)	$	(68,304	)	$	2,643

See Notes to Consolidated Financial Statements.

F-5

Isonics Corporation and Subsidiaries

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

	Year Ended April 30,
	2006			2005
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss	$	(32,341	)	$	(15,177	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization of intangible assets	1,677			1,193
Amortization of debt discount and debt issuance costs	6,939			732
Debt conversion expense	7,227			—
Interest paid in shares of common stock	949			—
Impairment of goodwill and intangible assets	—			2,682
Impairment of property and equipment (including assets held for sale)	498			—
Accounting charge for extension of warrant expiration dates	510			—
Fair value of common stock and warrants issued for services, amortization of deferred compensation and legal settlement	355			729
Equity in net income of investee	(30		)	—
Changes in operating assets and liabilities:
Accounts receivable	(1,087		)	225
Inventories	473			(284		)
Prepaid expenses and other current assets	(858		)	4
Accounts payable	688			201
Accrued liabilities	(410		)	332
Net cash used in operating activities	(15,410		)	(9,363		)
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment	(1,700		)	(3,741		)
Equity investment in a business	(336		)	—
Acquisition of assets of a business, net of cash acquired	(2,468		)	(49		)
Net cash used in investing activities	(4,504		)	(3,790		)
CASH FLOWS FROM FINANCING ACTIVITIES:
Principal payments under capital lease obligations	(44		)	(64		)
Principal payments on borrowings	(791		)	(375		)
Proceeds from the issuance of preferred stock and related warrants	—			3,069
Proceeds from the issuance of convertible debentures and related warrants	—			21,340
Proceeds from issuance of common stock	1,761			6,830
Preferred stock dividends	(101		)	(132		)
Net cash provided by financing activities	825			30,668
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS	(19,089		)	17,515
Cash and cash equivalents at beginning of year	21,206			3,691
Cash and cash equivalents at end of year	$	2,117		$	21,206

See Notes to Consolidated Financial Statements.

F-6

Isonics Corporation and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1—ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES

Organization

We are an advanced materials and technology company focused on the development and provision of homeland security products and services, the manufacture and reclamation of silicon wafers and the manufacture of silicon-on-insulator (“SOI”) wafers to the semiconductor industry and the supply of isotopes for life sciences and health-care applications. The consolidated financial statements (the “financial statements”) include our accounts and those of our wholly-owned subsidiaries, including: Protection Plus Security Corporation (“PPSC”), Isonics Homeland Security and Defense Corporation (“HSDC”), Isonics Vancouver, Inc. (“IVI”), Chemotrade GmbH (“Chemotrade”) and IUT Detection Technologies, Inc. (“IUTDT”).

We incurred significant losses from operations for the fiscal years presented and, as of April 30, 2006, have a working capital deficit of $6,707,000. Additionally, barring a restructuring of our company, it is likely that we will also incur operating losses in fiscal year 2007 as we continue to fund research and development of new and existing products and cover operating costs. Should losses be greater than anticipated, we may encounter liquidity problems which could require us to curtail development projects, seek joint venture partners, sell assets and/or obtain additional financing with terms that may not be as favorable as might otherwise be available. However, subsequent to year end (see Note 17) we raised additional financing, through long-term debt with a single investor, in the amount of $13,000,000. That investor has committed an additional $3,000,000 pending the successful registration with the Securities and Exchange Commission of the securities underlying the convertible debentures issued. We believe that based on our financial position at April 30, 2006, the subsequent financing (including the additional $3 million commitment by the investor) and our projections of future operations, we will be able to continue operations into fiscal year 2008.

Principles of Consolidation

These financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America. Intercompany accounts and transactions have been eliminated in consolidation.

Use of Estimates in the Financial Statements

In preparing financial statements in conformity with accounting principles generally accepted in the United States of America, we are required to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes, including those related to impairment of goodwill and intangible assets, impairment of equity investments and assets held for sale, recoverability of inventory and accounts receivable, the recording of various accruals, the useful lives of long-lived assets, income tax and potential losses from contingencies. These estimates are based upon management’s best findings, after considering past and current events and assumptions about future events. Actual results could differ from those estimates.

Cash Equivalents

Cash equivalents include investments purchased with an original maturity of less than ninety days.

F-7

Concentration of Credit Risk

The majority of our cash is maintained with one major bank headquartered in the United States and our cash equivalents are primarily held with one major financial institution. Cash balances with the bank exceed the amount of insurance provided on such deposits. Cash balances held in foreign bank accounts, $531,000 and $608,000 at April 30, 2006 and 2005, respectively, are subject to local banking laws and may bear higher or lower risk than cash deposited in the United States. We periodically evaluate the credit standing of the financial institutions and we have not sustained any credit losses from instruments held at these financial institutions.

Financial instruments that potentially subject us to concentrations of credit risk consist principally of trade receivables, for which our accounting policies are discussed in Accounts Receivable.

Accounts Receivable

The majority of our accounts receivable are due from customers of our security services segment and our semiconductor products and services segment. Credit is extended based on evaluation of a customer’s financial condition and, generally, collateral is not required. Accounts receivable are generally due within 30 days and are stated at amounts due from customers net of an allowance for doubtful accounts. Accounts outstanding longer than the contractual payment terms are considered past due. We determine our allowance by considering a number of factors, including length of time trade accounts receivable are past due, our previous loss history, our customer’s current ability to pay their obligation to us and the condition of the general economy and the industry as a whole. We write-off accounts receivable when they become uncollectible, and payments subsequently received on such receivables are credited to the allowance for doubtful accounts. Interest accrues beginning on the day after the due date of the receivable. Interest accruals are discontinued on accounts past due 90 days or more, and all interest previously accrued but not collected is reversed against current interest income. Interest income is subsequently recognized on these accounts only to the extent cash is received, or when the future collection of interest and the receivable balance is considered probable by management.

Inventories

Inventories are stated at the lower of cost (first-in, first-out) or market. We perform periodic assessments to determine the existence of obsolete, slow moving and non-salable inventories, and record provisions to reduce such inventories to net realizable value when necessary.

Property and Equipment

Property and equipment are stated at cost. Depreciation is computed using the straight-line method over the estimated useful lives of the assets. The estimated useful lives for office furniture and equipment range from three to seven years, for production equipment range from three to seven years and for vehicles are three years. Leasehold improvements are depreciated over the shorter of their estimated useful lives or the lease term.

Goodwill and Other Intangible Assets

Goodwill is recorded when the purchase price paid for an acquisition exceeds the estimated fair value of the net identified tangible and intangible assets acquired. Goodwill is not amortized, but instead is tested for impairment at the reporting unit level annually during our fiscal third quarter or more frequently

F-8

if the presence of certain circumstances indicates that impairment may have occurred. The impairment review process compares the fair value of the reporting unit in which goodwill resides to its carrying value. If the carrying amount of a reporting unit exceeds its fair value, then the amount of the impairment loss must be measured. The impairment loss would be calculated by comparing the implied fair value of reporting unit goodwill to its carrying amount. In calculating the implied fair value of reporting unit goodwill, the fair value of the reporting unit is allocated to all of the other assets and liabilities of that unit based on their fair values. The excess of the fair value of a reporting unit over the amount assigned to its other assets and liabilities is the implied fair value of goodwill. An impairment loss would be recognized when the carrying amount of goodwill exceeds its implied fair value (see Note 3).

Acquired identified intangible assets (other than goodwill) are amortized on a straight-line basis over the periods of benefit, ranging from three to ten years. We evaluate the recoverability of identifiable intangible assets whenever events or changes in circumstances indicate that an intangible asset’s carrying amount may not be recoverable. We measure the carrying amount of the asset against the estimated undiscounted future cash flows associated with it. Should the sum of the expected future net cash flows be less than the carrying value of the asset being evaluated, an impairment loss would be recognized. The impairment loss would be calculated as the amount by which the carrying value of the asset exceeds its fair value (see Note 3).

Equity Method Investments

Investee companies that are not consolidated, but over which we exercise significant influence, are accounted for under the equity method of accounting. Whether or not we exercise significant influence with respect to an investee depends on an evaluation of several factors including, among others, representation on the investee company’s board of directors and ownership level, which is generally a 20% to 50% interest in the voting securities of the investee company. Under the equity method of accounting, our share of the earnings or losses of the investee company is recognized and is reflected in the consolidated statements of operation in the caption “Equity in net income of investee.” The carrying value of the investment is reflected in the condensed consolidated balance sheet in the caption “Equity in net assets of investee.” We evaluate the recoverability of equity method investments whenever events or changes in circumstance indicate that its carrying amount may not be recoverable. A loss in value which is deemed other than temporary would result in recognition of an impairment loss.

Debt Issuance Costs

Debt issuance costs are capitalized, included in other assets and amortized over the term of the related debt issuance using the effective interest method. If the underlying debt instrument related to the debt issuance costs is a convertible debenture, upon conversion of such instrument by its holder the related unamortized debt issuance cost would be recognized as an expense immediately upon conversion.

Long-Lived Assets

Our policy is to record long-lived assets at cost, amortizing these costs over the expected useful lives of the related assets. In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 144 Accounting for the Impairment or Disposal of Long-Lived Assets, these assets are reviewed on a periodic basis for impairment whenever events or changes in circumstances indicate that the carrying amounts of the assets may not be realizable. Furthermore, assets held and used in operations are evaluated for continuing value and proper useful lives by comparison to expected undiscounted future cash flows. If

F-9

impairment has occurred, it is calculated based on the difference between the asset’s carrying value and the underlying discounted future cash flows it is expected to generate.

Income Taxes

We account for income taxes using an asset and liability approach for financial accounting and reporting purposes. A valuation allowance is provided when, based on the weight of available evidence, it is more likely than not that some portion or all of the deferred tax assets will not be realized.

Revenue Recognition

We recognize revenue when the following criteria are met: 1) persuasive evidence of an arrangement exists; 2) delivery has occurred or services have been rendered; 3) the sales price is fixed or determinable; and 4) collectibility is probable. Revenue from product sales is recognized upon shipment if all other revenue recognition criteria have been met. Customers are not granted return rights for reasons other than warranty claims and product returns have not been material in any period. Revenue for silicon wafer reclamation services is recognized when all services have been rendered and the reclaimed wafer is shipped back to the customer, if all other revenue recognition criteria have been met. Revenue for security services is recognized upon delivery of the services, if all other revenue recognition criteria have been met.

Warranty

We accrue for our product warranty costs at the time of shipment. Product warranty costs are estimated based upon our historical experience and specific identification of the products’ requirements. Warranty costs have not been material in any period.

Shipping Costs

Our shipping and handling costs for product sales are included in cost of sales for all periods presented.

Research and Development Expenditures

Costs related to the research, design, and development of products are charged to research and development expenses as incurred.

Fair Values of Financial Instruments

The fair value of cash and cash equivalents, trade receivables, trade payables and capital lease obligations approximates carrying value due to the short maturity of such instruments.

Translation of Foreign Currencies

We conduct substantially all of our transactions in U.S. dollars, except for certain transactions of Chemotrade that are conducted in Euros. The financial statements of Chemotrade are prepared in Euros and remeasured into U.S. dollars for purposes of consolidation, with the U.S. dollar as the functional currency. Gains and losses from remeasurement and transaction gains and losses are included in the statement of operations.

F-10

Accounting for Stock-Based Compensation

We account for stock-based compensation to employees and directors using the intrinsic value method in accordance with Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees and related interpretations, as permitted by SFAS No. 123 Accounting for Stock-Based Compensation, as amended by SFAS No. 148 Accounting for Stock-based Compensation—Transition and Disclosure. Compensation expense for stock options is measured as the excess, if any, of the quoted market price of our stock at the date of grant over the amount an employee must pay to acquire the stock. No stock-based employee compensation costs relating to options is reflected within our net loss as all options granted had an exercise price equal to or greater than the market value of the underlying common stock on the date of grant (though we have recognized expense for warrants granted to external parties for services as disclosed in Note 12). We record compensation expense for restricted stock awards based on the quoted market price of our stock at the date of the grant and the vesting period.

The following table illustrates the effect on net loss and net loss per share if we had applied the fair value recognition provisions of SFAS No. 123 to stock-based compensation (in thousands, except per share data):

	Year Ended April 30,
	2006			2005
Net loss attributable to common stockholders, as reported	$	(32,442	)	$	(16,515	)
Add: stock-based compensation costs included in reported net loss, net of tax effects	245			709
Deduct: Total stock-based compensation expense determined under fair value based method for all awards, net of related tax effects	(1,362		)	(1,759		)
Adjusted net loss attributable to common stockholders	$	(33,559	)	$	(17,565	)

	Year Ended April 30,
	2006			2005
Basic and diluted net loss per share attributable to common stockholders
As reported	$	(1.00	)	$	(.74	)
Adjusted	$	(1.04	)	$	(.78	)

Net Loss Per Share

Basic net loss per share is computed using the weighted average number of common shares outstanding during the period. Contingently issuable shares are included in the computation of basic net income (loss) per share when the related conditions are satisfied. Diluted net income (loss) per share is computed using the weighted average number of common shares and potentially dilutive securities outstanding during the period. Potentially dilutive securities consist of contingently issuable shares, the incremental common shares issuable upon conversion of preferred stock or convertible debt (using the “if converted” method) and shares issuable upon the exercise of stock options and warrants (using the “treasury stock” method). Potentially dilutive securities are excluded from the computation if their effect is anti-dilutive.

F-11

As of April 30, 2006, (a) a total of 2,933,932 outstanding stock options, (b) a total of 5,005,010 outstanding common stock warrants and (c) the unissued shares underlying our outstanding convertible debentures were excluded from the diluted net loss per share calculations, as their inclusion would be anti-dilutive. As of April 30, 2005, (a) a total of 2,846,647 outstanding stock options, (b) a total of 5,404,510 common stock warrants, (c) 6,666, 800 and 33,000 outstanding shares of Series A, D and E Convertible Preferred Stock, respectively, and (d) the unissued shares underlying our outstanding convertible debentures were excluded from the diluted net loss per share calculations, as their inclusion would be anti-dilutive.

Recently Issued Accounting Standards

In December 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 123 (revised 2004) Share-Based Payments (“SFAS 123(R)”). This statement requires that we record all share-based payment expense in our financial statements based on a fair value methodology. On April 14, 2005, the Securities and Exchange Commission (“SEC”) announced amended compliance dates for SFAS 123(R). The SEC previously required companies to adopt this standard no later than July 1, 2005, but the new rules now require us to adopt FAS 123(R) starting with our first quarter of our fiscal year beginning May 1, 2006. Additionally, in March 2005, the SEC issued Staff Accounting Bulletin No. 107 (SAB No. 107), which summarizes the staff’s views regarding share-based payment arrangements for public companies. We are evaluating the impact of the new standards and, although we have not completed our analysis, we anticipate that the expense would not exceed the amounts disclosed in Accounting for Stock-Based Compensation had we been expensing under the new rule.

In September 2005, the FASB ratified the consensus reached by the Emerging Issues Task Force (“EITF”) on EITF Issue No. 05-08 Income Tax Consequences of Issuing Convertible Debt with a Beneficial Conversion Feature (“EITF 05-08”). The EITF consensus noted that for the purpose of applying SFAS No. 109, Accounting for Income Taxes, (1) the issuance of convertible debt with a beneficial conversion feature results in a basis difference, (2) the basis difference is a temporary difference and (3) the recognition of deferred taxes for the temporary difference of the convertible debt with a beneficial conversion feature should be recorded as an adjustment to additional paid-in capital. The EITF also reached a consensus that the guidance in EITF 05-08 should be applied to financial statements beginning in the first interim or annual reporting period beginning after December 15, 2005. The guidance should be applied by retrospective application pursuant to SFAS No. 154, Accounting Changes and Error Corrections, to all instruments with a beneficial conversion feature accounted for under EITF Issue No. 00-27, Application of Issue No. 98-5 to Certain Convertible Instruments. The adoption of EITF 05-08 has not had a material impact on our consolidated financial statements.

In September 2005, the FASB ratified the consensus reached by the EITF on EITF Issue No. 05-07 Accounting for Modifications to Conversion Options Embedded in Debt Instruments and Related Issues (“EITF 05-07”). The EITF consensus requires that, when a modification of a convertible debt instrument results in a change in the fair value of an embedded conversion option, the change in fair value of the embedded conversion option be included in the analysis of whether there has been a substantial change in the terms of the convertible debt instrument for purposes of determining whether the debt has been extinguished. The consensus also requires subsequent recognition of interest expense for any change in the fair value of the embedded conversion option resulting from a modification of a convertible debt instrument. EITF 05-07 is effective beginning in the first interim or annual reporting period beginning

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after December 15, 2005. We do not expect the adoption of EITF 05-07 to have an impact on our results of operations or financial condition.

In September 2005, the FASB staff reported that the EITF postponed further deliberations on Issue No. 05-04 The Effect of a Liquidated Damages Clause on a Freestanding Financial Instrument Subject to Issue No. 00-19 (“EITF 05-04”) pending the FASB reaching a conclusion as to whether a registration rights agreement meets the definition of a derivative instrument. The legal agreements related to our 8% Convertible Debentures include a freestanding registration rights agreement. Once the FASB ratifies the then-completed consensus of the EITF on EITF 05-04, we will assess the impact on our consolidated financial statements of adopting the standard and, if an impact exists, follow the transition guidance for implementation.

In February 2006, the FASB issued SFAS No. 155, Accounting for Certain Hybrid Financial Instruments (“SFAS 155”), which amends SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities and SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities. SFAS 155 simplifies the accounting for certain derivatives embedded in other financial instruments by allowing them to be accounted for as a whole if the holder elects to account for the whole instrument on a fair value basis. The statement also clarifies and amends certain other provisions of SFAS No. 133 and SFAS No. 140. SFAS 155 is effective for all financial instruments acquired, issued, or subject to a remeasurement event occurring in fiscal years beginning after September 15, 2006. We do not expect the adoption of SFAS 155 to have an impact on our results of operations or financial condition.

In March 2006, the FASB issued SFAS No. 156, Accounting for Servicing of Financial Assets—an amendment to FASB Statement No. 140 (“SFAS 156”). SFAS 156 requires that all separately recognized servicing rights be initially measured at fair value, if practicable. In addition, this statement permits an entity to choose between two measurement methods (amortization method or fair value measurement method) for each class of separately recognized servicing assets and liabilities. This new accounting standard is effective January 1, 2007. We do not expect the adoption of SFAS 156 to have an impact on our results of operations or financial condition.

In June 2006, the FASB ratified the consensus reached by the EITF on EITF Issue No. 05-01, Accounting for the Conversion of an Instrument That Becomes Convertible Upon the Issuer’s Exercise of a Call Option (“EITF 05-01”). The EITF consensus applies to the issuance of equity securities to settle a debt instrument that was not otherwise currently convertible but became convertible upon the issuer’s exercise of call option when the issuance of equity securities is pursuant to the instrument’s original conversion terms. The adoption of EITF 05-01 is not expected to have an impact on our results of operations or financial condition.

In July 2006, the FASB issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109 (“FIN 48”). This interpretation clarifies the application of SFAS 109 by defining a criterion than an individual tax position must meet for any part of the benefit of that position to be recognized in an enterprise’s financial statements and also provides guidance on measurement, derecognition, classification, interest and penalties, accounting in interim periods and disclosure. FIN 48 is effective for our fiscal year commencing May 1, 2007. At this time, we have not completed our review and assessment of the impact of adoption of FIN 48.

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NOTE 2—FINANCIAL STATEMENT COMPONENTS

Inventories consist of the following (in thousands):

	April 30,
	2006		2005
Finished goods	$	604	$	565
Work in process	40		701
Materials and supplies	433		284
	$	1,077	$	1,550

Property and equipment consists of the following (in thousands):

	April 30,
	2006			2005
Office furniture and equipment	$	322		$	264
Production equipment	5,941			5,579
Vehicles	175			—
Construction in process	608			814
Leasehold improvements	653			396
	7,699			7,053
Accumulated depreciation and amortization	(2,845		)	(1,464		)
	$	4,854		$	5,589

Depreciation expense for the years ended April 30, 2006 and 2005, was $1,496,000 and $1,106,000, respectively. Such amounts include amortization on equipment under capital lease of $23,000 and $50,000 for the years ended April 30, 2006 and 2005, respectively.

Supplemental disclosure of non-cash investing and financing activities (in thousands):

	Year Ended April 30,
	2006		2005
Deemed dividends associated with beneficial conversion feature on issued Preferred Stock	$	—	$	1,206
Capital lease obligations for property and equipment	$	—	$	70
Capitalized debt issuance costs associated with issuance of convertible debenture and common stock warrants for services	$	—	$	887
Stock issued in connection with an acquisition	$	1,228	$	1,171
Note payable issued in connection with an acquisition	$	—	$	1,700
Payment of principal due on convertible debentures in common stock	$	4,313	$	—
Note payable issued for equipment	$	49	$	—

In the year ended April 30, 2006, we also issued 10,000 shares of common stock in a cashless exercise of a common stock warrant, issued 2,734,017 shares of common stock upon conversion of convertible preferred stock and issued 6,206,897 shares of common stock upon conversion of convertible debentures. In the year ended April 30, 2005, we also issued 363,719 shares of common stock in cashless exercises of

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common stock warrants and issued 5,784,094 shares of common stock upon conversion of convertible preferred stock.

Supplemental disclosures of cash flow information (in thousands):

	Year Ended April 30,
	2006		2005
Cash paid during the period for:
Interest	$	850	$	276
Income taxes	$	—	$	—

NOTE 3—GOODWILL AND OTHER INTANGIBLE ASSETS

Goodwill

Changes in the carrying amount of goodwill, by reportable segment, are as follows (in thousands):

	Homeland security products		Security services		Semiconductor products and services			Life sciences			Total
Balance as of April 30, 2004	$	—	$	—	$	—		$	1,807		$	1,807
Goodwill acquired during the year	—		—		447			—			447
Impairments	—		—		(447		)	(1,807		)	(2,254		)
Balance as of April 30, 2005	—		—		—			—			—
Goodwill acquired during the year	—		3,631		—			—			3,631
Impairments	—		—		—			—			—
Balance as of April 30, 2006	$	—	$	3,631	$	—		$	—		$	3,631

The goodwill acquired during the year ended April 30, 2006, relates to our acquisition of PPSC in May 2005 (see Note 4).

Goodwill related to the life sciences reportable segment resulted from the acquisition of Chemotrade in 1998 and was tested for impairment annually in our fiscal fourth quarter. Due to significant market pricing pressures on certain products (including oxygen-18) in the life sciences segment and to changes to other strategic initiatives, the cash flow forecast for the life sciences reportable segment was revised downward from prior forecasts to a lower positive cash flow level. In April 2005, we determined that the $1,807,000 of goodwill associated with this business segment had been impaired and the entire goodwill amount was written off to impairment of goodwill and intangible assets. The fair value of the reporting unit was estimated using the expected present value of future cash flows.

Goodwill related to the semiconductor products and services reportable segment resulted from the acquisition of the silicon wafer manufacturing and reclamation assets of Encompass Materials Group, Ltd. (“EMG,” see Note 4) in June 2004. Due to significant operating losses of the segment subsequent to the acquisition, we determined that there had been a significant adverse change to that acquired business. We determined that the $447,000 of goodwill associated with this business segment had been impaired and as a result, the entire amount of goodwill was written off to impairment of goodwill and intangible assets during the year ended April 30, 2005. The fair value of the reporting unit was estimated using the expected present value of future cash flows.

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Other Intangible Assets

Information regarding our intangible assets (other than goodwill) is as follows (in thousands):

	April 30,
	2006			2005
Gross carrying amount:
Trace and bulk detection technology	$	273		$	273
Customer lists—Semiconductor products and services	50			50
Customer base—Security services	431			—
	754			323
Accumulated amortization:
Trace and bulk detection technology	(93		)	(67		)
Customer lists—Semiconductor products and services	(32		)	(15		)
Customer base—Security services	(138		)	—
	(263		)	(82		)
	$	491		$	241

The customer base intangible asset acquired during the year ended June 30, 2006, relates to our acquisition of PPSC in May 2005 (see Note 4).

On September 14, 2001 we entered into a perpetual, exclusive technology license agreement with Silicon Evolution, Inc. (“SEI”) whereby we issued 500,000 shares of common stock (valued at $590,000) for the right to indefinitely use intellectual property assets owned or leased by SEI. In our fiscal year 2005 and in connection with our ongoing business review of our semiconductor operations, we determined that over the years SOI technology had been substantially modified to adapt to our current manufacturing plant and that the current processes are substantially removed from those acquired from SEI. As a result, an impairment loss for the then unamortized balance of $428,000 was recognized in the impairment of goodwill and intangible assets caption during the year ended April 30, 2005. The estimated fair value was determined using the expected present value of future cash flows. The impaired intangible asset relates to the semiconductor products and services reportable segment.

Amortization expense for the years ended April 30, 2006 and 2005, was $181,000 and $87,000, respectively. Estimated amortization expense for the intangible assets on our April 30, 2006 balance sheet for the fiscal years ended April 30, is as follows (in thousands):

2007	$	188
2008	172
2009	34
2010	27
2011	27
	$	448

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NOTE 4—SIGNIFICANT ACQUISITIONS AND COMBINATIONS

Acquisition of Business and Assets of Encompass Materials Group, Ltd.

On June 11, 2004, we acquired the business and assets of EMG, which was engaged in the business of manufacture and reclamation of silicon wafers. The results of the operations associated with the acquired assets have been included in the consolidated financial statements since that date. The aggregate purchase price was $2,920,000, which consisted of a $1,700,000 promissory note, 731,930 shares of our restricted common stock (valued at $1,171,000 based upon the fair market value of the common stock on June 11, 2004) and $49,000 of legal and accounting fees.

Acquisition of Protection Plus Security Corporation

On May 16, 2005, we signed and completed an agreement to acquire PPSC, a New York City based corporation that provides advanced security services. The results of PPSC’s operations have been included in the consolidated financial statements since that date. We acquired PPSC to enhance our product offerings in the homeland security market.

We acquired all of the outstanding equity securities of PPSC for a total price of $3,842,000. Of the purchase price, we paid $2,500,000 in cash and issued 506,527 shares of our restricted stock to the sellers. The number of shares issued was based on $1,125,000 (per the stock purchase agreement) divided by the average closing bid price on the Nasdaq Small Cap Market on each of the ten consecutive trading days ending four business days prior to the closing ($2.22 per share). The issued shares were then valued under purchase accounting using a measurement date of May 16, 2005, the day the acquisition was contractually agreed to and also consummated. The closing bid price for our common stock on the Nasdaq Small Cap Market on the measurement date was $2.55 per share, yielding a valuation of the shares issued for the acquisition of $1,292,000. We paid the purchase price to the two owners of PPSC, each of whom represented to us that he was an accredited investor and was acquiring the shares for investment purposes only and without a view toward further distribution. In addition, we paid $98,000 in legal and accounting fees. These payments, net of a small amount due from the seller, increased the effective purchase price that was allocated to the acquired tangible and intangible assets.

The stock was price protected for the benefit of the former owners of PPSC. The price protection provision would have provided a cash benefit to them if the as-defined market price of our common stock was less than $2.22 per share at the time they could first sell the shares (as defined, either due to their inclusion in an effective registration statement or pursuant to SEC Rule 144). On March 30, 2006, we entered into an agreement with the former owners of PPSC to settle this price protection provision. In exchange for 200,000 shares of common stock and forgiveness of our receivable from them in the amount of $64,000, the price protection clause was settled in full. The price protection clause and its ultimate settlement are deemed to be contingent consideration where the contingency is based on our common stock price. No adjustment to the cost of acquiring PPSC has been recorded. We recorded the fair value of the additional consideration issued ($282,000 for the shares of common stock based on a closing market price of $1.41 for our common stock on the date of the settlement and $64,000 for the forgiveness of the receivable from the former owners), however, the amount previously recorded for our common stock issued at the date of acquisition was simultaneously reduced. The net impact of the settlement was a reduction of $64,000 in the recorded amount of the cumulative common stock shares associated with the transaction, from the original amount of $1,292,000 to the final amount of $1,228,000.

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The following table summarizes (in thousands) the final fair values of the assets acquired and liabilities assumed at the date of acquisition.

Current assets	$	1,473
Property and equipment	11
Intangible assets—customer base	431
Goodwill	3,631
Total assets acquired	5,546
Current liabilities	(1,445		)
Long-term liabilities	(259		)
Net assets acquired	$	3,842

The $3,631,000 of goodwill was assigned to the security services segment and is not expected to be deductible for tax purposes. The $431,000 of intangible assets relates to the acquired customer base and is being amortized ratably over its estimated life of three years. As of April 30, 2006, the unamortized balance of the intangible asset is $293,000. There was no in-process research and development acquired in this transaction.

The following table summarizes our results of operations (in thousands) for the years ended April 30, 2006 and 2005, as if the acquisition of PPSC had occurred on May 1, 2005 and 2004, respectively. There have been no adjustments made to the historical results of PPSC.

	Year Ended
	April 30,
	2006			2005
Pro forma revenues	$	24,230		$	23,249
Pro forma net loss attributable to common stockholders	$	(32,426	)	$	(16,402	)
Pro forma net loss per share attributable to common stockholders—basic and diluted	$	(1.00	)	$	(.71	)

The pro forma information is presented for informational purposes only and is not necessarily indicative of the results of operations that actually would have been achieved had the acquisition been consummated as of that time, nor is it intended to be a projection of future results.

NOTE 5—EQUITY METHOD INVESTMENT

On December 1, 2005, we increased our equity ownership interest in Institut fur Umwelttechnologien GmbH (“IUT”), an entity located in Germany, from approximately 8% to 30% in exchange for cash consideration of approximately $336,000 (EUR 284,400). The Share Transfer Agreement also contemplates a potential further capital increase for IUT in the cumulative amount of approximately $230,000, of which approximately $70,000 would be required to be contributed by us in order to retain our 30% ownership interest. If the IUT shareholders approve the potential capital increase, we would have the right to fulfill our obligation by contribution of our common stock in lieu of cash. The other IUT shareholders would have the right to fulfill their respective obligations by contribution of their respective outstanding shareholder loans in lieu of cash. As of April 30, 2006, no additional capital contributions have occurred.

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We are now able to exert significant influence, but not control, over the operations of IUT and, accordingly, we are applying the equity method of accounting for the investment. Prior to the December 2005 equity purchase, the investment was accounted for under the cost method. An adjustment to prior period financial statements to restate our then-held investment from the cost method to the equity method would not be material. As of April 30, 2006, the difference between the carrying value of the IUT investment and the amount of underlying equity in the net assets of IUT is approximately $74,000. We will monitor our investment in IUT and recognize, if ever existing, a loss in value which is deemed to be other than temporary.

In June 2004, we entered into a research and development agreement with IUT, which contemplated the funding of certain projects of up to $4,000,000 over several years. The work was being funded in steps and was based upon the completion of various milestones, as defined. We had no obligation to fund any work under the agreement unless we had approved such effort. We recognized research and development expense related to the IUT funding of $1,463,000 and $650,000 for the years ended April 30, 2006 and 2005, respectively. In April 2006, this agreement was canceled and we entered into a new research and development agreement with IUT whereby we agreed to use the services of IUT for certain development work on a project-by-project basis.

In April 2006, we also entered into a one-year sales, marketing and licensing agreement with IUT whereby we granted them non-exclusive rights to be our sales representative in Europe and the Middle East (the “Sales Territory”). We have also granted them the right, under certain circumstances, to brand products sold in the Sales Territory as a product of Isonics Corporation or a product of IUT. If IUT selects to sell products under an IUT brand, we will make commercially reasonable efforts to provide them such products. We have also allowed for IUT to manufacture certain products for sale by them. IUT must meet quality control of such products to a level which is reasonably acceptable to us. Failure of IUT to maintain the quality control of the products may lead to a revocation of our license to manufacture the products.

In April 2006, in exchange for the 15% of IUTDT formerly owned by IUT and of contractually clarifying our ownership of certain trace and bulk detection technology, we granted IUT a royalty of 2% of the net selling price of product produced through technology developed under the research and development agreement. We now own 100% of IUTDT, an entity which holds intellectual property but which has no operations.

Additionally, IUT has, in the past, produced carbon-14 precursors for us that we resold in the market place. Total purchases from IUT for this product during the years ended April 30, 2006 and 2005 were $279,000 and $353,000, respectively. However, as of April 30, 2006, no further carbon-14 purchases are expected to be made from IUT.

NOTE 6—DEVELOPMENT AND LICENSING AGREEMENT

On December 5, 2005, we approved a development plan that resulted in us becoming obligated under a Development & Licensing Agreement (the “Agreement”) entered into with Lucent Technologies, Inc. (“Lucent”) in September 2005. Under this Agreement, the two companies will endeavor to develop a next-generation infrared imaging and night vision surveillance technology at Lucent’s micro electro-mechanical systems and nanotechnology fabrication facility. The Agreement provides for us to receive an exclusive right, except for certain rights reserved by Lucent, to make, use and sell licensed products arising from technology developed under the Agreement. In exchange for this license, we will fund Lucent’s development efforts for the project through the periodic payment over a two and one-half year period of a

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development fee totaling $12,000,000. We paid $2,000,000 under this agreement during the year ended April 30, 2006 and have charged $2,500,000 to research and development expense during the corresponding period. The balance will be paid in $1,000,000 increments approximately every three months thereafter (including a payment of $1,000,000 made on June 2, 2006). These development payments will continue to be expensed to research and development expense as the expenses are incurred. We have the right to terminate the development project for any reason from time-to-time, so long as termination is prior to the first commercial sale of a licensed product. When, if ever, commercial sales of developed products commence, a royalty payment based on revenue will be due Lucent (subject to a minimum semi-annual cumulative royalty payment amount). Additionally, if Lucent expends substantial sales effort to accomplish a sale, we will also pay them a sales referral fee based on revenue. Lastly, in order to retain the exclusivity of our license for the developed technology, we have agreed to pay an annual exclusivity payment commencing the October 1 following the first commercial sale or the end of the development project.

NOTE 7—ASSETS HELD FOR SALE

During the first quarter of fiscal year 2006, management committed to a plan to sell specific production equipment in our semiconductor products and services segment. Based on ongoing analysis of the semiconductor operations, these assets were deemed to be obsolete, unnecessary to support a more focused product portfolio or incompatible with the future direction of the segment’s operations. We have listed these assets for sale and are actively attempting to sell them. Immediately prior to the decision to sell the assets, the equipment had a cumulative net book value of approximately $1,026,000. In the first and fourth quarters of fiscal year 2006, certain assets have been written down to their fair value, less selling costs, yielding a cumulative impairment loss on assets held for sale in the amount of $466,000. The assets held for sale are now classified in current assets at the lower of their book value or fair value, less selling costs, in the cumulative amount of $560,000. During the year ended April 30, 2006, none of the assets held for sale were sold.

NOTE 8—CAPITAL LEASES

We lease certain production equipment under agreements that are classified as capital leases. The cost of equipment under capital leases is included in the consolidated balance sheets as property and equipment and was $70,000 and $244,000 at April 30, 2006, and April 30, 2005, respectively. Accumulated amortization of the leased equipment at April 30, 2006, and April 30, 2005, was approximately $43,000 and $91,000, respectively. Amortization of assets under capital leases is included in depreciation expense.

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The following represents the future minimum lease payments remaining under capital leases as of April 30, 2006 (in thousands):

Year ending April 30,
2007	$	19
2008	19
2009	19
Total minimum lease payments	57
Less: amount representing interest	9
Present value of minimum lease payments	48
Less: current portion of obligation under capital leases	14
Long term obligation under capital leases	$	34

NOTE 9—BORROWINGS

Commercial Debt, Line of Credit and Letter of Credit

We currently have three active lending facilities with financial institutions. Upon acquisition of PPSC in May 2005, there remained $376,000 on a bank term loan PPSC held with HSBC Bank USA, which is payable monthly through April 2008 and bears an interest rate of 6.90%. As of April 30, 2006, the outstanding balance on the loan is $259,000, of which $125,000 is a current liability. The note is not secured by collateral and bears no significant financial covenants. A line of credit bearing an interest rate of 10.1% is available to Chemotrade in the amount of 100,000 Euros (approximately $128,000). There were no borrowings under the line of credit during the years ended April 30, 2006 and 2005, respectively. A letter of credit for $50,000 formerly held by Chemotrade and relating to imports and exports expired on April 30, 2006. In March 2006, we entered into a note payable in the amount of $49,000 to fund the purchase of a fixed asset. The note bears an interest rate of 9.66% and is payable monthly through February 2011.

Note Issued in Connection with EMG Acquisition

In connection with the acquisition of the business and assets of EMG in June 2004, we issued a $1,700,000 promissory note that is collateralized by the assets acquired by us and certain other assets owned by us relating to our pre-existing semiconductor operations. The note was originally payable over 33months, through March 2007, with an interest rate of 6% and has a current outstanding balance as of April 30, 2006, of $653,000. The note is payable by our subsidiary, IVI. In accordance with the terms of the acquisition of the business and assets of EMG, we have guaranteed all payments of such loan should IVI be in default at any point over the life of the loan.

8% Convertible Debentures

Initial Accounting

On February 24, 2005, we completed a private placement pursuant to which we issued to accredited investors 8% convertible debentures (the “8% Debentures”) in the aggregate principal amount of $22,000,000 and common stock warrants (collectively, the “Warrants”) granting the right to purchase a total of 1,540,000 common shares. The Debentures are convertible by the holders into shares of our common stock at any time and at a conversion price of $5.00 per share (the “Conversion Price”). This Conversion Price will be adjusted upon the occurrence of any stock dividends, stock splits, pro rata

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distributions, or fundamental transactions as described in the 8% Debenture agreement. The Warrants are exercisable for a period of three years and at an exercise price of $6.25 per share. Under specified conditions, including the lack of an effective registration statement for the underlying shares, and after a period of one year from issuance, the Warrants may be exercised by means of a cashless exercise. This provision permits the warrant holder to cancel a portion of the warrants at the then current share price to receive the balance of the warrants in common stock without payment to us. Further, the Warrants contain a ratchet provision triggered by a subsequent equity sale. Under this provision, the warrant exercise price would be reduced to the effective price per share (or effective exercise price per share) of the subsequent equity sale. Concurrently, the number of warrants would be adjusted such that the aggregate exercise price would be equal to the aggregate exercise price prior to adjustment. See Note 17—Subsequent Events for further discussion of the warrant ratchet provision.

Interest on the 8% Debentures was payable quarterly at the end of each calendar quarter until March 1, 2006, at which time all accrued and unpaid interest became payable the first day of each calendar month thereafter. We commenced monthly principal payments on March 1, 2006, whereby we pay 1¤12 of the original principal balance on the first day of each calendar month on all 8% Debentures outstanding at the time of each payment. The 8% Debentures will mature on February 28, 2007. We may not prepay the principal amount of the 8% Debentures without the consent of the holders (see Note 17—Subsequent Events for information on prepayments which have occurred subsequent to April 30, 2006).

Both the principal and interest are payable, at our option, in common stock or cash, subject to various requirements. If we choose to make a scheduled principal payment by issuing common stock, and all requirements to do so are met, the conversion price will be the lesser of the then Conversion Price or 88% of the average of the ten final bid prices ending on the trading day immediately prior to the monthly redemption date. If we choose to make a scheduled interest payment by issuing common stock, and all requirements to do so are met, the conversion price will be the lesser of the then Conversion Price or the lesser of (i) 90% of the average of the twenty final bid prices ending on the trading day immediately prior to the applicable interest payment date or (ii) 90% of the average of the twenty final bid prices ending on the trading day immediately prior to the date the applicable interest payment shares are issued and delivered if after the interest payment date.

The 8% Debentures are now redeemable at our option, in whole or in part, if the closing prices for any twenty days in a thirty consecutive trading day period (such period commencing after February 25, 2006) exceeds 150% of the then Conversion Price.

The 8% Debentures and the Warrants have certain limitations on our ability to issue shares to the holders of the 8% Debentures and Warrants (the “Holders”). Under the terms of the 8% Debentures and the Warrants, we are prohibited from issuing shares of our common stock to the holders of the 8% Debentures (upon conversion, in payment of interest, or in redemption or payment of the 8% Debentures) and the Warrants (upon exercise) if: (a) the issuance would result in any Holder owning more than 4.99% of our outstanding common stock (although the holders can waive this provision upon more than 60 days’ notice to us) or (b) the issuance would result in more than 5,514,601 shares having been issued pursuant to the Debentures and the Warrants (19.999% of the total number of shares outstanding on February 24, 2005) unless our shareholders have approved the transaction as required by the Nasdaq rules. As our shareholders approved the transaction on October 25, 2005, the 19.999% contractual limitation as to the number of shares that can be issued is no longer be applicable, although the 4.99% limitation will continue

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to be applicable until (if ever) waived by a the respective Holder. Waiver by one Holder does not eliminate the provision as to all Holders.

As a result of a freestanding registration rights agreement, we had an obligation to register the shares underlying the 8% Debentures and Warrants (the registration statement became effective on July 26, 2005) and have a continuing obligation to keep the registration statement continuously effective. Failure to meet this obligation, as defined, will result in our incurring liquidated damages in the amount of 1.0% of the principal amount of the purchase price per month for any shares derived from the Debentures or Warrants and then held by each of the holders of the 8% Debentures at the time liquidated damages are payable.

Additionally, other events, as defined in the 8% Debenture agreement, may also allow the 8% Debenture holders to declare us in default. Remedies for an event of default include the option to accelerate payment of the full principal amount of the 8% Debentures, together with interest and other amounts due, to the date of acceleration. The principal amount of the 8% Debentures shall be equal to 130% of the then-principal amount of the 8% Debentures plus all interest and other amounts due or a conversion calculation, whichever is higher.

We evaluated the embedded conversion feature in the 8% Debentures and concluded that the feature does not require classification as a derivative instrument because the feature would be classified in equity if it were a freestanding instrument and, therefore, meets the scope exception found in SFAS 133 Accounting for Derivative Instruments and Hedging Activities (“SFAS 133”). Included in this evaluation is the conclusion that the Debentures meet the definition of “conventional convertible debt instrument” and, therefore, the embedded conversion feature is not subject to the more onerous provisions of EITF 00-19. Further, we evaluated the detachable Warrants and concluded that the warrants also meet the scope exception found in SFAS 133 and, therefore, are appropriately classified in equity. Lastly, we evaluated the freestanding registration rights agreement (discussed above) and concluded that it meets the definition of a derivative instrument under SFAS 133. The fair value of this derivative liability is immaterial based on a probability-weighted, discounted cashflow evaluation of its terms.

We allocated the proceeds received between the 8% Debentures and the Warrants based on the relative fair value of each instrument. The $3,525,000 allocated to the Warrants was recorded as additional paid-in capital and as a corresponding reduction to the carrying value of the 8% Debentures. In addition, in accordance with EITF 00-27 “Application of Issue No. 98-5 to Certain Convertible Instruments” we calculated the intrinsic value of the conversion option by using the effective conversion price based on the proceeds allocated to the 8% Debentures. As a result, we determined that the value of the beneficial conversion feature (based upon a $5.00 conversion price) contained in the 8% Debentures to be $1,720,000. This amount was recorded as additional paid-in capital and as a corresponding reduction to the carrying value of the 8% Debentures. The cumulative discount on the 8% Debentures as originally booked is being amortized to interest expense over the term of the 8% Debentures using the effective interest method at an effective interest rate of 19%. During the year ended April 30, 2006, $4,270,000 of this discount was amortized to interest expense.

In connection with completing the financing arrangement, we paid a placement agent (i) a 6.5% fee consisting of $660,000 and a $770,000 convertible debenture and (ii) a Common Stock Purchase Warrant granting the right to purchase 53,900 shares of common stock (valued at $142,000 using the Black-Scholes pricing model). The convertible debenture and related debt issuance cost was measured at the fair value of the convertible debenture, $745,000. The total debt issuance costs of $1,547,000 were capitalized and are

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being amortized to amortization of debt issuance costs over the life of the convertible debenture using the effective interest method. During year ended April 30, 2006, $1,260,000 of the capitalized debt issuance costs was amortized to expense. At April 30, 2006, the unamortized debt issuance cost is $121,000. The terms of both the convertible debenture and the warrant are the same as those for the accredited investors, as described above. The discount on the convertible debenture is being amortized to interest expense over the term of the convertible debenture using the effective interest method.

Payment of Principal and Interest in Shares of Common Stock

In our third fiscal quarter of our year ended April 30, 2006, we determined that it had become probable that we would repay the principal portion of the 8% Debentures in common stock instead of cash. As such, we commenced accreting the aggregate 8% Debentures balance in our consolidated balance sheet to the fixed monetary amount of the obligation when settled in common stock. If paid in common stock, the fixed monetary amount of principal repayment would have been $25,875,000, as compared to $22,770,000 if paid in cash, the difference being due to the aforementioned fixed discount applied to the price of our common stock in the calculation of the number of common shares due for each principal payment, as defined. As a result, for the year ended April 30, 2006, we recorded additional interest expense of $1,392,000, representing the increased accretion resulting from the probable repayment of the 8% Debentures principal in common stock.

Having met all requirements to allow us to do so, we elected to make the quarterly interest payment due on September 30, 2005, in shares of our common stock. Accordingly, we issued 200,600 shares of common stock in settlement of our interest obligation for the quarter ended September 30, 2005. A charge in the amount of $506,000 was recorded as interest expense related to the share issuance, an amount that represents the fixed monetary amount of the interest obligation when settled in stock (as opposed to a fixed monetary amount of $455,000 if the interest payment had been made in cash).

Having met all requirements to allow us to do so, we elected to make the monthly principal and interest payments due for our 8% Debentures on March 1, 2006 and April 1, 2006, in shares of our common stock. Accordingly, we issued a total of 1,347,361 and 1,606,270 shares of common stock, respectively, in settlement of (1) our repayment of 1¤12 of the original principal balance (an amount of $2,156,000 for each payment which represents the fixed monetary amount of the payment when made in stock, as compared to a fixed monetary amount of $1,897,000 if the payment had been made in cash) and (2) our interest obligation for the two months ending February 2006 and the one month of March 2006, respectively. In our statement of operations for the year ended April 30, 2006, charges in the amount of $337,000 and $89,000, respectively, were recorded as interest expense related to the share issuance, an amount that represents the fixed monetary amount of the interest obligation when settled in stock (as compared to a fixed monetary amounts of $304,000 and $79,000, respectively, if the interest payments had been made in cash).

See Note 17—Subsequent Events for additional information about payments on our Debentures made in shares of our common stock.

Induced Conversion

On March 9, 2006, holders of our 8% Debentures converted outstanding principal in the amount of $9,000,000 into 6,206,897 shares of our common stock. We gave the holders of all 8% Debentures the temporary right to convert a portion or their entire principal amount into shares of our common stock at a

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temporary conversion price of $1.45 per share (a reduction from the prior conversion price of $5.00 per share). At the close of business on March 8, 2006, the closing price for our common stock was $1.64 per share. Additionally, we issued 10,036 shares of our common stock in payment of interest then due on the converted principal amount. We have accounted for this transaction by applying the induced conversion principles set out in SFAS No. 84 Induced Conversions of Convertible Debt—An Amendment of APB Opinion No. 26 (“SFAS 84”). This standard sets out the method of accounting for conversions of convertible debt to equity securities when the debtor induces conversion of the debt by offering additional securities or other consideration to convertible debt holders. In accordance with SFAS 84, we calculated the expense equal to the fair value of all securities transferred in the transaction in excess of the fair value of securities issuable pursuant to the original conversion terms. As a result, for the year ended April 30, 2006, we recognized debt conversion expense in the amount of $7,227,000.

The following represents the scheduled maturities of long-term debt, excluding capital leases, for amounts on our balance sheet as of April 30, 2006 (in thousands):

Year ending April 30,
2007	$	11,218
2008	143
2009	10
2010	10
2011	10
Long-term obligations	$	11,391

NOTE 10—COMMITMENTS AND CONTINGENCIES

As of April 30, 2006 we had commitments outstanding for capital expenditures of $1,470,000.

Operating lease commitments

In February 2006, we renewed a month-to-month lease (at a rate of $3,077 per month) with the Colorado School of Mines Research Institute to continue leasing office and storage space at our current location.

We rent additional office and production facilities under operating leases expiring through September 2013. Rent expense for operating leases was $468,000 and $308,000 for the years ended April 30, 2006 and 2005, respectively. Future minimum annual operating lease commitments are as follows (in thousands):

Year ending April 30,
2007	$	323
2008	280
2009	175
2010	180
2011	193
	$	1,151

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Purchase commitment

In December 2003 we extended our production, marketing and sales agreement with our supplier of oxygen—18 through July 2010. The agreement originally required the purchase of certain quantities at prices to be determined as a percentage of the then prevailing market price. In June 2006, we renegotiated the pricing terms with our supplier to a fixed price negotiated annually in advance. Additionally, we have moved from the long-term purchase obligations in the plan to successive one-year purchase commitments set annually in advance. Under the terms of the agreement and communications with our supplier since entering the agreement, we estimate that our purchase obligation (based on estimates of future market prices) is approximately $5,100,000 through the end of the agreement. During fiscal years 2006 and 2005, we made purchases under this agreement of $2,638,000 and $3,380,000, respectively.

Other contingencies

In October 2004, we received an inquiry from the Nasdaq Listing Investigation Unit (the “Nasdaq inquiry”), which included questions regarding our press releases, our public relations advisors and certain other disclosures that we have made publicly. In December 2004, we received an informal request for information from the SEC which asked questions similar to those posed in the Nasdaq inquiry, but which also asked about the termination of Grant Thornton LLP as our independent auditor. We have provided information, which we believe to be responsive to all of the questions posed in the Nasdaq inquiry and to the SEC. We have not received further requests for information from either entity since January 2005. We have no knowledge, however, whether either investigation will result in any action against us, which action may materially and adversely impact us, and our ability to carry on our business.

In June 2006, we received notification from Nasdaq that we have failed to meet certain listing requirements (including stockholders’ equity of at least $2.5 million or market value of listed securities of at least $35 million). We were provided until July 26, 2006 to regain compliance or face delisting procedures. Compliance can be obtained by, among other things, having stockholders’ equity in excess of $2.5 million in a company’s most current filing with the SEC. Within these consolidated financial statements, our stockholders equity as of April 30, 2006, is $2,643,000, which we believe will be sufficient to satisfy the issues raised by Nasdaq in June 2006. On July 10, 2006, we received a second letter from Nasdaq that advised us that the minimum bid price of our common stock had closed at less than $1.00 per share over the previous 30 consecutive business days, and, as a result, did not comply with Marketplace Rule 4310(c)(4). Therefore, in accordance with Marketplace Rule 4310(c)(8)(D), we were provided 180 calendar days, or until January 8, 2007, to regain compliance with the Rule (which consists of the bid price of our common stock closing at $1.00 per share or more or a minimum of 10 consecutive business days). If we fail to obtain compliance, as long as we meet the Nasdaq Capital Market initial listing criteria as set forth in Marketplace Rule 4310(c), except for the bid price requirement, we will be granted an additional 180 calendar days to obtain compliance.

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NOTE 11—INCOME TAXES

Deferred tax assets (liabilities) are comprised of the following (in thousands):

	April 30,
	2006			2005
Deferred tax assets
Accruals and expenses deductible in future periods	$	4,094		$	1,773
Net operating loss and credit carryforwards	16,629			9,570
Total deferred tax assets	20,723			11,343
Valuation allowance	(20,723		)	(11,343		)
	—			—
Deferred tax liabilities
Amortization and depreciation	—			—
	$	—		$	—

Income tax expense (benefit) consists of the following (in thousands):

	April 30,
	2006		2005
Current
Federal	$	—	$	—
State	—		—
Foreign	—		—
	—		—
Deferred
Federal	—		—
State	—		—
Foreign	—		—
	—		—
	$	—	$	—

A reconciliation of our effective tax rate to the federal statutory tax rate of 34% follows (in thousands):

	April 30,
	2006			2005
Expected benefit at federal statutory rate	$	(10,996	)	$	(5,160	)
State taxes net of federal benefit	(1,003		)	(470		)
Foreign income taxed at different rates	23			233
Warrant exercise tax deductions in excess of book expense	(29		)	(1,277		)
Debt conversion expense	2,457			—
Other items	168			189
Change in valuation allowance	9,380			6,485
	$	—		$	—

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The federal net operating loss (“NOL”) carryforward of approximately $42,367,000 as of April 30, 2006 expires on various dates through 2026. Internal Revenue Code Section 382 places a limitation on the amount of taxable income which can be offset by NOL carryforwards after a change in control (generally greater than 50% change in ownership) of a loss corporation. Generally, after a change in control, a loss corporation cannot deduct NOL carryforwards in excess of the Section 382 limitation. Due to these “change in ownership” provisions, utilization of NOL carryforwards may be subject to an annual limitation regarding their utilization against taxable income in future periods. We have not performed a Section 382 analysis. However, if performed, Section 382 may be found to limit potential future utilization of our NOL carryforwards.

Chemotrade has a net operating loss carryforward of approximately $3,645,000. Under current German tax law, the carryforward is limited to 1 million Euros of net income in a given year without restriction. Any remaining loss can be offset against up to 60% of the net income exceeding the limit.

We have established a full valuation allowance against the deferred tax assets because, based on the weight of available evidence including our continued operating losses, it is more likely than not that all of the deferred tax assets will not be realized.

NOTE 12—EQUITY INSTRUMENTS ISSUED FOR SERVICES OR SETTLEMENT OF LITIGATION

In March 2006, we entered into a financial advisory services agreement with Harborview Capital Management LLC, whereby we issued 100,000 shares of restricted common stock (valued at $140,000 based on the market price of our common stock on the date of grant). The common stock was recorded as prepaid consulting expense, to be amortized ratably over the expected service period of approximately ten months. As of April 30, 2006, $28,000 has been expensed to selling, general and administrative expenses.

In September 2005, we entered into a financial advisory services agreement with Clayton Dunning Capital Partners, Inc., whereby we issued a common stock warrant (valued at $152,000 using the Black-Scholes pricing model) to purchase 100,000 shares of common stock at $2.81 per share. The common stock warrant vested immediately, expires on September 8, 2007, and was recorded as prepaid consulting expense, to be amortized ratably over the expected service period of one year. As of April 30, 2006, $101,000 has been expensed to selling, general and administrative expenses. In May 2006, we granted Clayton Dunning Capital Partners, Inc. a warrant to purchase an additional 50,000 shares of common stock at $1.05 per share.

In September 2005, we entered into a consulting agreement with an individual to provide management services in our semiconductor products and services segment, whereby we issued a common stock warrant (valued at $75,000 using the Black-Scholes pricing model) to purchase 50,000 shares of common stock at $2.84 per share. The common stock warrant vested immediately, expires on August 16, 2007, and was recorded as prepaid consulting expense, to be amortized ratably over the expected service period of eight months. As of April 30, 2006, the entire $75,000 has been expensed to selling, general and administrative expenses.

On October 7, 2004, we established HSDC, a wholly owned Delaware corporation to consolidate our efforts in the homeland security market. In connection with the establishment of HSDC, we created an advisory board which provides guidance and advice to HSDC in matters of technology, business and applications as we develop technologies and products for the homeland security marketplace. In November 2004 we issued 300,000 common stock warrants (valued at $669,000 using the Black-Scholes pricing model) to three newly hired advisory board members. The common stock warrants vested

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immediately, are exercisable at $4.00 per share, expire on November 1, 2007 and were expensed to selling, general and administrative expenses during the year ended April 30, 2005. In May 2005 (see the discussion of PPSC in Note 4) we acquired an entity owned in part by one of our advisory board members.

On October 22, 2003, we entered into a non-exclusive investment banking agreement with vFinance, Inc. (“vFinance”) whereby we issued a common stock warrant (valued at $369,600 using the Black-Scholes pricing model) to purchase 560,000 shares of our restricted common stock at $1.25 per share. The common stock warrant (which was exercised in its entirety during the year ended April 30, 2005) vested immediately, would have expired on April 30, 2006, and was considered full payment for services to be provided through June 30, 2004. The common stock warrant was expensed to selling, general and administrative expenses ratably over the eight-month period beginning November 1, 2003. We recognized expense of $92,000 during the year ended April 30, 2005.

On March 25, 2005, Prime International Equities, LLC (“the Plaintiff”) filed a complaint against us in the United States District Court for the District of Colorado (Civil Case No. 05-F-562 (BNB). On October 31, 2006, a settlement agreement was signed in which no liability or wrongdoing was admitted. In return for dismissal of the complaint, we paid the Plaintiff $50,000 and issued a common stock warrant (valued $109,000 using the Black-Scholes pricing model) to purchase 120,000 shares of common stock at $2.40 per share. The common stock warrant vested immediately, expires on December 29, 2006, and was recorded as a selling, general and administrative expense in the three months ended October 31, 2005. Further, the common stock warrant included a registration rights clause whereby we agreed to use our best efforts to include the common stock underlying the warrant in a registration statement by not later than May 31, 2006. We included the shares underlying the warrant in a registration statement which was declared effective in April 2006.

NOTE 13—STOCKHOLDERS’ EQUITY

Preferred Stock Authorized

Originally 10,000,000 shares of preferred stock were authorized for issuance, while at April 30, 2006, there were 7,650,000 shares remaining which may be issued. As of April 30, 2006, there are no outstanding shares of any series of our preferred stock, but there remain 2,500,000 shares designated as Series B Preferred Stock, 22,000 shares designated as Series C Preferred Stock, 32,950 shares designated as Series D Preferred Stock and 33,000 shares designated as Series E Preferred Stock. The designation of rights, preferences, privileges and restrictions of the Series C Preferred Stock, Series D Preferred Stock, and Series E Preferred Stock will be cancelled by filing an amendment to our articles of incorporation with the California Secretary of State and thereby the shares will be returned to undesignated “blank check” preferred stock. Our authorized preferred stock balance as of April 30, 2005, has been amended from 7,622,516 previously reported to 7,656,666 in order to recognize the impact of California state law (our state of incorporation) on our authorized preferred stock balance.

Series E Convertible Preferred Stock

On October 4, 2004 we completed a financing arrangement whereby we issued 33,000 shares of our Series E Convertible Preferred Stock (“Series E Stock”) and 614,000 common stock warrants to Asset Managers International, Ltd. (“AMI”) for $3,300,000. In addition, we paid AMI $251,000 in due diligence fees and related expenses. Each common stock warrant is exercisable for one share of common stock through October 4, 2007. One-half (307,000) of the common stock warrants had an exercise price of

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$1.24 per share while the remaining half (307,000) of the common stock warrants had an exercise price of $1.35 per share. As of April 30, 2006, common stock warrants exercisable for a total of 153,500 shares of common stock remain outstanding. On July 27, 2005, 23,000 shares of Series E Stock were converted into 1,854,838 shares of common stock. On October 19, 2005, the remaining 10,000 shares of Series E Stock were converted into 806,452 shares of common stock. As a result, as of April 30, 2006, there were zero shares of Series E Stock outstanding.

We had an obligation to register the shares underlying the Series E Stock and the common stock warrants, including the obligation to file a registration statement by November 7, 2004 and to obtain effectiveness of the registration statement within 70 days after the filing of the registration statement. We incurred a penalty under this obligation in the amount of $2,200 per day until such time that the registration was filed and declared effective. Accordingly, an expense in the amount of $368,000 was recognized in the year ended April 30, 2005.

We allocated the proceeds received between the Series E Stock and related warrants based on the relative fair value of each instrument. In addition, in accordance with EITF 00-27 “Application of Issue No. 98-5 to Certain Convertible Instruments” we calculated the intrinsic value of the conversion option by using the effective conversion price based on the proceeds allocated to the convertible instrument. As a result, we determined that the value of the beneficial conversion feature (based upon a $1.24 conversion price) contained in our Series E Stock to be $1,206,000, which has been reported as a deemed dividend on preferred stock for the year ended April 30, 2005.

Series D Convertible Preferred Stock

On April 5, 2004 we completed a financing arrangement whereby we issued 32,950 shares of our Series D Convertible Preferred Stock (“Series D Stock”) and 600,000 common stock warrants to accredited investors who are affiliated with Mercator Advisory Group, LLC (“MAG”) for $3,295,000. In addition, we paid MAG $230,000 in due diligence fees and related expenses and issued them a common stock warrant to acquire 2,400,000 shares of our common stock. The common stock warrants, which were exercisable for one share of common stock for between $1.10 and $1.30 per share, were exercised in their entirety during the year ended April 30, 2005. During the year ended April 30, 2005, 32,150 shares of Series D Stock were converted into 2,922,726 shares of common stock. On May 19, 2005, the remaining 800 shares of Series D Stock were converted into 72,727 shares of common stock. As a result, as of April 30, 2006, there were zero shares of Series D Stock outstanding.

Series C Convertible Preferred Stock

On January 27, 2004 we completed a financing arrangement whereby we issued 22,000 shares of our Series C Convertible Preferred Stock (“Series C Stock”) and 200,000 common stock warrants to accredited investors who are affiliated with MAG for $2,200,000. In addition, we paid MAG $200,000 in due diligence fees and related expenses and issued them a common stock warrant to acquire 227,701 shares of our common stock. Each common stock warrant (which were exercised in their entirety as of May 23, 2005) issued in this transaction is exercisable for one share of common stock at $1.25 per share and would have expired on January 27, 2007. During the year ended April 30, 2005, the remaining 9,000 shares of Series C Stock were converted (at $.95 per share) into 947,368 shares of common stock. As a result of these conversions, there were no shares of Series C Stock outstanding as of April 30, 2005.

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Series A Convertible Preferred Stock

The Series A Stock originally consisted of 1,830,000 shares issued with a liquidation preference of $1.50 per share. During the year ended April 30, 2005, 957,000 shares of Series A Convertible Preferred Stock (“Series A Stock”) were converted into 1,914,000 shares of common stock. As of April 30, 2005, there were 6,666 shares of Series A Stock outstanding convertible into 13,332 shares of common stock based upon the current conversion ratio. On August 9, 2005, we redeemed the remaining 6,666 outstanding shares of the Series A Stock. As a result, the holder no longer is able to convert the shares and the rights and preferences associated with the Series A Stock have been terminated. The holder is entitled to receive $1.50 for each share of the Series A Stock, an amount of approximately $10,000.

Stock Option and Purchase Plans

2005 Stock Option Plan

The 2005 Stock Option Plan authorized the grant to our key employees, officers, consultants or advisors of incentive and nonqualified stock options to purchase shares of our authorized but unissued common stock. The maximum number of shares of our common stock available for issuance under this plan is 3.5 million shares. As of April 30, 2006, there are 680,000 options outstanding and the maximum number of shares available for future grants under this plan is 2,820,000 shares. The exercise period shall not exceed ten years from the date of grant or three months following the date of termination of employment, whichever occurs earlier. The option price shall not be less than the fair market value of the common stock on the date of grant.

1996 Stock Option Plan

The 1996 Stock Option Plan authorized the grant of incentive and nonqualified stock options to our key employees, directors or consultants. The options generally expire ten years from the date of grant. In September 1997, the Board of Directors terminated the 1996 Stock Option Plan. As of April 30, 2006, there remain 151,429 options outstanding and zero shares are available for grant under the 1996 Stock Option Plan.

Directors’ Stock Option Plan

The 1998 Directors’ Plan provides that each person serving as a member of the Board, who is not an employee of Isonics, receive options to purchase 20,000 shares of common stock when such person accepts his position as a director and to receive an additional option to purchase 10,000 shares when such person is re-elected as a director provided such person is not an employee of Isonics at the time of election (such amount was increased to 20,000 shares upon reelection as a director effective May 1, 2006). The exercise price for the options is the quoted market price on the date of grant and the options are exercisable for five years from such date. The options granted under the directors’ plan vest immediately. In the event a director resigns or is not re-elected to the Board, failure to exercise the options within three months results in the options’ termination. As of April 30, 2006, options to purchase a total of 190,000 shares were outstanding under the directors’ plan.

Executive and Incentive Stock Option Plans

In November 1996 (and modified subsequently), the Board of Directors adopted the Executives’ Incentive and Incentive Stock Option Plans authorizing the granting of up to 1,000,000 and 500,000

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incentive and nonqualified stock options, respectively, to our key employees, directors or consultants. Effective November 13, 2001, our shareholders approved an increase in the authorized shares for the Executive and Incentive Stock Option Plans to 2,000,000 and 1,000,000, respectively. Incentive stock options are granted at a price not less than fair market value, and nonqualified stock options are granted at a price not less than 85% of the fair market value. Options are exercisable when vested, typically over four to five years and expire five to ten years after the date of grant. In April 2005, the Board of Directors terminated the Executives’ Incentive and Incentive Stock Option Plans. As of April 30, 2006, options to purchase a total of 1,912,503 shares remain outstanding and zero shares are available for grant under the Executive’s Incentive and Incentive Stock Option Plans.

Employee Stock Purchase Plan

The employee stock purchase plan has reserved 200,000 shares of our common stock for sale to all permanent employees who have met minimum employment criteria. Employees who do not own 5% or more of the outstanding shares are eligible to participate through payroll deductions. At the end of each offering period, shares are purchased by the participants at 85% of the lower of the fair market value of our common stock at the beginning or the end of the offering period. As of April 30, 2006, 78,209 shares have been issued under the plan. As of May 1, 2006, the Employee Stock Purchase Plan was terminated.

SFAS No. 123 Disclosures

We have adopted the disclosure-only provisions of SFAS No. 123, Accounting for Stock-Based Compensation. See Note 1 for the related pro forma disclosures, in accordance with SFAS No. 148, Accounting for Stock-Based Compensation—Transition and Disclosure. The following assumptions were applied for the SFAS No. 123 disclosure-only provision information included in Note 1.

For purposes of the pro forma disclosures, the fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions for the years ended April 30, 2006 and 2005, respectively; no expected dividends, volatility of 100%; risk-free interest rate of 4.0%; and expected lives of three to five years. A summary of the status of our stock option plans as of April 30, 2006 and 2005, and changes during the years ended on these dates is presented below.

			Weighted
			Average
	Number of		Exercise
	Shares		Price
Outstanding, April 30, 2004	1,745,647		$	1.39
Granted	1,410,000		2.70
Exercised	(93,000	)	1.19
Canceled	(216,000	)	2.86
Outstanding, April 30, 2005	2,846,647		1.93
Granted	525,000		2.13
Exercised	(419,115	)	0.84
Canceled	(18,600	)	2.19
Outstanding, April 30, 2006	2,933,932		$	2.12

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The weighted average fair value of options granted during the years ended April 30, 2006 and 2005 was $1.57 and $2.04, respectively. The fair value of the options granted was determined using the Black-Scholes model with the following weighted-average assumptions for fiscal 2006: expected life of 4.7 years, interest rate of 4%, volatility of 100% and no dividend yield.

The following information applies to options outstanding at April 30, 2006:

				Weighted
				Average Remaining
Range of	Number	Weighted Average		Contractual	Number	Weighted Average
Exercise Price	Outstanding	Exercise Price		Life (Years)	Exercisable	Exercise price
$.90 - $1.52	1,452,503	$	1.24	5.1	1,109,753	$	1.16
$1.69 - $3.50	1,006,429	$	2.21	6.4	685,179	$	2.28
$4.64	475,000	$	4.64	8.8	197,500	$	4.64
	2,933,932	$	2.12	6.2	1,992,432	$	1.89

Warrants

We have issued warrants in connection with debt offerings, private placements of both common and convertible preferred stock, our IPO, services, legal settlements and as consideration for concessions from lenders and vendors. A summary of the activity in our warrants follows:

			Weighted
			Average
	Number of		Exercise
	Shares		Price
Outstanding, April 30, 2004	8,825,311		$	1.35
Warrants issued for services	300,000		4.00
Warrants issued in connection with financings	2,207,900		4.87
Exercised	(5,858,701	)	1.25
Expired	(70,000	)	3.00
Outstanding, April 30, 2005	5,404,510		3.03
Warrants issued for services	151,000		2.82
Warrants issued for legal settlement	120,000		2.40
Class C warrants issued in connection with exercise of Class B warrants	362,011		2.50
Exercised	(1,032,511	)	1.34
Expired	—		—
Outstanding, April 30, 2006	5,005,010		$	3.32

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The outstanding warrants as of April 30, 2006, are summarized as follows:

		Weighted
		Average
	Number	Exercise		Expiration
	Outstanding	Price		Date
Class B Warrants	1,418,099	$	1.50	12-29-2006	(1)
Class C Warrants	564,511	$	2.50	12-29-2006	(1)
Other Warrants	3,022,400	$	4.32		(2)
	5,005,010	$	3.32

(1) The expiration date of the Class B Warrants and Class C Warrants was extended from December 31, 2005, to December 29, 2006, in June 2005.

(2) The other warrants expire at various dates ranging from June 2006 through February 2008.

Extension of Warrant Expiration Dates

On June 17, 2005, we extended the expiration date of the Class B Warrants and the Class C Warrants from December 31, 2005, to December 29, 2006, via an amendment to the Warrant Agreement. There were no other changes made to the terms and conditions of the Warrant Agreement. The holders of these warrants had been unable to exchange the warrants for registered shares of our common stock since October 2004, at which time the underlying registration statement was no longer current. We attempted to file a post-effective amendment to the respective registration statement, but we were unable to do so because our former auditor, Grant Thornton LLP, was unwilling to consent to the inclusion of its report on our April 30, 2004 and 2003, financial statements in the post-effective amendment. In the first quarter of our fiscal year 2006, we recorded a non-cash charge in the statement of operations in the amount of approximately $300,000, such charge representing the excess of the fair value of the amended warrant over the fair value of the original warrant immediately prior to amendment.

On December 29, 2005, we extended the expiration date of certain warrants to purchase 232,500 shares of common stock at an exercise price of $1.25. The warrants were initially issued in a financing transaction and the holder of the warrants had, for a period of time as described in the Class B and C Warrant disclosure above, an inability to exercise the warrants for registered shares of our common stock. The expiration date of the warrants was extended from December 31, 2005, to December 29, 2006. There were no other changes made to the terms and conditions of the warrant agreements. During the year ended April 30, 2006, we recorded a non-cash operating expense in the statement of operations in the amount of approximately $213,000, such charge representing the excess of the fair value of the amended warrant over the fair value of the original warrant immediately prior to amendment.

NOTE 14—EMPLOYEE BENEFIT PLAN

We contribute to a multi-employer retirement savings plan qualified under section 401(k) of the Internal Revenue Code. The plan is a defined contribution plan, covering substantially all of our non-PPSC employees. Our contributions to the plan aggregated approximately $104,000 and $82,000 for the years ended April 30, 2006 and 2005, respectively.

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NOTE 15—BUSINESS SEGMENT, GEOGRAPHIC, CUSTOMER AND PRODUCT INFORMATION

Segment information

We currently have four reportable segments: homeland security products, security services, semiconductor products and services and life sciences. Our homeland security products segment is currently marketing and developing certain trace and bulk detection technologies. Our security services segment provides advanced security and investigative services and is substantially comprised of the operations of PPSC which was acquired in May 2005. Our semiconductor products and services segment (formerly called the “semiconductor materials and products” segment) manufactures and reclaims silicon wafers, sells SOI wafers and is involved in several research and development projects including silicon-28. Our life sciences segment sells stable and radioisotopes in elemental and simple compound forms for use in life sciences applications. Our segments are strategic business units, each of which consists of similar products or services. They are managed separately because each segment requires different technology and marketing strategy and because each segment sells to different customers. Reconciling items consist primarily of corporate assets or expenses that have not been allocated to a specific reportable segment. Prior period amounts have been reclassified to conform to current period presentation.

Information by segment is set forth below (in thousands):

	As of and for the Year Ended
	April 30,
	2006			2005
Segment revenues from external sources:
Homeland security products	$	35		$	—
Security services	12,814			—
Semiconductor products and services	5,731			2,692
Life sciences	5,136			7,413
Total	$	23,716		$	10,105
Segment operating (loss) income
Homeland security products	$	(3,489	)	$	(1,728	)
Security services	(24		)	—
Semiconductor products and services	(5,151		)	(6,484		)
Life sciences	(968		)	(2,206		)
Reconciling amounts(1)	(6,999		)	(3,744		)
Total	$	(16,631	)	$	(14,162	)
Total assets:
Homeland security products	$	800		$	206
Security services	5,992			—
Semiconductor products and services	7,027			6,356
Life sciences	1,713			2,432
Reconciling amounts(2)	2,331			22,187
Total	$	17,863		$	31,181

(1) Reconciling amounts for the operating loss information includes corporate expenses consisting primarily of payments to Lucent under our development agreement (see Note 6), corporate salaries and benefits, professional and consulting fees, investor relations costs, insurance and directors’ compensation.

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(2) Reconciling amounts for the total asset information includes corporate assets consisting primarily of cash and cash equivalents invested centrally, unamortized debt issuance costs and miscellaneous prepaid items.

Geographic information

A summary of our operations by geographic area is presented below (in thousands):

	As of and for the Year Ended
	April 30,
	2006		2005
Net revenues from external sources:
United States	$	22,153	$	7,405
Germany	1,563		2,700
Total	$	23,716	$	10,105
Long-lived assets:
United States	$	4,853	$	5,586
Germany	1		3
Total	$	4,854	$	5,589
Net assets:
United States	$	2,077	$	8,861
Germany	566		727
Total	$	2,643	$	9,588

The geographic summary of net revenue from external sources is based on the Isonics sales location generating the respective sales. The shipment locations corresponding to the respective customers may be outside that geographic area. The geographic summary of long-lived and total assets is based on physical location. During the year ended April 30, 2006, we elected to close the Chemotrade office due to increasing supplier prices causing the loss of substantially all of our radioisotope customers.

Customer Information

Two customers (Foot Locker Retail, Inc.and Qimonda Richmond LLC, formerly Infineon Technologies Richmond) accounted for approximately 17% and 10% of revenues, respectively, for the year ended April 30, 2006. Two customers (Eastern Isotopes, Inc. and PerkinElmer, Inc.) accounted for approximately 19% and 10% of revenues, respectively, for the year ended April 30, 2005. As of April 30, 2006, three customers accounted for approximately 30% of total net accounts receivable. As of April 30, 2005, three customers accounted for approximately 29% of total net accounts receivable. A decision by a significant customer to substantially decrease or delay purchases from us or an inability to collect significant amounts owed to us could have a material adverse effect on our consolidated financial condition and results of operations.

Product Information

One product (oxygen-18) accounted for approximately 14% and 43% of revenue for the years ended April 30, 2006 and 2005, respectively. A change in customer demand or market pricing of this product could have a material adverse effect on our consolidated financial condition and results of operations.

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NOTE 16—RELATED PARTY TRANSACTIONS

On January 1, 2002, we entered into a one-year consulting agreement with HS-Consult GmbH (“HSC”) primarily to assist Chemotrade in buying and selling isotope products. HSC primarily consists of the former managing director of Chemotrade and an additional former key employee of Chemotrade. The initial consulting agreement expired on December 31, 2002 and required a monthly payment of 5,500 Euros (approximately $7,000) for the services to be provided. The consulting agreement was renewed for terms of one year on January 1, 2005 and 2004 and required monthly payments of 5,500 Euros. The consulting agreement was not renewed for calendar year 2006.

PPSC continues to lease premises partially owned by a former owner who is a current employee of PPSC. The lease term was originally for the four-year period ended May 15, 2009. Annual rent payments were originally $48,000 in each of the four years of the lease term. In March 2006, we amended the lease from a fixed term to a month-to-month term and increased the monthly base rent to $4,500 per month. Additionally, we reimburse the landlord 80% of the costs incurred by the landlord for taxes, maintenance of common areas and fire and hazard insurance as well as the entire amount of the premium incurred for rental loss insurance.

NOTE 17—SUBSEQUENT EVENTS

Investment in ISCON Video Imaging, Inc.

ISCON Video Imaging, Inc. (“ISCON”) is a company that is attempting to develop patent-pending infrared imaging-based technologies for the non-invasive detection of objects hidden under clothing as well as technology for the determination of the chemical composition of such objects to identify explosives and drugs. On May 12, 2006, we signed a stock purchase agreement with ISCON that provides us the option, but not the obligation, to purchase authorized but unissued shares of Series B common stock from ISCON at five intervals based on successful completion of developmental and commercial milestones. If ISCON succeeds in meeting all five milestones and if we choose to exercise our option to purchase shares for each completed milestone, we would own 51% of ISCON for a cumulative investment of $1,750,000. On June 9, 2006, we made our first investment in the amount of $100,000. As a result, we currently own approximately 9% of ISCON.

8% Convertible Debentures

On May 18, 2006, we made an offer to the holders of our outstanding 8% Debentures to pay in cash the principal balance remaining immediately subsequent to making the monthly payment scheduled June 1, 2006, plus a 5% premium and accrued interest, both items to also be paid in cash. On May 19, 2006, approximately $5.0 million out of the then-outstanding $8.2 million 8% Debentures accepted our offer. The offer was made and accepted contingent upon the cash payment being made to the accepting holders on or before June 1, 2006, from the proceeds of a financing that were then working to complete and which is discussed below. In accepting our offer, the holders agreed to limit the anti-dilution provision on their warrants originally issued with their debentures such that the warrants would fully ratchet based upon the financing completed on May 31, 2006, and then the ratchet would be converted to a price-only ratchet whereby the exercise price would still be reduced to the effective price per share (or effective exercise price per share) of the subsequent equity sale but where the number of shares purchasable under the warrant would be fixed. The holders also agreed to waive certain provisions of the Securities Purchase Agreement entered into concurrently with the 8% Debentures which relate to entering into a future

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financing with variable conversion terms (such contractual terms we do not believe to be in force). In accordance with this offer and subsequently to closing the financing on May 31, 2006, we paid approximately $4.1 million from the proceeds of the financing to the holders accepting our offer. This payment resulted in a reduction in the principal balance of the 8% Debentures of $3,880,000.

As a result of entering the financing transaction discussed below, which includes a fixed conversion price of $1.25, the warrants associated with the 8% Debentures were amended per the warrant such that the warrant exercise price was reduced from $6.25 per share of common stock to $1.25 per share of common stock. Simultaneously, the number of shares purchasable under the warrants increased from 1,593,900 to 7,969,500. Due to our offer made on May 18, 2006, to the holders of the 8% Debentures and the acceptance of the offers by certain holders, of the currently outstanding warrants associated with the 8% Debentures, warrants to purchase 4,557,000 shares of common stock have a price ratchet only whereby no change to the number of shares purchasable will occur and warrants to purchase 3,412,500 shares of commons stock continue to retain the original ratchet provisions.

Having met all requirements to allow us to do so, we elected to make the monthly principal and interest payments due for our 8% Debentures on May 1, 2006, and June 1, 2006, in shares of our common stock. Accordingly, we issued a total of 1,616,433 and 1,997,265 shares of common stock, respectively, in settlement of (1) principal amounts owed on the 8% Debentures in the amounts of $1,822,500 and $1,647,500, respectively and (2) interest obligations for the months of April 2006 and May 2006 in the nominal amounts of $66,500 and $21,250, respectively. As discussed in Note 9—Borrowings, as the payments were made in stock in lieu of cash, the fixed monetary amounts of the principal and interest payments will have a larger impact on the consolidated financial statements as compared to the nominal amounts disclosed. This difference is due to application of the fixed discount applied to the price of our common stock in the calculation of the number of common shares due for each principal payment and interest payment when made in shares of our common stock, as defined. We elected to make our monthly principal and interest payment due on July 1, 2006 in cash. This payment included a reduction to outstanding principal of $562,000 and interest in the amount of $17,500. Subsequent to this payment, the outstanding principal balance on the 8% Debentures was $2,062,500.

In June 2006, one of the two remaining holders of our 8% Debentures, with remaining principal outstanding in the amount of $312,500, asserted that the issuance of the 6% Convertible Debentures (see discussion below) constituted a default (due to a potential variable conversion provision contained within the 6% Convertible Debenture agreement) under the 8% Debentures. We have contested that allegation on several bases and will defend against any further allegation of default as necessary. As outline in Note 9—Borrowings, remedies for an event of default include the option to accelerate payment of the full principal amount of the debentures, together with interest and other amounts due, to the date of acceleration. The principal amount of the debentures shall be equal to 130% of the then-principal amount of the debentures plus all interest and other amounts due or a conversion calculation, whichever is higher. The holder had approximately $937,000 (and the other remaining holder had $2,250,000) due on its debenture at the time we entered into the 6% Convertible Debentures.

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6% Convertible Debentures

On May 31, 2006, we completed a private placement pursuant to which we issued to one accredited investor, Cornell Capital, L.P. (“Cornell”) a 6% secured convertible debenture with a principal amount of $10,000,000, which is the first of three 6% secured convertible debentures (cumulatively, the “6% Debentures”), for which the aggregate principal amount will be $16,000,000. On June 5, 2006 (two trading days prior to filing of a registration statement contemplated in the transaction documents correlated with the 6% Debentures), we issued the second of the three 6% Debentures. This 6% Debenture has a principal amount of $3,000,000. The final 6% Debenture with a principal amount of $3,000,000 is scheduled to be issued and funding received two trading days prior to a registration statement being declared effective by the Securities and Exchange Commission. The 6% Debentures are convertible into shares of our common stock at the lesser of $1.25 (the “Fixed Conversion Price”) or 80% of the average of the two lowest daily volume weighted average prices of our stock during the five trading days immediately preceding the conversion date (the “Market Conversion Price”). The 6% Debentures mature on May 31, 2009 (the “Maturity Date”). In addition to the 6% Debentures, we issued three warrants (the “6% Debenture Warrants”) to purchase a total of 8,000,000 shares of our common stock at exercise prices of $1.25 per share (2,000,000 warrants), $1.75 per share (3,000,000 warrants) and $2.00 per share (3,000,000 warrants). Each of the warrants can be exercised for a period of three years.

The then-effective conversion price will be adjusted upon the occurrence of any stock dividends, stock splits, pro rata distributions, or fundamental transactions as described in the 6% Debenture agreement. Additionally, the Fixed Conversion Price will be reduced if we issue shares of stock or other instruments that are exchangeable into or convertible into common stock at an effective price less than the Fixed Conversion Price. The Fixed Conversion Price will be adjusted to mirror the conversion, exchange or purchase price at issue. Our issuance and exercise of options which are compensatory and pursuant to our stock option or stock purchase plans will not cause an adjustment under this provision.

Interest accrues on the outstanding principal balance at the annual rate of 6%. Interest is payable on the Maturity Date in cash or shares of our common stock, at our option. If we choose to pay accrued interest in shares of our common stock, the number of shares to be issued will be calculated as the amount of interest due divided by 88% of the volume weighted average price of our common stock for the five trading days preceding the Maturity Date.

The investor and an unaffiliated party provided us services in connection with completing the transaction. To compensate these people for those services, we issued them 660,000 shares of our common stock (the “Buyers Shares”). We also have paid Cornell or its affiliates fees in the amount of $735,000 and will pay from proceeds of the unissued $3 million 6% Debenture an additional $165,000 when issued.

We have agreed to seek shareholder approval of this transaction by no later than October 31, 2006, (exclusive of any shares acquired in this transaction or related transactions), including the ability to issue a maximum of 64 million shares upon conversion of the 6% Debentures and to approve an increase in authorized shares of common stock to at least 175 million shares.

The 6% Debentures, the 6% Debenture Warrants and the Buyers Shares have certain limitations on our ability to issue shares to the holders of the instruments and impose certain limitations on Cornell’s ability to sell shares.

· We are prohibited from issuing shares of our common stock to the holders of the 6% Debentures (upon conversion or payment of interest) and the 6% Debenture Warrants (upon exercise) if the

F-39

issuance would result in Cornell beneficially owning more than 4.99% of our outstanding common stock (although Cornell can waive this provision upon more than 65 days’ notice to us).

· Until (and if) the shareholders approve the transaction as required by Nasdaq rules, the number of shares issuable upon conversion of the 6% Debentures shall not be greater than 6,075,785, which along with the Buyers Shares and the 2,000,000 warrant shares exercisable at $1.25 represent less than 19.99% of the total number of shares outstanding on May 31, 2006.

· Cornell is prohibited from selling shares related to the 6% Debentures until the later of the related registration statement achieving effectiveness or September 28, 2006 (120 days subsequent to the issuance of the first 6% Debenture).

· Between September 29, 2006, and January 26, 2007, if converting using the Market Conversion Price, Cornell is limited to converting no more than $200,000 of the principal or accrued interest on the 6% Debentures into shares of our common stock in any seven calendar day period. Subsequent to January 26, 2007, if converting using the Market Conversion Price, Cornell is limited to converting no more than $400,000 of the principal or accrued interest on the 6% Debentures into shares of our common stock in any seven calendar day period.

· The maximum number of shares that may be issued upon conversion of the principal amount of the 6% Debentures is contractually limited to 64 million shares.

If there is an effective underlying registration statement and if the volume weighted average price of our common stock is equal to or greater than $2.50 for twenty consecutive trading days, we may force Cornell to convert the outstanding principal and any accrued interest, subject to the share issuance limitations discussed above.

We have the right, after providing ten trading days advance written notice, to redeem a portion or all amounts outstanding under the 6% Debentures prior to the Maturity Date provided the closing bid price of our common stock is less than $2.50 at the time the redemption notice is provided. If we exercise this redemption right, a redemption premium in the amount of 20% of the principal amount being redeemed will be due. During the ten day notification period, Cornell may elect to convert any portion or all of the outstanding 6% Debenture amount.

For a period of one year subsequent to entering into the 6% Debenture agreements on May 31, 2006, we have granted Cornell the right to participate in any allowed capital raise up to 50% of the raise. After that one year period expires and until such time no portion of the principal and interest due on the 6% Debentures is outstanding, we have granted Cornell the right to participate in any allowed capital raise up to 25% of the raise.

As a result of a freestanding registration rights agreement, we have an obligation to register the shares underlying the 6% Debentures, Buyers Shares and 6% Debenture Warrants. We were required to file an initial registration statement to register 8,735,785 shares of common stock underling no later than August 7, 2006 (a registration statement was filed on June 7, 2006) and to have the initial registration statement declared effective by September 28, 2006. If we fail to meet our effectiveness deadline, we will incur liquidated damages of one percent of the outstanding balance of the 6% Debentures for each thirty-day period subsequent to the date of the deadline missed until such time as the registration statement is declared effective. Within thirty days of obtaining shareholder approval to issue in excess of 19.99% of the outstanding shares of ours as of May 31, 2006, we must file an amended registration statement to register

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the full number of shares required under the 6% Debenture transaction documents (representing the Buyers Shares, shares underlying the 6% Debenture Warrants and shares upon the conversion of the 6% Debentures based on a defined formula but in an amount not to exceed 64 million shares). Additionally, once effectiveness of both the initial and the amended registration statement is achieved and until such time that all eligible shares have been sold under the registration statements, if sales are not able to be made under the registration statement (due to failure to keep the registration statement effective or failure to register sufficient shares or otherwise), Cornell will have recourse to the aforementioned 1% per thirty day liquidated damages penalty. We are contractually not obligated to pay liquidated damages for more than a total of 365 calendar days. Failure to comply with our registration obligations may, subsequent to any grace periods and opportunities to cure, be deemed an event of default.

Additionally, other events, as defined in the 6% Debenture agreement, may also allow the 6% Debenture holders to declare us in default. Remedies for an event of default, include the option to accelerate payment of the full principal amount of the Debentures, together with interest and other amounts due, to the date of acceleration and Cornell will have the right to request such payment in cash or in shares of our common stock.

So long as principal amounts are outstanding under the 6% Debentures, we have agreed to not sell capital stock or grant security interests which meet certain defined characteristics without the prior consent of Cornell. However, certain transactions defined as Excluded Securities are exempted from this prior consent provision. Excluded Securities include (1) securities issued in connection with a strategic partnership or joint venture, (2) securities issued as consideration for a merger or consolidation or the acquisition of a business, product, license or other asset of another person or entity, (3) options (priced not less than at the market) provided to employees within the first thirty days of employment, (4) securities issued pursuant to an approved stock plan, (5) up to 1 million shares (priced not less than market) which may be issued as long as no registration rights are included and as long as not pursuant to a Form S-8 and (6) any other issuances to holders of other pre-existing securities if such issuances are provided for in the terms of such instrument.

The 6% Debenture Warrants are exercisable for cash only, unless after January 15, 2007, there is no effective underlying registration statement, at which point a cashless exercise can be elected by the holder. The then-effective warrant exercise price will be adjusted upon the occurrence of any stock dividends, stock splits, pro rata distributions, or fundamental transactions as described in the 6% Debenture Warrant agreements. Additionally, the exercise price and number of shares upon issuance of common stock are subject to adjustment in cases where we issue shares of common stock (other than Excluded Securities or issuances in connection with other components of the 6% Debenture documents) for consideration per share less than the then-existing warrant exercise price. If an adjustment is triggered, the warrant exercise price for the warrant for 2,000,000 shares at an exercise price of $1.25 per share and the warrant for 3,000,000 shares at an exercise price of $1.75 per share will be adjusted to a price determined by multiplying such exercise price by a fraction of which (a) the numerator shall be the number of shares of common stock outstanding immediately before such issuance plus the number of shares of common stock that the aggregate consideration received by us for such issuance would purchase at the warrant exercise price then in effect and (b) the denominator shall be the number of shares of common stock outstanding immediately prior to such issuance plus the number of new shares to be issued in the triggering event. Concurrently, the number of shares issuable upon exercise of the warrant will be adjusted such that the aggregate exercise price would be equal to the aggregate exercise price prior to adjustment. The warrant for 3,000,000 shares exercisable at $2.00 per share has a different adjustment calculation whereby a subsequent

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triggering equity issuance would lead to a reduction in the warrant exercise price per share equal to the price per share (of effective exercise price per share) of the subsequent equity issuance. There would be no change to the number shares issuable under the warrant.

The 6% Debentures are secured by individual security agreements with IVI, HSDC and PPSC.

We are currently computing the cumulative accounting impact of the issuance of the 6% Debentures, including the allocation of debt proceeds between the financial instruments issued, the potential existence of derivative liabilities and the potential existence of a beneficial conversion feature. While our accounting evaluation is not complete, because of certain contractual provisions in the 6% Debentures and accompanying transaction documents together with certain provisions of United States Generally Accepted Accounting Principles, we will likely be required to record significant non-cash interest charges over the life of the 6% Debentures (in addition to interest expense relating to the 6% interest rate borne by the 6% Debentures which will be paid in cash or shares of our common stock, at our option). Additionally, we will likely be required to initially record the accompanying warrants and the embedded conversion feature of the 6% Debentures as derivative liabilities, which will be required to be marked to market on a quarterly basis.

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California		77-0338561
(State or other jurisdiction of		(IRS Employer
incorporation or organization)		Identification No.)

5906 McIntyre Street
Golden, Colorado		80403
(Address of principal executive offices)		(Zip Code)

Exhibit Number		Title

23.10*		Consent of Independent Registered Public Accounting Firm
31*		Certification pursuant to Rule 13a-14(a)
32*		Certification pursuant to 18 U.S.C. §1350

	ISONICS CORPORATION,
	a California Corporation


By:		/s/ James E. Alexander
		James E. Alexander
		President, Chief Executive Officer and Chairman of the Board

September 25, 2006

/s/ James E. Alexander
James E. Alexander
Chief Executive Officer and President

September 25, 2006

/s/ John Sakys
John Sakys
Chief Financial and Accounting Officer

September 25, 2006


/s/ James E. Alexander
James E. Alexander, Chief Executive
Officer

September 25, 2006


/s/ John Sakys
John Sakys, Chief Financial Officer

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