UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10K



(Mark One)x
        ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 for the fiscal year ended September 30, 2006.ORo
        TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 for the transition period from ___________ to _____________.




Commission File Number 000-23357

BIOANALYTICAL SYSTEMS, INC.

(Exact name of the registrant as specified in its charter)



INDIANA
(State or other jurisdiction of incorporation or organization)
        
        35-1345024
(I.R.S. Employer Identification No.)2701 KENT AVENUE
WEST LAFAYETTE, INDIANA
(Address of principal executive offices)
        
        47906
(Zip code)(765) 463-4527
(Registrants telephone number, including area code)




Securities registered pursuant to Section 12(b) of the Act: None



Securities registered pursuant to section 12(g) of the Act: Common Shares

Indicate by checkmark if the registrant is a well-known seasoned issuer, as
defined  by  Rule  405 of the  Securities  Act.     YES      NO

Indicate by checkmark
if the registrant is not required to file reports pursuant to Section 13 or Section 15(d)
of the Act.     YES     NO

Indicate by check mark
whether the registrant (1) has filed all reports required to be filed by Section 13 or
15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such
shorter period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days.    YES
    NO

Indicate by check mark
if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not
contained herein, and will not be contained, to the best of registrants knowledge,
in definitive proxy or information statements incorporated by reference in Part III of
this Form 10-K or any amendment to this Form 10-K.

Indicate by check mark
whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).    YES
    NO

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

Based on the closing
price on the NASDAQ stock market on March 31, 2006, the aggregate market value of
the voting and non-voting common equity held by non-affiliates of the registrant is
$22,390,000. As of December 20, 2006, 4,892,127 shares of registrants common shares
were outstanding. No shares of registrants Preferred Stock were outstanding as of
December 20, 2006.

Portions of the
following documents have been incorporated by reference into this report:

|Registrants Document                                                           |  | Parts Into Which Incorporated
|------------------------------------------------------------------------------- |  | -----------------------------
|                                                                                |  |                              
|Annual Report to security holders for the fiscal year ended September 30, 2006  |  | Part II                      
|                                                                                |  |                              
|Proxy Statement for Annual Meeting of Shareholders to be held February 15, 2007 |  | Part III                     

TABLE OF CONTENTS



PagePART IItem 1.
        Business
        1Item 1A.
        Risk Factors
        13Item 1B.
        Unresolved Staff Comments
        17Item 2.
        Properties
        17Item 3.
        Legal Proceedings
        17Item 4.
        Submission of Matters to a Vote of Security Holders
        17PART IIItem 5.
        Market for Registrants Common Equity and Related Stockholder Matters
        17Item 6.
        Selected Financial Data
        18Item 7.
        Managements Discussion and Analysis of Financial Condition and Results of Operations
        18Item 7A.
        Quantitative and Qualitative Disclosures about Market Risk
        26Item 8.
        Financial Statements
        26Item 9.
        Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
        49Item 9A.
        Controls and Procedures
        49Item 9B.
        Other Information
        49PART IIIItem 10.
        Directors and Executive Officers of the Registrant
        50Item 11.
        Executive Compensation
        51Item 12.
        Security Ownership of Certain Beneficial Owners and Management
        51Item 13.
        Certain Relationships and Related Transactions
        51Item 14.
        Principal Accounting Fees and Services
        51PART IVItem 15.
        Exhibits and Financial Statement Schedules
        52


# PART I

This Report contains
certain statements that are forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities
Exchange Act of 1934, as amended. Readers of this Report are cautioned that reliance on
any forward-looking statement involves risks and uncertainties. Although Bioanalytical
Systems, Inc. (the Company) believes that the assumptions on which the
forward-looking statements contained herein are based are reasonable, any of those
assumptions could prove to be inaccurate given the inherent uncertainties as to the
occurrence or nonoccurrence of future events. There can be no assurance that the
forward-looking statements contained in this Report will prove to be accurate. The
inclusion of a forward-looking statement herein should not be regarded as a representation
by the Company that the Companys objectives will be achieved.

# Item 1. Business.

# General

The Company, which is a
corporation organized in Indiana, provides contract development services and research
equipment to many leading global pharmaceutical, medical research and biotechnology
companies and institutions. It has played a significant role in understanding the
underlying causes of central nervous system disorders, diabetes, osteoporosis and other
diseases since its start in 1974.

We offer an efficient,
variable cost alternative to our clients internal product development programs.
Outsourcing development work to reduce overhead and speed drug approvals through the Food
and Drug Administration (FDA) is an established alternative to in-house
development among pharmaceutical companies. We derive our revenues from sales of our
research services and drug development tools, both focused on determining drug safety and
efficacy.

We support preclinical
and clinical development needs of researchers and clinicians for small molecule through
large biomolecule drug candidates. The Company believes its scientists have the skills in
analytical instrumentation development, chemistry, computer software development,
physiology, medicine, and toxicology to make the services and products it provides
increasingly valuable to its current and potential clients. Scientists engaged in
analytical chemistry, clinical trials, drug metabolism studies, pharmacokinetics and basic
neuroscience research at many of the largest global pharmaceutical companies are our
principal clients.

# Acquisitions

PharmaKinetics
Laboratories, Inc.

On May 26, 2003,
PharmaKinetics Laboratories, Inc., a Maryland corporation (PKLB), became a
majority owned subsidiary of the Company. Following the acquisition, PKLB was renamed BASi
Maryland, Inc. The Company acquired this site to broaden its service offering base through
the addition of Phase I and bioequivalence testing in human subjects. In addition, the
Company wanted to establish a meaningful operating presence physically near current and
potential clients on the East Coast of the United States (U.S.). This
sites operating performance prior to the acquisition had been poor. Since the
acquisition, the Company had made significant organizational, managerial, staff, and
physical plant changes to improve performance at the Baltimore clinic; however, the loss
of a major client as a result of its acquisition during the current year caused a
significant downturn in BASi Maryland's operating results.  This resulted in the Company adjusting the
carrying value of the assets of the operation in the third quarter of the current fiscal year.

LC Resources, Inc.

On December 13, 2002,
the Company acquired LC Resources, Inc. (LCR), a privately held company with
its operations in McMinnville, Oregon. The Company believes that, prior to the acquisition, LCR had a strong
reputation in liquid chromatography and bioanalysis, and provides a location that is
significantly closer to clients on the West Coast of the U.S.

# Changing Nature of
the Pharmaceutical Industry

The Companys
services and products are marketed globally to pharmaceutical, medical research and
biotech companies and institutions engaged in drug research and development. The research
services industry is highly fragmented among many niche vendors led by a small number of
larger companies; the latter offer an ever-growing portfolio of cradle-to-grave
pharmaceutical development services. The Companys products are also marketed to
academic and governmental institutions. The Companys services and products may have
distinctly different customers (often separate divisions in a single large pharmaceutical
company) and requirements. The Company believes that all clients are facing increased
pressure to outsource facets of their research and development activities and that the
following factors will increase client outsourcing:

1

Accelerated Drug
Development

Clients continue to
demand faster, more efficient, more selective development of a larger pool of drug
candidates. Clients demand fast, high quality service in order to make immediate,
well-informed decisions to quickly exclude poor candidates and speed development of
successful ones. The need for additional development capacity to exploit more
opportunities, accelerate development, extend market exclusivity and increase
profitability drives the demand for outsourced services.

Cost Containment

Pharmaceutical
companies continue to push for more efficient operations through outsourcing to optimize
profitability as development costs climb, staff costs increase, generic competition
challenges previously secure profit generators, political and social pressures to reduce
health care costs escalate, and shareholder expectations mount.

Patent Expiration

As exclusivity ends
with patent expiry, drug companies defend their proprietary positions against generic
competition with various patent extension strategies. Both the drug company creating these
extensions and the generic competitors should provide additional opportunities for the
Company.

Alliances

Strategic alliances
allow pharmaceutical companies to share research know-how and to develop and market new
drugs faster in more diverse, global markets. The Company believes that alliances will
lead to a greater number of potential drugs in testing, many under study by small
companies lacking broad technical resources. Those small companies can add shareholder
value by further developing new products through outsourcing, reducing risk for potential
allies.

Mergers and
Acquisitions

Consolidation in the
pharmaceutical industry is commonplace. As firms blend personnel, resources and business
activities, the Company believes they will continue to streamline operations, minimizing
staffing which should lead to more outsourcing. This consolidation may result in short-term disruption
in placement of, or progress on, drug development programs as merging companies
rationalize their respective drug development pipelines. In the current fiscal year, an
acquisition of a significant client of our Baltimore clinic resulted in the client
cancelling its scheduled work in our clinic, resulting in losses from their operations, As
a result, we determined that the assets of that operation had been impaired, and recorded
an adjustment to their value in our third fiscal quarter. See Managements Discussion
and Analysis of Financial Condition and Results of Operations, Impairment of Long-lived
Assets including Goodwill, and Note 1(i) to the Consolidated Financial Statements included
herein.

Biotechnology
Industry and Virtual Drug Company Growth

The biotech industry
continues to grow and has introduced many new developmental drugs. Many biotech drug
developers do not have in-house resources to conduct development. Many new companies
choose only to carry a product to a developed stage sufficient to attract a partner who
will manufacture and market the drug. Efficient use of limited funds motivates smaller
firms to seek outside service providers like the Company rather than build expensive
infrastructure.

Unique Technical
Expertise

The increasing
complexity of new drugs requires highly specialized, innovative, solution-driven research
not available in all client labs. The Company believes that this need for unique technical
expertise will increasingly lead to outsourcing of research activity.

2

Data Management
Expertise

Our clients and the FDA
require more data, greater access to that data, consistent and auditable management of
that data, and greater security and control of that data. The Company has made significant
investments in software throughout its contract services groups to optimize efficiency and
ensure it complies with FDA regulations and client expectations.

Globalization of
the Marketplace

Foreign firms are
relying on independent development companies with experience in the U.S. to provide
integrated services through all phases of product development and to assist in preparing
complex regulatory submissions. Domestic drug firms are broadening product availability
globally, demanding local regulatory approval. The Company believes that domestic service
providers with global reach, established regulatory expertise, and a broad range of
integrated development services will benefit from this trend. The Company has a
significant European presence and experience in managing foreign operations from its West
Lafayette offices.

# The Companys
Role in the Drug Development Process

After a new drug
candidate is identified and carried through preliminary screening, the development process
for new drugs has three distinct phases.

1)    
          The preclinical phaseincludes safety testing to prepare an
          Investigational New Drug (IND) exemption for submission to the FDA.
          The IND must be accepted by the FDA before the drug can be tested in humans.
          Once a pharmacologically active molecule is fully analyzed to confirm its
          integrity, the initial dosage form for clinical trials is created. An analytical
          chemistry method is developed to enable reliable quantification. Stability and
          purity of the formulation is also determined.

Clients work with the
Companys preclinical services group to establish pharmacokinetics, pharmacodynamics
and safety testing of the new drug. These safety studies range from acute safety
monitoring on drugs and medical devices to chronic, multi-year oncogenicity studies.
Bioanalyses of blood sampled under these protocols by the Companys bioanalytical
services group provide kinetic, metabolism and dose-ranging data. Upon successful
completion of preclinical safety studies, an IND submission is prepared and provided to
the FDA for review prior to human clinical trials.

Many of the
Companys products are designed for use in preclinical development. The Culex®
APS, a robotic automated pharmacology system, enables researchers to develop
pharmacokinetic profiles of drugs during early screening in rodents quickly and cost
effectively. Several variations of this technology are in development. Clients and the
Companys bioanalytical services group sometimes use the Companys
electrochemistry and chromatography products to develop a single, quick, proprietary
method to screen drugs in biological samples. Liquid chromatography coupled to mass
spectrometry is now a mainstay of the Companys bioanalytical laboratories. The
Company has invested heavily in robotics and mass spectrometry systems over the last ten
years.

2)    
          The clinical phasefurther explores the safety and efficacy
          of the substance in humans. The sponsor conducts Phase I human clinical trials
          in a limited number of healthy individuals to determine safety and tolerability.
          Bioanalytical assays determine the availability and metabolism of the active
          ingredient following administration. Expertise in method development and
          validation is critical, particularly for new chemical entities.

Exhaustive safety,
tolerability and dosing regimens are established in sick humans in Phase II trials. Phase
III clinical trials verify efficacy and safety. After successful completion of Phase III
trials, the sponsor of the new drug submits a New Drug Application (NDA) or
Product License Application (PLA) to the FDA requesting that the product be
approved for marketing. Early manufacturing demonstrates production of the substance in
accordance with FDA Good Manufacturing Practices (GMP) guidelines. Data are
compiled in an NDA, or for biotechnology products a PLA, for submission to the FDA
requesting approval to market the drug or product. The Companys bioanalytical work
per study grows rapidly from Phase I through III. The number of samples per patient
declines as the number of patients grows in later studies. Phase II and III studies take
several years, supported by well-proven, consistently applied analytical methods. It is
unusual for a sponsor to change laboratories unless there are problems in the quality or
timely delivery of results.

The Company
performs Phase I studies at its clinic in Baltimore. Phase I services include
bioavailability testing to monitor the rate and extent to which a drug becomes
available in the blood. Bioavailability can also be used to compare the
bioequivalence of similar generic and brand name drugs.

3

3)    
          Post-approvalfollows FDA approval of the NDA or PLA. This
          includes production and continued analytical and clinical monitoring of the
          drug. The post-approval phase also tracks development and regulatory approval of
          product modifications and line extensions, including improved dosage forms. The
          drug manufacturer must comply with quality assurance and quality control
          requirements throughout production and must continue analytical and stability
          studies of the drug during commercial production to continue to validate
          production processes and confirm product shelf life. Samples from each
          manufactured batch must be tested prior to release of the batch for distribution
          to the public.

The Company also
provides services in all areas during the post-approval phase, concentrating on
bioequivalence studies of new formulations, line extensions, new disease indications and
drug interaction studies.

The Companys
ability to solve client problems combining its knowledge base, services and products has
been a factor in the Companys selection by major pharmaceutical companies to assist
in several preclinical and Phase I, II and III clinical trials, as well as in the
post-approval phase.

# Company Services and
Products

Overview

The Company operates in
two business segments  contract research services and research products, both of
which address the bioanalytical, preclinical, and clinical research needs of drug
developers. Both segments arose out of the Companys expertise in a number of core
technologies designed to quantify trace chemicals in complex matrices. The Company
evaluates performance and allocates resources based on these segments.

Services

The Companys
contract research services segment provides screening and pharmacological testing,
preclinical safety testing, formulation development, clinical trials, regulatory
compliance and quality control testing. Revenues from the Companys services segment
were $34.3 million for fiscal 2006. For additional financial information regarding the
services segment, please see Note 10 to the Notes to Consolidated Financial Statements
included in Item 8 of this report. The following is a description of the services provided
by the Companys contract research services segment:

| | o | Product
Characterization, Method Development and Validation:Analytical methods
determine potency, purity, chemical composition, structure and physical properties of a
compound. Methods are validated to ensure that data generated are accurate, precise,
reproducible and reliable and are used consistently throughout the drug development
process and in later product support.
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | o | Bioanalytical
Testing:The Company analyzes specimens from preclinical and clinical
trials to measure drug and metabolite concentrations in complex biological matrices.
Bioanalysis is performed at Company facilities in Indiana, Oregon and the United Kingdom (UK).
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | o | Stability
Testing:The Company tests stability of drug substances and formulated
drug products and maintains secure storage facilities necessary to establish and confirm
product purity, potency and shelf life in West Lafayette, Indiana. The Company has
multiple ICH (International Conference on Harmonization) validated controlled climate GMP
(Good Manufacturing Practices) systems.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | o | In
Vivo Pharmacology:The Company provides preclinical in vivosampling
services for the continuous monitoring of chemical changes in life, in particular, how a
drug enters, travels through, and is metabolized in living systems. Most services are
performed in customized facilities in West Lafayette, Indiana using the Companys
robotic Culex® APS (Automated Pharmacology System) system and in Evansville, Indiana.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | o | Preclinical
and Pathology Services:The Company provides pharmacokinetic and safety
testing in studies ranging from acute safety monitoring of drugs and medical devices to
chronic, multi-year oncogenicity studies in its newly expanded Evansville, Indiana site.
Depending on protocol, multiple tissues may be collected to monitor pathological changes.
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | o | Phase
I & II(a) Clinical Trials:The Company performs Phase I human
clinical trials in its 110-bed clinic in Baltimore. These are principally bioavailability
and bioequivalence studies, both for generic drug and innovator pharmaceutical firms.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

4

Research Products

The Company is focusing
its products business on expediting preclinical screening of developmental drugs. The
Company competes in very small niches of the multibillion dollar analytical instrument
industry. The Companys products business targets, and in some cases dominates,
unique niches in life science research. The Company designs, develops, manufactures and
markets state-of-the-art:

| | o | Robotic
sampling systems and accessories (disposables, training, systems qualification)
| | - | ---------------------------------------------------------------------------------------

| | o | In
vivo microdialysis collection systems
| | - | ----------------------------------------

| | o | Physiology
monitoring tools
| | - | ---------------------------

| | o | Liquid
chromatography and electrochemistry instruments platform
| | - | ---------------------------------------------------------------

Revenues for the
Companys products segment were $8.7 million for fiscal 2006. For additional
financial information regarding the products segment, please see Note 10 to the Notes to
Consolidated Financial Statements included in Item 8 of this report. The following is a
description of the products offered by the Company:

| | o | The Culex® APS robotic automated pharmacology system is used by
pharmaceutical researchers to monitor drug concentrations and response as a function of
time. Compared to current manual methods, the Culex® offers greater than 80% reduction
in test model use and comparable reduction in labor. The Culex® also offers
computer-controlled blood sampling protocol, behavioral monitoring, flexibility to collect
other biological samples, exceptional cost savings, significant reduction in model stress
and expeditious data delivery.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | o | Bioanalytical separation systems (liquid chromatography) used in
connection with Windows® software, detect and quantify low concentrations of
substances tracking complex chemical, physiological and behavioral effects in biological
fluids and tissues from humans and laboratory animal models.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | o | Specialized chemical analyzers monitor trace levels of organic
chemicals such as neurotransmitters in biological samples using core electrochemistry,
liquid chromatography and enzymology technologies to separate and quantify drugs,
xenobiotics, metabolites and other chemicals in blood, cerebrospinal fluid and other
biological media.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | o | epsilon is a single liquid chromatography and electrochemistry
instrument control platform for the separation systems and chemical analyzers noted above.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------

| | o | A line of miniaturized in vivo sampling devices sold to drug developers and
medical research centers, assist in the study of a number of medical conditions including
stroke, depression, Alzheimers and Parkinsons diseases, diabetes and
osteoporosis.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | o | Vetronics small animal diagnostic electro-cardiogram and vital signs
monitors are used primarily in veterinary clinics with growing applications in preclinical
research.
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------

# Clients

Over the past five
years, the Company has regularly provided its services and/or products to most of the top
25 pharmaceutical companies in the world, as ranked by 2006 research and development
spending. Approximately 13% of the Companys revenues are
generated from customers outside of North America.

The Company has been
balancing its business development effort between large pharmaceutical developers and the
next tier of smaller drug development companies. The Company believes that smaller
companies are more inclined to establish a consistent, long-term, strategic relationship
with the Company but realizes that they may be poorly funded. The Company has adapted by
increasing its focus on a larger number of specialist service buyers at large and small
clients and by engaging in a more active and more diversified business development effort
staffed with specialists.

Pfizer (including its
predecessor companies) is the Companys largest client. Pfizer accounted for
approximately 7.3%, 10.1% and 12.5% of the Companys total revenues in fiscal 2006,
2005 and 2004, respectively. Pfizer accounted for 12.8% and 6.0% of total trade accounts
receivable at September 30, 2006 and 2005, respectively.

5

There can be no
assurance that the Companys business will not continue to be dependent on continued
relationships with Pfizer or other clients, or that annual results will not be dependent
on a few large projects. In addition, there can be no assurance that significant clients
in any one period will continue to be significant clients in other periods. In any given
year, there is a possibility that a single pharmaceutical company may account for 5% or
more of the Companys total revenue. Since the Company does not have long-term
contracts with its clients, the importance of a single client may vary dramatically from
year to year.

# Sales and Marketing

Capitalizing on its
long history of innovation and technical excellence, the current sales and marketing plan
of the Company targets key accounts among the top 200 global pharmaceutical companies and
approaches smaller companies opportunistically. The Company recognizes that its growth and
customer satisfaction depend upon its ability to continually improve client relationships.

The Companys
products and services are sold directly to the client. The Company has seventeen employees
on its business development staff. In late fiscal 2005, this team was reorganized under a
new executive vice president, with more clearly defined sales objectives, territories and
incentives. The Company also attends multiple trade shows in many disciplines and has
created a collection of web sites, catalogs, training and technical support literature,
media presentations, branding, workshops and academic publications.

Sales, marketing and
technical support are based in the Companys corporate headquarters located in West
Lafayette, Indiana. The Company also maintains offices in Baltimore, Maryland; Evansville,
Indiana; McMinnville, Oregon; and Warwickshire, UK. For additional financial information
relating to geographic segments, please see Note 10 to the Notes to Consolidated Financial
Statements included in Item 8 of this report.

Bioanalytical Systems,
Ltd., a wholly owned, UK-based subsidiary, provides a direct liaison with research service
clients in Europe and maintains a laboratory to provide those services, as well as a
distribution center for the Companys European sales of products. In addition, the
Company has a network of 18 established distributors covering Japan, the Pacific Basin,
South America, the Middle East, India, South Africa and Eastern Europe. All of the
Companys distributor relationships are managed from the Companys headquarters
in West Lafayette, Indiana. International growth is planned through stronger local
promotion to support the Companys distributor network.

# Contractual
Arrangements

The Companys
service contracts typically establish an estimated fee to be paid for identified services.
In most cases, some percentage of the contract costs is paid in advance. While the Company
is performing a contract, clients often adjust the scope of services to be provided by the
Company based on interim project results. Fees are adjusted accordingly. Generally, the
Companys fee-for-service contracts are terminable by the client upon written notice
of 30 days or less for a variety of reasons, including the clients decision to
forego a particular study, the failure of product prototypes to satisfy safety
requirements, and unexpected or undesired results of product testing. Cancellation or
delay of ongoing contracts may result in fluctuations in the Companys quarterly and
annual results. The Company is generally able to recover at least its invested costs when
contracts are terminated.

The Companys
products business offers annual service agreements on most product lines.

# Backlog

The contracts pursuant to
which the Company provides its services are terminable upon written notice of 30 days or
less. The Company maintains projections based on bids and contracts to optimize asset
utilization. Similarly, virtually all of the Companys products are made to order.
Backlog may not be a good indicator of future sales trends. Management does not believe
that backlog is material to an understanding of the Companys business taken as a
whole.

6

# Competition

Services

The Company competes
primarily with in-house research, development, quality control and other support service
departments of pharmaceutical and biotechnology companies. There are also full-service
Contract Research Organizations (CROs) that compete in this industry. The
largest CRO competitors offering research services similar to the Companys include:

| | o | Covance, Inc.
| | - | -------------

| | o | Pharmaceutical
Product Development, Inc.
| | - | ----------------------------------------

| | o | Charles
River Laboratories, Inc.
| | - | --------------------------------

| | o | MDS
Health Group Ltd.
| | - | ---------------------

CROs generally compete
on:

| | o | regulatory
compliance record and quality system
| | - | -----------------------------------------------

| | o | previous
experience
| | - | -------------------

| | o | medical
and scientific expertise in specific therapeutic areas
| | - | --------------------------------------------------------------

| | o | scientist-to-scientist
relationships
| | - | ------------------------------------

| | o | quality
of contract research
| | - | ----------------------------

| | o | financial
viability
| | - | -------------------

| | o | database
management
| | - | -------------------

| | o | statistical
and regulatory services
| | - | -----------------------------------

| | o | recruiting
investigators
| | - | ------------------------

| | o | integrating
information technology with systems to optimize research efficiency
| | - | -------------------------------------------------------------------------------

| | o | an
international presence with strategically located facilities
| | - | ---------------------------------------------------------------

| | o | price
| | - | -----

Several of the
Companys competitors have significantly greater financial resources than the
Company.

Products

The Company was founded
as a provider of instrumentation and products utilized in life sciences research
laboratories, the product niche it serves today. The Company targets underserved markets
not addressed by larger capital equipment manufacturers. While the Company must sometimes
compete on price with its products, the Company mainly competes on its overall value
proposition, providing equipment that enables its customers to attain premium scientific
laboratory information, on a reasonable operating investment. The Company continually
invests in refinement of its products, and in new product opportunities that meet its
operating objectives.

Culex® APS:
Two small vendors have offered simple, semi-automated blood sampling systems. However, the
Company does not believe that either vendor presents significant competition for
Culex®. In addition, the Company has established strong relationships with the largest
vendors of animal models who now provide catheterized Culex® ready models
to the Companys customers on a just-in-time basis, further increasing convenience
and lowering cost to the customer.

Chemical Analysis:
The Company competes with several large equipment manufacturers, including Agilent, Waters
Corporation and Perkin Elmer Corporation. Competitive factors include market presence,
product quality, reliability and price. The Company believes it competes well in its niche
markets because of its reputation and the quality of its products, together with the
technical assistance and service it offers. Many of the Companys competitors are
much larger and have greater resources than the Company, which makes it difficult for the
Company to capture business from clients other than those who need the Companys
unique capabilities.

Vetronics/in vivosampling devices: There are few competitors in this area of the Companys
business. The Company is the largest vendor in these very small, technically demanding
niches.

7

# Government Regulation

The Company is subject
to various regulatory requirements designed to ensure the quality and integrity
of its data and products. These regulations are governed primarily under the
Federal Food, Drug and Cosmetic Act, as well as by associated Good Laboratory
Practice (GLP), Good Manufacturing Practice (GMP), and
Good Clinical Practice (GCP) guidelines administered by the FDA. The
standards of GLP, GMP, and GCP are required by the FDA and by similar regulatory
authorities around the world. These guidelines demand rigorous attention to
employee training; detailed, authorized documentation; equipment validation;
careful tracking of changes and routine auditing of compliance. Noncompliance
with these standards could result in disqualification of project data collected
by the Company. Material violation of GLP, GMP, or GCP guidelines could result
in additional regulatory sanctions and, in severe cases, could also result in a
discontinuance of selected Company operations. Since October 2004, the company
has been audited, on a routine basis, by the FDA and UKs MHRA five times;
twice in West Lafayette, and once each in the UK, Evansville, and Baltimore
locations. Of the four FDA audits, three were without findings; the audits
findings in Baltimore were addressed and the UK facility was found to be
compliant with GLP and GCP. There were no material, adverse findings in any of
these audits.

The Company has not
experienced any significant problems to date in complying with the regulations of such
agencies and does not believe that any existing or proposed regulations will require
material capital expenditures or changes in its method of operation.

Analytical Services

Laboratories that
provide information included in INDs, NDAs and PLAs must conform to regulatory
requirements that are designed to ensure the quality and integrity of the testing process.
Most of the Companys contract research services are subject to government standards
for laboratory practices that are embodied in guidelines for GLP. The FDA and other
regulatory authorities require that test results submitted to such authorities be based on
studies conducted in accordance with GLP. These guidelines are set out to help the
researcher perform work in compliance with a pre-established plan and standardized
procedures. These guidelines include but are not restricted to:

| | o | Resources
- organization, personnel, facilities and equipment
| | - | -------------------------------------------------------------

| | o | Rules
- protocols and written procedures
| | - | ----------------------------------------

| | o | Characterization
- test items and test systems
| | - | ----------------------------------------------

| | o | Documentation
- raw data, final report and archives
| | - | ---------------------------------------------------

| | o | Quality
assurance unit - formalized internal audit function
| | - | -----------------------------------------------------------

Preclinical Services

The Company must also
maintain reports for each study for specified periods for auditing by the study sponsor
and by the FDA or similar regulatory authorities in other parts of the world.
Noncompliance with GLP can result in the disqualification of data collection during the
preclinical trial.

The Companys
animal research facilities are subject to a variety of federal and state laws and
regulations, including The Animal Welfare Act and the rules and regulations enforced by
the United States Department of Agriculture (USDA) and the National Institutes
of Health (NIH). These regulations establish the standards for the humane
treatment, care and handling of animals by dealers and research facilities. The
Companys animal research facilities maintain detailed standard operating procedures
and the documentation necessary to comply with applicable regulations for the humane
treatment of the animals in its custody. Besides being licensed by the USDA as a research
facility, this business is also accredited by the Association for Assessment and
Accreditation of Laboratory Animal Care International (AAALAC) and has
registered assurance with the NIH.

Clinical Services

The Companys
Clinical Research Unit in Baltimore is principally subject to GCP guidelines that cover
activities such as obtaining informed consent, verifying qualifications of investigators,
complying with Standard Operating Procedures (SOP), reporting adverse
reactions to drugs and maintaining thorough and accurate records. The Company must
maintain source documents for each study for specified periods. Such documents are
frequently reviewed by the study sponsor during visits to the Companys facility and
may be reviewed by the FDA during audits. In the fall of 2005, the facility was audited by
the FDA. The FDA cited areas for needed improvement, which we have addressed and responded
to the FDA concerns.

8

The Company is subject
to regulation and inspection by local, state, federal and foreign agencies where the
Companys facilities are located. The Company has not experienced any significant
problems to date in complying with the regulations of such agencies and does not believe
that any existing or proposed regulations will require material capital expenditures or
changes in its method of operation.

Quality Assurance
and Information Technology

To assure compliance
with applicable regulations, the Company has established quality assurance programs at its
facilities that audit test data, train personnel and review procedures and regularly
inspect facilities. In addition, FDA regulations and guidelines serve as a basis for the
Companys SOPs where applicable. On an ongoing basis, the Company endeavors to
standardize SOPs across all relevant operations. In addition, the Company has both
developed and purchased software to ensure compliant documentation, handling and reporting
of all laboratory generated study data. In fiscal 2004, the Company purchased similar 21
CFR Part 11 compliant software for its preclinical research group. At the end of fiscal
2006, the Companys laboratory operations were fully in compliance with 21 CFR Part
11, in its analytical, bioanalytical, toxicology, lab information management, and document
management systems, and all of these systems were formally validated and released for use
in regulated studies.

Also in fiscal 2004,
the Company initiated implementation of a new Enterprise Resource Planning
(ERP) system, which was launched at all the Companys locations in the
third quarter of fiscal 2005. The implementation of this system is ongoing, with various
additional phases planned for fiscal 2007. The introduction of a new ERP system is part of
the Companys response to the Sarbanes-Oxley Act (the Act). The Company
determined that it was not practical to comply with the control, documentation and
testing requirements of Section 404 of the Act while operating on different,
decentralized, obsolete systems at its various locations. As part of the implementation of
the new system, documentation has been and will continue to be developed, and testing
procedures initiated, in preparing for managements assessment and report on internal
controls over financial reporting required by the Act for fiscal 2008. Although the
Company is working diligently to ensure that the ERP system and related procedures will be
adequately installed and successfully tested by September 30, 2008, there can be no
assurance that all necessary procedures required by the Act will be completed by that
date.

Controlled,
Hazardous, and Environmentally Threatening Substances

Some of the
Companys development and testing activities are subject to the Controlled Substances
Act administered by the Drug Enforcement Agency (DEA), which strictly
regulates all narcotic and habit-forming substances. The Company maintains
restricted-access facilities and heightened control procedures for projects involving such
substances due to the level of security and other controls required by the DEA. In
addition, the Company is subject to other federal and state regulations concerning such
matters as occupational safety and health and protection of the environment.

Our U.S. laboratories
are subject to licensing and regulation under federal, state and local laws relating to
hazard communication and employee right-to-know regulations, the handling and disposal of
medical specimens and hazardous waste, as well as the safety and health of laboratory
employees. All of our laboratories are subject to applicable federal and state laws and
regulations relating to the storage and disposal of all laboratory specimens including the
regulations of the Environmental Protection Agency, the Department of Transportation, the
National Fire Protection Agency and the Resource Conservation and Recovery Act. Although
we believe that the Company is currently in compliance in all material respects with such
federal, state and local laws, failure to comply could subject the Company to denial of
the right to conduct business, fines, criminal penalties and other enforcement actions.

The regulations of the
U.S. Department of Transportation, the U.S. Public Health Service and the U.S. Postal
Service apply to the surface and air transportation of laboratory specimens. The
Companys laboratories also comply with the International Air Transport Association
regulations which govern international shipments of laboratory specimens. Furthermore,
when materials are sent to a foreign country, the transportation of such materials becomes
subject to the laws, rules and regulations of such foreign country.

Safety

In addition to its
comprehensive regulation of safety in the workplace, the Occupational Safety and Health
Administration has established extensive requirements relating to workplace safety for
health care employers whose workers may be exposed to blood-borne pathogens such as HIV
and the hepatitis B virus. These regulations, among other things, require work practice
controls, protective clothing and equipment, training, medical follow-up, vaccinations and
other measures designed to minimize exposure to chemicals, and transmission of blood-borne
and airborne pathogens. Furthermore, relevant employees of the Company receive initial and
periodic training focusing on compliance with applicable hazardous materials regulations
and health and safety guidelines.

9

HIPAA

The Department of
Health and Human Services has promulgated final regulations under the Health Insurance
Portability and Accountability Act of 1996 (HIPAA) that govern the disclosure
of confidential medical information in the United States. The Company has had a global
privacy policy in place since January 2001, which includes a designated privacy officer,
and believes that we are in compliance with the current EU (European Union) and HIPAA
requirements. Nevertheless, we will continue to monitor our compliance with these new
regulations and we intend to take appropriate steps to ensure compliance as these and
other privacy regulations come into effect.

# Product Liability and
Insurance

The Company maintains
product liability and professional errors and omissions liability insurance, providing
approximately $6.0 million in coverage on a claims-made basis. Additionally, in certain
circumstances the Company seeks to manage its liability risk through contractual
provisions with clients requiring the Company to be indemnified by the client or covered
by clients product liability insurance policies. Also, in certain types of
engagements the Company seeks to limit its contractual liability to clients to the amount
of fees received by the Company. The contractual arrangements are subject to negotiation
with clients, and the terms and scope of such indemnification, liability limitation and
insurance coverage vary by client and project.

# Research and
Development

In fiscal 2006, 2005
and 2004 the Company spent $1.4 million, $1.3 million, and $1.1 million, respectively, on
research and development. Separate from the Companys contract research services
business, the Company maintains applications research and development to enhance its
products business.

Expenditures cover
hardware and software engineering costs, laboratory supplies, animals, drugs and reagents,
labor, prototype development and laboratory demonstrations of new products and
applications for those products.

# Intellectual Property

The Company believes
that its patents, trademarks, copyrights and other proprietary rights are important to its
business and, accordingly, it actively seeks protection for those rights both in the
United States and abroad. Where the Company deems it to be an appropriate course of
action, it will vigorously prosecute patent infringements. The Company does not believe,
however, that the loss of any one of its patents, trademarks, copyrights or other
proprietary rights would be material to its consolidated revenues or earnings.

The Company currently
holds nine federally registered trademarks, as well as one copyright registration for
software. The Company also maintains a small pool of issued and pending patents. Most of
these patents are related to the Companys Culex® or in vivoproduct line.
Of these patents, most are either issued or pending in the United States, although there
are also patents issued and pending in the European Union and Japan. Although the Company
believes that at least two of these patents are important to the Culex® product line,
the success of the Culex® business is not dependent on the Companys intellectual
property rights because the Company also generates client value through continuing client
support, hardware and software upgrades, system reliability and accuracy. In addition to
these formal intellectual property rights, the Company relies on trade secrets, unpatented
know-how and continuing applications research which it seeks to protect through means of
reasonable business procedures, such as confidentiality agreements. The Company believes
that the greatest value that it generates for its clients comes from these trade secrets,
know-how and applications research.

# Raw Materials

There are no
specialized raw materials that are particularly essential to the Companys business,
and the Company has a variety of alternative suppliers for its essential components.

10

# Employees

At September 30, 2006,
the Company had 330 full-time employees. All employees enter into confidentiality
agreements intended to protect the Companys proprietary information. The Company
believes that its relations with its employees are good. None of the employees of the
Company are represented by a labor union. The Companys performance depends on its
ability to attract and retain qualified professional, scientific and technical staff. The
level of competition among employers for skilled personnel is high. The Company believes
that its employee benefit plans enhance employee morale, professional commitment and work
productivity and provide an incentive for employees to remain with the Company.

# Executive Officers of
the Registrant

The following
information concerns the persons who served as the executive officers of the Company as of
September 30, 2006. Except as indicated in the following paragraphs, the principal
occupations of these persons has not changed in the past five years. Officers are elected
annually at the annual meeting of the board of directors.

|Name                     | Age | Position
|------------------------ | --- | --------
|                        
|Peter T. Kissinger, Ph.D |     |         
|Richard M. Shepperd      |     |         
|Ronald E. Shoup, Ph.D    |     |         
|Michael R. Cox           |     |         
|Edward M. Chait, Ph.D    |     |         
|Candice B. Kissinger     |     |         
|Craig S. Bruntlett, Ph.D |     |         
|Lina L. Reeves-Kerner    |     |         

Peter T. Kissinger,
Ph.D. founded the Company in 1974 and had served as its Chairman, President and Chief
Executive Officer from 1974 until September, 2006, when he resigned the position of
President and Chief Executive Office to assume the role of Chief Scientific Officer. He is
also a part-time Professor of Chemistry at Purdue University, where he has been teaching
since 1975. Dr. Kissinger has a Bachelor of Science degree in Analytical Chemistry
from Union College and a Ph.D. in Analytical Chemistry from the University of North
Carolina.

Dr. Kissinger is a
highly recognized pioneer in hydrodynamic electroanalytical techniques for the
neurosciences, modern liquid chromatography and in vivo methodology for drug metabolism.
Dr. Kissinger has published over 220 scientific papers and has presented more than
400 invited lectures. He is a Fellow of the AAPS and the AAAS and was a finalist for Ernst
& Young Entrepreneur of the Year Award ® in the Indiana Heartland region for 2001
and 2003. Dr. Kissinger is the husband of Candice B. Kissinger.

Richard M.
Shepperd was elected President and Chief Executive Officer of the Company in September
2006, on an interim basis, and is expected to serve for one year or less.
Mr. Shepperd, 66, served for the past two years with Able Laboratories, Inc., of
Cranbury, New Jersey (Able) as its Chief Restructuring Officer and Director of
Restructuring. Able was formerly a generic pharmaceutical manufacturing company which
filed a voluntary petition for bankruptcy on July 18, 2005 following the loss of FDA
approval for its product line. Mr. Shepperds duties for Able included
exercising executive authority over all operational and restructuring activities of Able,
which included advising its Board, creditors committee and courts regarding strategies to
maintain and realize the most value from the companys assets. Able was not
affiliated with the Company. For the three years prior to serving with Able,
Mr. Shepperd served as an independent management consultant for various businesses.
In that capacity, he advised these businesses on developing strategies to improve their
financial health and maximize the assets of those organizations.

Ronald E. Shoup,
Ph.D.serves as Chief Operating Officer of the Companys Contract Research
Services and is Managing Director of BAS Analytics, Ltd. in the UK. His current
responsibilities include directing operations at the Companys Contract Research
Services sites. He joined the Company in 1980 as an applications chemist, became Research
Director in 1983 and launched the Contract Research Services group within the Company in
1988. Dr. Shoup has a Bachelor of Science degree in Mathematics and Chemistry from
Purdue University and then attended Michigan State and Purdue University for his Ph.D. in
Analytical Chemistry.

11

Dr. Shoup has
served on the editorial board of the Journal of Chromatography, participated in NIH
Special study sections, and is a member of the external advisory board to the Purdue
University Department of Chemistry. He has published over 40 scientific papers.

Michael R. Cox
has been Vice President, Finance, Chief Financial Officer and Treasurer since April 2004.
He was Vice President, Finance and CFO of Integrity Pharmaceutical Corporation, a private
specialty pharmaceutical company, from October, 2003 until its acquisition and merger in
March, 2004. Prior to that he was Senior Vice President, Finance of Intergen Company, a
private biotech manufacturing and research products company, from 1997 until its
acquisition in 2001, and continued with the acquirer, Serologicals Corporation, on special
projects until joining Integrity. Prior to that, Mr. Cox held various executive
positions in two environmental services firms and an investment firm. He was a partner in
Touche Ross & Co., where he began his career after obtaining a BS in business
administration from the University of North Carolina.

Edward M. Chait,
Ph.D.has been Executive Vice President, Chief Scientific Officer since August, 2005.
Prior to that, from August 2003, Dr. Chait served as the Chief Executive Officer of
Spectral Genomics, Inc., a developer of products and services related to molecular
genetics and diagnostics enabling the identification of the causal factors of disease at
the genetic level. From 2001 to 2003, Dr. Chait served as the Chief Executive Officer
of PharmaCore, Inc., a small-molecule drug discovery company providing molecular building
blocks, custom organic synthesis and GMP services to biotechnology and pharmaceutical
companies. From 1991 to 2001, Dr. Chait was Senior Vice President in charge of
Business Development for Intergen Company, a manufacturer of cell culture, diagnostic and
research products. Since 2002, Dr. Chait has also served as an advisor to the Purdue
Cancer Center, a National Cancer Center designated basic-research cancer center. From 1968
to 1991, Dr. Chait held positions of increasing responsibility in marketing and
business development at DuPont in instrument and life science products. Dr. Chait has
a Ph.D. in chemistry from Purdue.

Candice B.
Kissinger currently devotes all of her time to branding, client relationship
management, sales, product development, and managing installation and service for in vivo
products and services, principally the Culex® APS. She was named Senior Vice
President, Marketing in January 2000 and is currently Director of Research. From 1981 to
2000 she served as Vice President, International Sales and Marketing. Ms. Kissinger
has a Bachelor of Science degree in Microbiology from Ohio Wesleyan University and a
Master of Science degree in Food Science from the University of Massachusetts.
Dr. Peter Kissinger is the husband of Ms. Kissinger. She has served as a
director and Secretary of the Company since 1978.

Craig S. Bruntlett,
Ph.D. has been Senior Vice President of Sales Development since September
2005. Prior to that, he was Senior Vice President of International Sales from
1999. From 1992 to 1999 he was Vice President, Electrochemical Products. From
1980 to 1990, Dr. Bruntlett was Director of New Products Development for
the Company. Dr. Bruntlett has a Bachelor of Arts degree in Chemistry and
Mathematics from St. Cloud State University in Minnesota and a Ph.D. in
Chemistry from Purdue University.

Lina L.
Reeves-Kerner has been Vice President, Human Resources since 1995 and is responsible
for the administrative support functions of the Company, including shareholder relations,
human resources and community relations. From 1980 to 1990, Ms. Reeves-Kerner served
as an Administrative Assistant with the Company. Ms. Reeves-Kerner has a Bachelor of
Science degree in Business Administration from Indiana Wesleyan University.

12

Item 1A.    Risk Factors.

While it is impossible
to identify all such factors, the risks and uncertainties that may affect the operations,
performance and results of the Companys business include the following:

A reduction in
research and development budgets at pharmaceutical and biotechnology companies may
adversely affect our business.

Our customers include
researchers at pharmaceutical and biotechnology companies. Our ability to continue to
grow and win new business is dependent in large part upon the ability and willingness of
the pharmaceutical and biotechnology industries to continue to spend on research and
development and to outsource the products and services we provide. Fluctuations in the
research and development budgets of these researchers and their organizations could have
a significant effect on the demand for our products and services. Research and
development budgets fluctuate due to changes in available resources, mergers of
pharmaceutical and biotechnology companies, spending priorities and institutional
budgetary policies. Our business could be adversely affected by any significant decrease
in life sciences research and development expenditures by pharmaceutical and
biotechnology companies. Similarly, economic factors and industry trends that affect our
clients in these industries also affect our business.

Our future success
depends on our ability to keep pace with rapid technological changes that could make our
services and products less competitive or obsolete.

The biotechnology,
pharmaceutical and medical device industries generally and Contract Research ("CRO") services
more specifically are subject to increasingly rapid technological changes. Our
competitors or others might develop technologies, services or products that are more
effective or commercially attractive than our current or future technologies, services or
products, or that render our technologies, services or products less competitive or
obsolete. If competitors introduce superior technologies, services or products and we
cannot make enhancements to ours to remain competitive, our competitive position, and in
turn our business, revenues and financial condition, would be materially and adversely
affected.

# The CRO services industry is highly competitive.

The CRO services industry is highly competitive. We often compete for business not
only with other CRO companies, but also with internal
discovery and development departments within our clients, some of which are large
pharmaceutical and biotechnology companies with greater resources than we have. If we do
not compete successfully, our business will suffer. The industry is highly fragmented,
with numerous smaller specialized companies and a handful of full-service companies with
global capabilities much larger than ours. Increased competition might lead to price and
other forms of competition that might adversely affect our operating results. As a result
of competitive pressures, our industry experienced consolidation in recent years. This
trend is likely to produce more competition among the larger companies for both clients
and acquisition candidates. In addition, there are few barriers to entry for smaller
specialized companies considering entering the industry. Because of their size and focus,
these companies might compete effectively against larger companies such as us, which
could have a material adverse impact on our business.

# The loss of our key
personnel could adversely affect our business.

Our success
depends to a significant extent upon the efforts of our senior management team
and other key personnel. The loss of the services of such personnel could
adversely affect our business. Also, because of the nature of our business, our
success is dependent upon our ability to attract, manage and retain
technologically qualified personnel. There is substantial competition for
qualified personnel, and an inability to recruit, manage or retain qualified
personnel may impact our ability to grow our business and compete effectively in
our industry.

Any failure by us to
comply with existing regulations could harm our reputation and operating results.

Any failure on our
part to comply with existing regulations could result in the termination of ongoing
research or the disqualification of data for submission to regulatory authorities. This
would harm our reputation, our prospects for future work and our operating results.
Furthermore, the issuance of a notice from the FDA based on a finding of a material
violation by us of good clinical practice, good laboratory practice or good manufacturing
practice requirements could materially and adversely affect us.

Proposed and
future legislation or regulations might increase the cost of our business or limit our
service or product offerings.
Federal  or  state  authorities  might  adopt  healthcare   legislation  or
regulations      that      are      more      burdensome      than      existing
regulations.      Changes in regulation  could  increase our
expenses or limit our ability to offer some of our services or products.

13

Our business uses
biological and hazardous materials, which could injure people or violate laws, resulting
in liability that could hurt our financial condition and business.

Our activities involve
the controlled use of potentially harmful biological materials, as well as hazardous
materials, chemicals and various radioactive compounds. We cannot completely eliminate
the risk of accidental contamination or injury from the use, storage, handling or
disposal of these materials. In the event of contamination or injury, we could be held
liable for damages that result, and any liability could exceed our ability to pay. Any
contamination or injury could also damage our reputation, which is critical to getting
new business. In addition, we are subject to federal, state and local laws and
regulations governing the use, storage, handling and disposal of these materials and
specified waste products. The cost of compliance with these laws and regulations is
significant and if changes are made to impose additional requirements, these costs could
increase and have an adverse impact on our financial condition and results of operations.

The majority of our
customers contracts can be terminated upon short notice.

Most of our contracts
for CRO services are terminable by the client upon 30 to 90 days notice.
Clients terminate or delay their contracts for a variety of reasons, including but not
limited to:

| | o | products
being tested fail to satisfy safety requirements;
| | - | ----------------------------------------------------------

| | o | products
have undesired clinical results;
| | - | -----------------------------------------

| | o | the
client decides to forego a particular study;
| | - | ------------------------------------------------

| | o | inability
to enroll enough patients in the study;
| | - | -------------------------------------------------

| | o | inability
to recruit enough investigators;
| | - | ------------------------------------------

| | o | production
problems cause shortages of the drug; and
| | - | ----------------------------------------------------

| | o | actions
by regulatory authorities.
| | - | ----------------------------------

The termination of one or more significant Contracts could have a material
adverse effect on our quarterly or annual financial results.

# Our Products business
depends on our intellectual property.

Our products business
is dependent, in part, on our ability to obtain patents in various jurisdictions on our
current and future technologies and products, to defend our patents and protect our trade
secrets and to operate without infringing on the proprietary rights of others. There can
be no assurance that the our patents will not be challenged by third parties or that, if
challenged, those patents will be held valid. In addition, there can be no assurance that
any technologies or products developed by us will not be challenged by third parties
owning patent rights and, if challenged, will be held not to infringe on those patent
rights. The expense involved in any patent litigation can be significant. We also rely on
unpatented proprietary technology, and there can be no assurance that others will not
independently develop or obtain similar products or technologies.

We might incur
substantial expense to develop products that are never successfully developed and
commercialized.

We have incurred and
expect to continue to incur substantial research and development and other expenses in
connection with our products business. The potential products to which we devote
resources might never be successfully developed or commercialized by us for numerous
reasons, including:

| | o | inability
to develop products that address our customers' needs;
| | - | ----------------------------------------------------------------

| | o | competitive
products with superior performance;
| | - | -----------------------------------------------

| | o | patent
conflicts or unenforceable intellectual property rights;
| | - | ---------------------------------------------------------------

| | o | demand
for the particular product; and
| | - | --------------------------------------

| | o | other
factors that could make the product uneconomical.
| | - | -------------------------------------------------------

14

Incurring significant
expenses for a potential product that is not successfully developed and/or commercialized
could have a material adverse effect on our business, financial condition, prospects and
stock price.

We dose human volunteers with new drug candidates in our clinical operations.

Our clinical research services involes the introduction of experimental
pharmaceutical compounds into consenting human volunteers during the studies of
such compounds. This activity may expose us to liability as a result of adverse
reactions of these volunteers to the compounds being tested. We seek to limit
our risk through "hold harmless" provisions with the volunteers, obtaining
indemnity from the sponsors, and by maintaining insurance. We bear the risk that
these agreements may not protect us from liabilities, that our insurance may not
be sufficient to cover our losses, and that such insurance may not continue to
be available on terms acceptable to us.

# Contract research
services create a risk of liability.

In certain
circumstances, we seek to manage our liability risk through contractual provisions with
clients requiring the Company to be indemnified by the client or covered by the clients product
liability insurance policies. Although most of the Companys clients are large,
well-capitalized companies, the financial performance of these indemnities is not
secured. Therefore, the Company bears the risk that the indemnifying party may not have
the financial ability to fulfill its indemnification obligations or the liability would
exceed the amount of applicable insurance. Furthermore, we could be held liable for
errors and omissions in connection with the services we perform. There can be no
assurance that our insurance coverage will be adequate, or that insurance coverage will
continue to be available on acceptable terms or that we can obtain indemnification
arrangements or otherwise be able to limit its liability risk.

If we are
unable to attract suitable willing volunteers for our clinical trials, our clinical business might suffer.
The clinical research studies we run in our Baltimore
laboratory rely upon the ready accessibility and willing participation of volunteer subjects.
Volunteer subjects generally include people from the communities in which the studies are
conducted, including our Phase I clinic in Baltimore, Maryland, which to date has provided
a substantial pool of potential subjects for research studies. Our clinical research
development business could be adversely affected if we were unable to attract suitable and
willing volunteers on a consistent basis.

# We may expand our
business through acquisitions.

We review many
acquisition candidates and, in addition to acquisitions which we have already made, we are
continually evaluating new acquisition opportunities. Factors which may affect our ability
to grow successfully through acquisitions include:

| | o | difficulties
and expenses in connection with integrating the acquired companies and achieving the
expected benefits;
| | - | --------------------------------------------------------------------------------------------------------------------

| | o | diversion
of management's attention from current operations;
| | - | ------------------------------------------------------------

| | o | the
possibility that we may be adversely affected by risk factors facing the acquired
companies;
| | - | ------------------------------------------------------------------------------------------------

| | o | acquisitions
could be dilutive to earnings, or in the event of acquisitions made through the issuance
of our common stock to the shareholders of the acquired company, dilutive to the
percentage of ownership of our existing stockholders;
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | o | potential
losses resulting from undiscovered liabilities of acquired companies not covered by the
indemnification we may obtain from the seller;
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------

| | o | loss
of key employees of the acquired companies.
| | - | ------------------------------------------------

Changes in
government regulation or in practices relating to the pharmaceutical industry could change
the need for the services we provide.

Governmental agencies
throughout the world, but particularly in the United States, strictly regulate the drug
development process. Our business involves helping pharmaceutical and biotechnology
companies comply with the regulatory drug approval process. Changes in regulation, such as
a relaxation in regulatory requirements or the introduction of simplified drug approval
procedures, or an increase in regulatory requirements that we have difficulty satisfying,
or that make our services less competitive, could substantially change the demand for our
services. Also, if the government increases efforts to contain drug costs and
pharmaceutical and biotechnology company profits from new drugs, our customers may spend
less, or reduce their growth in spending on research and development.

15

# Privacy regulations
could increase our costs or limit our services.

The US Department of
Health and Human Services has issued regulations under the Health Insurance Portability
and Accountability Act of 1996 (HIPAA). These regulations demand greater
patient privacy and confidentiality. Some state governments are considering more
stringent regulations. These regulations might require us to increase our investment in
security or limit the services we offer. We could be found legally liable if we fail to
meet existing or proposed regulation on privacy and security of health information.

# We might lose
business opportunities as a result of healthcare reform.

Numerous governments
have undertaken efforts to control growing healthcare costs through legislation,
regulation and voluntary agreements with healthcare providers and drug companies.
Healthcare reform could reduce demand for our services and products, and, as a result,
our revenue. In the last several years, the U.S. Congress has reviewed several
comprehensive health care reform proposals. The proposals are intended to expand
healthcare coverage for the uninsured and reduce the growth of total healthcare
expenditures. The U.S. Congress has also considered and may adopt legislation that could
have the effect of putting downward pressure on the prices that pharmaceutical and
biotechnology companies can charge for prescription drugs. Any such legislation could
cause our customers to spend less on research and development. If this were to occur, we
would have fewer business opportunities for our business, which could reduce our
earnings. Similarly, pending or future healthcare reform proposals outside the United
States could negatively impact our revenues from our international operations.

# Reliance on air
transportation.

Our laboratories and
certain of our other businesses are heavily reliant on air travel for transport of samples
and other material, products and people, and a significant disruption to the air travel
system, or our access to it, could have a material adverse effect on our business.

We have experienced periods of losses on our operating activities.

Our overall
strategy includes increasing revenue and reducing/controlling operating
expenses. We have concentrated our efforts in ongoing, Company-wide efficiency
activities intended to increase productivity and reduce costs including
personnel reductions, reduction or elimination of non-personnel expenses and
realigning and streamlining operations. We cannot assure that our efforts will
result in increased profitability for any meaningful period of time.

The outsourcing trend in the biotechnology and pharmaceutical industries may
decrease, which could slow our growth.

Over the
past several years, some areas of our businesses have grown significantly as a
result of the increase in pharmaceutical and biotechnology companies outsourcing
their preclinical and clinical research support activities. We believe that due
to the significant investment in facilities and personnel required to support
drug development, pharmaceutical and biotechnology companies look to outsource
some or all of those services. By doing so, they can focus their resources on
their core competency of drug discovery, while obtaining the outsourced services
from a full-service provider like the Company. While industry analysts expect
the outsourcing trend to continue for the next several years, a decrease in
preclinical and/or clinical outsourcing activity could result in a diminished
growth rate in the sales of one or more of our expected higher-growth areas and
adversely affect our financial condition and results of operations. Furthermore,
our customer contracts are generally terminable on little or no notice.
Termination of a large contract or multiple contracts could adversely affect our
sales and profitability.

Our
operations and financial results could be significantly affected by the
above-mentioned risks.

Our previous
independent registered public accounting firm advised management and our audit committee
that they identified material weaknesses in our internal controls and we have concluded
that we had material weaknesses as of June 30,
2006. Our business and stock price may be adversely affected by these identified material
weaknesses if we do not remediate them or if we have other material weaknesses in our
internal controls.

As we
disclose in Part II, Item 9, Controls and Procedures of this Form
10-K, our management and previous independent accountants concluded that a
material weakness existed in our internal controls as of June 30, 2006. The
Company has instituted measures to address these risks. We believe these actions
have addressed the weaknesses cited by our previous independent accountants.
However, any failure to implement and maintain the improvements in the controls
over our financial reporting, or difficulties encountered in the implementation
of these improvements in our controls, could cause us to fail to meet our
reporting obligations. Any failure to improve our internal controls to address
the identified material weaknesses could also cause investors to lose confidence
in our reported financial information, which could harm our operations or
results or cause us to fail to meet our reporting obligations, and could have a
negative impact on the trading price of our stock. We cannot be certain that any
steps we may take to improve our internal controls to address the identified
material weaknesses will ensure that we implement and maintain adequate controls
over our financial processes and reporting in the future.

16

# Item 1B.    Unresolved Staff Comments.

Not applicable.

# Item 2.    Properties.

The Company operates in
the following locations all of which are owned by the Company, except as otherwise
indicated:

    West
Lafayette, IN: principal executive offices are located at 2701 Kent Avenue, West
Lafayette, Indiana 47906, and constitutes multiple buildings with approximately 135,000
square feet of operations, manufacturing, and administrative space. Both the services
segment and the products segment conduct operations at this facility. A new 20,000 square
foot ADME preclinical research facility became fully functional in April, 2005. It is
custom-designed to provide contract pharmacokinetic and ADME research services based on
its Culex® Automated Pharmacology system. Both the new facility and the prior portion
of the building have been financed by mortgages.

    BAS
Evansvilleoccupies 10 buildings with roughly 100,000 square feet of operating and
administrative space on 52 acres. Most of this site is engaged in preclinical toxicology
testing of developmental drugs in animal models. A recent addition was financed by a
mortgage.

    BASi Clinical
Research Unit(BASi Maryland) in Baltimore, Maryland occupies a seven story, 126,000
square foot historic building in downtown Baltimore. On January 5, 2005, this building was
sold to a developer and the Company and the developer entered into a three-year lease back
for approximately 85% of the space in the building. This site contains a 110 bed, three
ward, Phase I Clinical Trials facility along with administrative offices committed to
recruitment and enrollment of study participants, medical and clinical trials staff, data
management, and later phase Clinical Trials Management. The Company intends to use the
lease back period to develop its long-term space alternatives.

    Bioanalytical
Systems, Ltd., Warwickshire, UK contains the Companys contract services and
instruments operations in roughly 12,000 square feet of leased space for laboratories,
sales and technical support services in the U.K.

    BASi
Northwest Laboratoryis in McMinnville, Oregon, approximately 40 miles from Portland.
The Company leases roughly 8,600 square feet of laboratory and administrative space,
principally used for bioanalytical services.

The Company believes
that its facilities are adequate for the Companys operations and that suitable
additional space will be available if and when needed. The terms of any mortgages and
leases for the above properties are detailed in Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations, and Notes 3, 5 and 6 to the Notes
to Consolidated Financial Statements.

# Item 3.    Legal
Proceedings.

The Company does not
have any current pending legal proceedings.

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

Not applicable.

# PART II

# Item 5.    Market for
Registrants Common Equity and Related Stockholder Matters

You can find
information regarding the market for the Companys common shares and related
stockholder matters under the heading Common Shares in our 2006 Annual Report.
That information is incorporated herein by reference.

17

Equity Compensation
Plan Information

The Company maintains
stock option plans that allow for the granting of options to certain key employees and
directors of the Company. The following table gives information about equity awards under
the stock option plans of the Company:

|Plan Category                      | Number of Securities to be
Issued upon Exercise of
Outstanding Options | Weighted Average
Exercise Price of
Outstanding Options | Number of Securities Remaining
Available for Future Issuance
under the Equity Compensation Plan
(Excluding Securities Reflected
in First Column)
|---------------------------------- | ---------------------------------------------------------------------- | ------------------------------------------------------ | ------------------------------------------------------------------------------------------------------------------------------------------------
|Equity compensation plans approved |                                                                        |                                                        |                                                                                                                                                 
|by security holders                |                                                                        |                                                        |                                                                                                                                                 
|                                  
|Equity compensation plans not      |                                                                        |                                                       
|approved by security holders(1)    |                                                                        |                                                        |                                                                                                                                                 
|                                  
|Total                              |                                                                        |                                                        |                                                                                                                                                 

(1)    
Includes option to purchase 25,000 shares at $4.57 granted April 1, 2004, and 25,000 shares at $5.69 granted
August 1, 2005. Each of these grants is fully vested expire after 10 years.

For additional
information regarding the Companys stock option plans approved by security holders,
please see Note 8, to the Consolidated Financial Statements included in Item 8 of
this report.

# Item 6.    Selected
Financial Data.

You can find Selected
Financial Data for each of our five most recent fiscal years in our 2006 Annual Report
under Selected Consolidated Financial Data. That information is incorporated
herein by reference.

Item 7.    Management's
Discussion and Analysis of Financial Condition and Results of Operations.

This report contains
statements that constitute forward looking statements within the meaning of the Private
Securities Litigation Reform Act of 1995. Those statements appear in a number of places in
this Report and may include statements regarding the intent, belief or current
expectations of the Company or its management with respect to, but are not limited to (i)
the Companys strategic plans; (ii) trends in the demand for the Companys
products; (iii) trends in the industries that consume the Companys products; (iv)
the Companys ability to refinance its debt; (v) the ability of the Company to
develop new products; and (vi) the ability of the Company to make capital expenditures and
finance operations. Readers are cautioned that any such forward looking statements are not
guarantees of future performance and involve risks and uncertainties. Actual results may
differ materially from those in the forward looking statements as a result of various
factors, many of which are beyond the control of the company.

In addition, the
Company has based these forward-looking statements on its current expectations and
projections about future events. Although the Company believes that the assumptions on
which the forward-looking statements contained herein are based are reasonable, any of
those assumptions could prove to be inaccurate, and as a result, the forward-looking
statements based upon those assumptions also could be incorrect. The following discussion
and analysis should be read in conjunction with Selected Consolidated Financial Data and
the Companys Consolidated Financial Statements and notes thereto included or
incorporated by reference elsewhere in this Report. In addition to the historical
information contained herein, the discussions in this Report may contain forward-looking
statements that involve risks and uncertainties which are discussed in Item 1A, Risk
Factors. The Companys actual results could differ materially from those discussed in
the forward-looking statements.

18

# Overview

The business of
Bioanalytical Systems, Inc. is dependent on the level of pharmaceutical and biotech
companies efforts in new drug discovery and approval. Our services segment is the
direct beneficiary of these efforts, through outsourcing by these companies of research
work, and our products segment is the indirect beneficiary, as increased drug development
leads to capital expansion providing opportunities to sell the equipment we produce and
the consumable supplies we provide that support our products.

Developments within the
industries we serve have a direct, and sometimes material, impact on our operations.
Currently, many large pharmaceutical companies have major block-buster drugs
that are nearing the end of their patent protections. This puts significant pressure on
these companies both to develop new drugs with large market appeal, and to re-evaluate
their cost structures and the time-to- market of their products. Contract research
organizations (CROs) have benefited from these developments, as the
pharmaceutical industry has turned to out-sourcing to both reduce fixed costs, and to
increase the speed of research and data development necessary for new drug applications.

The number of
significant drugs that have reached or are nearing the end of their patent protection has
also benefited the generic drug industry. That sector of the drug industry has seen
significant growth in the past decade, and, we believe, will continue to experience strong
growth in the foreseeable future. Generic drug companies provide a significant source of
new business for CROs as they develop, test and manufacture their generic compounds.

A significant portion
of innovation in the pharmaceutical industry is now being driven by biotech and small,
venture capital funded, drug development companies. Many of these companies are
single-molecule entities, whose success depends on one innovative compound.
While several of the biotech companies have reached the status of major pharmaceuticals,
the industry is still characterized by smaller entities. These developmental companies
generally do not have the resources to perform much of the clinical research within their
organizations, and are therefore dependent on the CRO industry for both their research and
for guidance in preparing their FDA submissions. These companies have provided significant
new opportunities for the CRO industry, including BASi. They do, however, provide
challenges in selling, as they frequently have only one product in development, which
causes CROs to be unable to develop a flow of projects from a single company. These
companies may expend all their available funds and cease operations prior to fully
developing a product. Additionally, the funding of these companies is subject to
investment market fluctuations, which change the risk profile and appetite of investors.

Although the past year
has not seen large mergers in either the pharmaceutical or CRO industries, consolidation
continues at a smaller pace in the CRO sector. We believe that consolidation of the CRO
sector will continue to be a factor in our markets.

Research services are
capital intensive. The investment in equipment and facilities to serve our markets is
substantial and continuing. While our physical facilities are excellent to meet market
needs for the near term, rapid changes in automation, precision, speed and technologies
necessitate a constant investment in equipment and software to meet market demands. We are
also impacted by the heightened regulatory environment and the need to improve our
business infrastructure to support our increasingly diverse operations, which will
necessitate additional capital investment. Our ability to generate capital to reinvest in
our capabilities, both through operations and financial transactions, is critical to our
success. While we are currently committed to fully utilizing recent additions to our
capacity, sustained growth will require additional investment in future periods.

19

# Results of Operations

The following table
summarizes the consolidated statement of operations as a percentage of total revenues:

|                                  | Year Ended September 30,
|--------------------------------- | ------------------------
|
|                                 
|Service revenue                   |                         
|Product revenue                   |                         
|                                  |                         
|Total revenue                     |                         
|                                 
|Cost of service revenue (a)       |                         
|Cost of product revenue (a)       |                         
|                                  |                         
|Total cost of revenue             |                         
|                                 
|Gross profit                      |                         
|                                 
|Total operating expenses          |                         
|                                  |                         
|                                  |                         
|                                 
|Operating income (loss)           |                         
|                                 
|Other (expense)                   |                         
|                                  |                         
|                                 
|Income (loss) before income taxes |                         
|                                 
|Income tax expense (benefit)      |                         
|                                  |                         
|                                 
|Net (loss)                        |                         
|                                  |                         

(a)    Percentage
of service and product revenues, respectively.

# Year Ended September
30, 2006, Compared with Year Ended September 30, 2005

Total revenue for the
year ended September 30, 2006 increased 1% to $43.0 million from $42.4 million for the
year ended September 30, 2005. Service revenue increased to $34.3 million for the year
ended September 30, 2006 from $33.0 million for the year ended September 30, 2005, an
increase of 4%. This increase was the result of 36% growth in our toxicology business,
offset by a 25% decline in revenues of our clinical research unit. Revenues in our
bioanalytical laboratories were essentially flat compared to the prior year. The revenue decline in
our clinical research unit was the result of the acquisition of its largest client,
resulting in the cessation of research by them in our facility. As a consequence, we
revalued the assets of that unit, recording an impairment charge in the third quarter of our 2006
fiscal year (discussed below). Revenues in our bioanalytical laboratories were negatively
impacted by delays in critical projects by our clients. Our revenues from products
declined in the current year to $8.7 million, an 8% decline from last years product
revenues of $9.4 million. This decline was across our product line. In the fiscal year
ended September 30, 2006, we did not have any major new adopters of our Culex® system,
which resulted in flat year-to-year sales. Our mature analytical instruments line
continued prior trends of declining sales. Inflation in prices did not have a material
impact on revenue increases.

20

Costs of revenue
increased 8% to $29.2 million for the year ended September 30, 2006 from $27.1 million for
the year ended September 30, 2005. This increase of $2.2 million was due to:  a) increases in
the cost of service revenue as a result of the capacity added in our bioanalytical
laboratories in fiscal 2005 which was not fully utilized in the current fiscal year as a
result of the lack of revenue growth in the current year, b) increased staffing in our in
vivo pharmacology unit as we increased our commercial offerings, and c) additional
costs in our toxicology business as a result of its growth. Cost of revenue as a
percentage of revenues increased in both service and product segments due to the lower
utilization of capacity. A significant portion of our production costs are relatively
fixed, which results in decreased margins as we decrease our utilization of facilities.
Costs of revenue for the Companys products segment increased to 40.6% as a
percentage of product revenue for the year ended September 30, 2006 from 36.7% of product
revenue for the year ended September 30, 2005.

Selling expenses for
the year ended September 30, 2006 increased by 6% to $2.7 million from $2.6 million during
the year ended September 30, 2005, as we filled positions in our expanded sales group
during the year. Research and development expenses for the year ended September 30, 2006
increased 9% to $1.4 million from $1.3 million for the year ended September 30, 2005. This
increase is primarily due to additional research activities around our Culex® product
line.

General and
administrative expenses for the year ended September 30, 2006 increased 18% to
$12.0 million from $10.2 million for the year ended September 30, 2005. In
September of 2006, in order to address our lack of profitability, we reduced our
headcount by approximately 12%, which resulted in severance costs of $600,000.
In fiscal 2006, we began expensing employee stock options, increasing
expenses by $319,000. Our provision for bad debts increased by $480,000,
principally the result of one contract that we were not able to collect.
Increases in our costs of health insurance, property taxes, outside audit, and
additional administrative support of our growth in toxicology were major
contributors to the remainder of the increase.

In our third
fiscal quarter of the current year, we determined that, due to the loss of a
significant customer in our clinical research unit, there had been a permanent
impairment of the value of its assets. We determined that the carrying value of
the unit's assets exceeded their fair value, requiring adjustment. The
adjustment of $1.1 million is shown as a separate line item in our 2006
Consolidated Statement of Operations.

Other income (expense),
net, was $(1,013,000) for the year ended September 30, 2006 as compared to $(969,000) in
the year ended September 30, 2005, as a result of increased interest expense. We reduced
our average outstanding borrowings on both our revolving line of credit and our mortgage
financing, while adding $1.5 million of lease financing to acquire laboratory equipment.

The Companys
effective tax rate was 41.2% for the benefits of our loss for fiscal 2006.

As a result of the
above, the Company lost $0.53 per share in fiscal 2006, both basic and diluted, compared
to a net loss in fiscal 2005 of $0.02 per share, both basic and diluted.

# Year Ended September
30, 2005, Compared with Year Ended September 30, 2004

Total revenue for the
year ended September 30, 2005 increased 14% to $42.4 million from $37.2 million for the
year ended September 30, 2004. Service revenue increased to $33.0 million for the year
ended September 30, 2005 from $24.9 million for the year ended September 30, 2004, an
increase of 33%. This increase came from all domestic locations, as we had strong growth
in our bioanalytical laboratories, our toxicology facility, and our clinical research
unit. Our laboratory in the UK had a decline in revenues. Our revenues from products
declined in fiscal 2005 to $9.4 million, a 23% decline from prior fiscal years
product revenues of $12.2 million. This decline was across our product line, following a
particularly strong year in product sales in fiscal 2004. In the fiscal year ended
September 30, 2005, we did not have any major new adopters of our Culex® system,
whereas the prior fiscal years sales had been strongly influenced by some major
buying programs by our customers. Our sales of Culex® supplies, on the other hand,
increased due to the larger installed base of Culex® users. Inflation in prices did
not have a material impact on revenue increases.

Costs of revenue
increased 6% to $27.1 million for the year ended September 30, 2005 from $25.6 million for
the year ended September 30, 2004. This increase of $1.5 million was due to increases in
the cost of service revenue as a result of the significant increase in the volume of our
services business in fiscal 2005, partially offset by a reduction in the cost of product
revenue resulting from the decrease in the number of products sold and a change in product
mix. Cost of service revenue as a percentage of service revenues decreased due to the
higher utilization of capacity in our Services segment. A significant portion of our costs
in our Services segment are relatively fixed, which results in increasing margins as we
increase our utilization of facilities. Costs of revenue for the Companys products
segment increased to 36.7% as a percentage of product revenue for the year ended September
30, 2005 from 34.9% of product revenue for the year ended September 30, 2004. This small
change was the result of lower utilization of manufacturing capacity.

21

Selling expenses for
the year ended September 30, 2005 decreased by 4% to $2.6 million from $2.7 million during
the year ended September 30, 2004, due to decreased headcount in sales. Research and
development expenses for the year ended September 30, 2005 increased 18% to $1.3 million
from $1.1 million for the year ended September 30, 2004. This increase is primarily due to
additional research activities around our Culex® product line.

General and
administrative expenses for the year ended September 30, 2005 increased 36% to $10.2
million from $7.5 million for the year ended September 30, 2004. Approximately $1.7
million of the increase was in our Baltimore clinical unit, where we had approximately
$700,000 of additional personnel expense as a result of increased business, more expensive
new hires and compensation increases, and $800,000 of occupancy cost relating to the sale
and leaseback of our building. In our West Lafayette facility, we commissioned
approximately 19,000 square feet of new research and laboratory space, causing
approximately $500,000 of additional depreciation and other space related costs. The
remainder of the increase was related to compensation increases, increases in liability,
property and health care coverages, and higher energy costs.

Other income (expense),
net, was $(969,000) in the year ended September 30, 2005 as compared to $(832,000) in the
year ended September 30, 2004, as a result of increased interest expense. We reduced our
average outstanding borrowings from the second fiscal quarter due to the sale of our
Baltimore building, but added $1.1 million of capital leases to finance new laboratory
equipment and had higher interest rates on our floating rate revolving credit facility.

The Companys
effective tax rate was 135% for fiscal 2005 as a result of foreign taxable losses which
reduced our pre-tax income by approximately $800,000, without corresponding tax benefit.
The prior years tax benefit was the result of a U.S. loss which we could carry back
against prior years income, and foreign income for which foreign tax loss
carryforwards were available.

As a result of the
above, the Company lost $0.02 per share in fiscal 2005, both basic and diluted, compared
to a net loss fiscal 2004 of $0.04 per share, both basic and diluted.

# Liquidity and Capital Resources

Comparative Cash Flow
Analysis

Since its inception,
the Companys principal sources of cash have been cash flow generated from operations
and funds received from bank borrowings and other financings. At September 30, 2006, the
Company had cash and cash equivalents of $1.6 million compared to $1.3 million at
September 30, 2005.

The Companys net
cash generated by operating activities was $3.9 million for the year ended September 30,
2006, compared to cash used of $0.5 million in fiscal 2005 and cash generated of $2.8
million in fiscal 2004. Cash generated was primarily from improved collection of
receivables, generating $4.5 million, offset by a reduction in customer advances of $1.7
million. Non-cash charges to operations of $3.9 million for depreciation and amortization,
and $1.1 million for the impairment of long-term assets in our clinical research unit
increased our loss, but did not consume cash. Our receivables vary depending on where we
stand in our mix of contracts, however, we believe that new procedures instituted during
the year in billings and collections contributed to the improved cash flow.

Cash used by investing
activities was $1.5 million for the year ended September 30, 2006 compared to cash
provided of $3.6 million and cash used of $3.5 million for the years ended September 30,
2005 and 2004, respectively. During fiscal 2005, the Company sold and leased back its
building in Baltimore, MD. This transaction resulted in net cash to the Company of $5.9
million, which helped finance the $2.3 million investment in capital assets in fiscal
2005. In fiscal 2006, our investments were in recurring capital asset additions and
replacements.

Cash used by financing
activities was $2.0 million for the year ended September 30, 2006, compared to cash used
of $2.8 and cash provided of $0.3 million, respectively for fiscal 2005 and 2004. Cash utilized in fiscal 2006 was
used for payment of debt and lease obligations.

In January, 2005 the
Company sold and leased back its facility in Baltimore, Maryland. The sales price was $6.5
million, and the Company leased back the majority of the space through December, 2007.
After transaction expenses, the Company generated $5.9 million in cash from this
transaction, which was used to reduce outstanding debt and increase working capital.

22

Capital Resources

Total expenditures by
the Company for property and equipment were $1.7 million, $2.3 million (funded by proceeds
from the sale of the Baltimore building), and $3.6 million (funded by funds generated from
operations, long-term debt and revolving credit), in fiscal 2006, 2005 and 2004,
respectively. Expenditures in fiscal 2006 and 2005 were primarily for the purchase of
laboratory equipment. In fiscal 2004, expenditures were for completion of facilities
expansion in West Lafayette and Evansville, Indiana, and improvements in the Baltimore
clinical facility. The decline in capital expenditures in fiscal 2006 is the result of the
completion of expansion programs. Capital investments for the purchase of additional
laboratory equipment are driven by anticipated increases in research services to be
provided by the Company, and by the replacement or upgrading of the Companys
equipment. Additionally, the Company funded $1.5 million of laboratory equipment in fiscal
2006 through capital leases. Although the Company may consider strategic acquisition
opportunities it does not intend to aggressively pursue additional acquisitions until the
Company is fully utilizing existing capacity.

The Company has a
revolving credit facility of $6 million with a commercial bank and three mortgage notes
payable to another bank aggregating $8.5 million. Borrowings under these credit agreements
are collateralized by substantially all assets related to the Companys operations
and all common stock of the Companys U.S. subsidiaries and 65% of the common stock
of its non-United States subsidiaries, and the assignment of a life insurance policy on
the Companys Chairman. Under the terms of these credit agreements, the Company has
agreed to restrict advances to subsidiaries, limit additional indebtedness and capital
expenditures as well as to comply with certain financial covenants outlined in the
borrowing agreements. These credit agreements contain cross-default provisions. Details of
each debt issue are discussed below. We were not in compliance with our loan covenants at
September 30, 2006, and have received a waiver from our bank of the non-compliance. In
connection with the waiver, our bank raised our rate from LIBOR plus 250-300 basis points
to LIBOR plus 325 basis points, or from prime plus 25 basis points to prime plus 50 basis
points, increased our fee on the unused portion of the line from 25 basis points to 37.5
basis points, and limited capital additions for fiscal 2007 to $1.2 million. None of the
other provisions of the Companys debt agreement are expected to have an impact on
operations.  The Company expects to be in compliance with the loan covenants throughout fiscal 2007.

The maximum amount
available under the terms of the Companys revolving line of credit is $6 million
with outstanding borrowings limited to the borrowing base as defined in the agreement. As
of September 30, 2006 there were no outstanding balances on this line of credit. Interest
accrues monthly on the outstanding balance at the banks prime rate to prime rate
plus 50 basis points or at LIBOR plus 325 basis points, as elected by the Company. As of
September 30, 2006 the prime rate was 8.25%. The Company paid a fee equal to 37.5 basis
points on the unused portion of the line of credit. Borrowings under the facility are
based on a lending formula utilizing the Companys accounts receivable and inventory.
At September 30, 2006 the Company had $1.8 million available under the facility after
offsetting a $2 million outstanding letter of credit which secures the Baltimore lease
(this letter of credit reduces to $1.0 million in January 2007). The Companys line
of credit is a revolver against which the Company applies cash receipts, and draws cash as
needed. The line of credit is committed until January, 2008.

The Company has three
outstanding mortgages with a commercial bank on its facilities in West Lafayette and
Evansville, Indiana, with essentially the same terms, which total $8.5 million. The
mortgages have a fixed interest rate of 5.69% through June, 2007 and mature in November 2012. See Note 6 to the
Consolidated Financial Statements.

The following table
summarizes the cash payments under the Companys contractual term debt and lease
obligations at September 30, 2006 and the effect such obligations are expected to have on
its liquidity and cash flows in future periods (amounts in thousands). The table does not
include the Companys revolving credit facility.

23

|                          | 2007 |  | 2008 |       | 2009 |   | 2010  |  | 2011 |       | After 2011 |   | Total
|------------------------- | ---- |  | ---- | ----- | ---- | - | ----- |  | ---- | ----- | ---------- | - | -----
|                         
|Mortgage notes payable    |      |  | $    | 361   |      | $ | 384   |  | $    | 407   |            | $ | 431  
|Subordinated debt*        |      |  |      | 360   |      |   | 4,477 |  |      |      |            |   |     
|Capital lease obligations |      |  |      | 472   |      |   | 510   |  |      | 582   |            |   | 424  
|Operating leases          |      |  |      | 2,139 |      |   | 491   |  |      | 69    |            |   | 8    
|                          |      |  |      |       |      |   |       |  |      |       |            |   |      
|                         
|                          |      |  | $    | 3,332 |      | $ | 5,862 |  |      | 1,058 |            |   | 863  
|                          |      |  |      |       |      |   |       |  |      |       |            |   |      

*  Subordinated
debt includes notes to related parties.

The Company expects to
spend approximately $1.2 million in fiscal 2007 on capital assets, primarily laboratory
equipment. As of September 30, 2006, no firm commitments had been made to purchase capital
assets.

The covenants in the
Companys credit agreement requiring the maintenance of certain ratios of
interest-bearing indebtedness (not including subordinated debt) to EBITDA and net cash
flow to debt servicing requirements may restrict the amount the Company can borrow to fund
future operations, acquisitions and capital expenditures.

Based on its current
business activities, the Company believes cash generated from its operations and amounts
available under its existing credit facilities will be sufficient to fund the
Companys working capital and capital expenditure requirements for the foreseeable
future and through September 30, 2007. The Company has $4.0 million of subordinated
convertible notes maturing in January, 2008 which will require the Company to develop
sources to fund the payment.

# Inflation

The Company believes
that inflation has not had a material adverse effect on its business, operations or
financial condition.

# Critical Accounting
Policies

Managements
Discussion and Analysis of Financial Condition and Results of Operations and
Liquidity and Capital Resources discusses the consolidated financial
statements of the Company, which have been prepared in accordance with accounting
principles generally accepted in the United States. Preparation of these financial
statements requires management to make judgments and estimates that affect the reported
amounts of assets, liabilities, revenues and expenses, and the disclosures of contingent
assets and liabilities. Certain significant accounting policies applied in the preparation
of the financial statements require management to make difficult, subjective or complex
judgments, and are considered critical accounting policies by the Company. The Company has
identified the following areas as critical accounting policies.

Revenue Recognition

The majority of the
Companys service contracts involve the processing of bioanalytical samples for
pharmaceutical companies. These contracts generally provide for a fixed fee for each assay
method developed or sample processed and revenue is recognized under the specific
performance method of accounting. Under the specific performance method, revenue and
related direct costs are recognized when services are performed. The Companys other
service contracts generally consist of preclinical and clinical trial studies for
pharmaceutical companies. Service revenue is recognized based on the ratio of direct costs
incurred to total estimated direct costs under the proportional performance method of
accounting. Losses on contracts are provided in the period in which the loss becomes
determinable. Revisions in profit estimates are reflected on a cumulative basis in the
period in which such revisions become known. The establishment of contract prices and
total contract costs involves estimates made by the Company at the inception of the
contract period. These estimates could change during the term of the contract which could
impact the revenue and costs reported in the consolidated financial statements. Projected
losses on contracts are provided for in their entirety when known. Revisions to estimates
have not been material to the Company. Service contract fees received upon acceptance are
deferred and classified within customer advances, until earned. Unbilled revenues
represent revenues earned under contracts in advance of billings.

24

The
Companys product revenue is derived primarily from sales of equipment
utilized for scientific research. Revenue from equipment not requiring
installation, testing or training is recognized upon shipment to customers. One
Company product includes internally developed software and requires
installation, testing and training, which occur concurrently. Revenue from this
product is recognized upon completion of the installation, testing and
training.

Impairment
of Long-Lived Assets, Including Goodwill

Long-lived
assets, such as property and equipment, and purchased intangibles subject to
amortization, are reviewed for impairment whenever events or changes in
circumstances indicate that the carrying amount of an asset may not be
recoverable. Recoverability of assets to be held and used is measured by a
comparison of the carrying amount of an asset to estimated undiscounted future
cash flows expected to be generated by the asset. If the carrying amount of an
asset exceeds its estimated future cash flows, an impairment charge is
recognized by the amount by which the carrying amount of the asset exceeds the
fair value of the asset. Assets to be disposed of would be separately presented
in the balance sheet and reported at the lower of the carrying amount or fair
value less costs to sell, and are no longer depreciated. The assets and
liabilities of a disposal group classified as held for sale would be presented
separately in the appropriate asset and liability sections of the balance
sheet.

Goodwill and
other indefinite lived intangible assets, collectively referred to as
indefinite lived assets, are tested annually for impairment, and are
tested for impairment more frequently if events and circumstances indicate that
the asset might be impaired. An impairment loss is recognized to the extent that
the carrying amount exceeds the assets fair value. This determination is
made at the reporting unit level and consists of two steps. First, the Company
determines the fair value of a reporting unit and compares it to its carrying
amount. Second, if the carrying amount of a reporting unit exceeds its fair
value, an impairment loss is recognized for any excess of the carrying amount of
the reporting units indefinite lived assets over the implied fair value of
those indefinite lived assets. The implied fair value of the indefinite lived
assets is determined by allocating the fair value of the reporting unit in a
manner similar to a purchase price allocation, in accordance with SFAS No. 141,
Business Combinations. The residual fair value after this allocation is
the implied fair value of the reporting units indefinite lived
assets.

Our clinical research
unit was acquired in a business combination in fiscal 2003. It had experienced
losses since acquisition, including $2,952,000 in fiscal 2006 before impairment
charge. Although improvement had been achieved in operating results since
acquisition prior to fiscal 2006, the acquisition of one of its major customers
by a company that had other clinical study providers, and the subsequent
cancellation of previously scheduled studies seriously impacted operating
results in fiscal 2006. Establishing future profitable operations of the unit
will require additional sales effort to attract new customers. Consequently, in
the third quarter of fiscal 2006, we determined that there was a permanent
impairment of value of the assets acquired (net of accumulated amortization), and recorded an impairment loss of
$1,100,000 to write down the value of property and equipment by $330,000, other
intangible assets by $387,000 and reduce the value of goodwill by $383,000 to
adjust the values to our estimate of realizable values. We also recorded a
deferred tax benefit of $436,000 related to these charges. The clinical research
unit is included in the Services segment in the financial statements and
footnotes.

Income Tax
Accounting

Income taxes
are accounted for in accordance with SFAS No. 109, Accounting for Income
Taxes. SFAS No. 109 requires recognition of deferred tax liabilities and
assets for the expected future tax consequences of events that have been
included in the financial statements or tax returns. Under this method, deferred
tax assets and liabilities are determined based on the difference between the
financial statement and tax bases of assets and liabilities. These deferred
taxes are measured by applying the provisions of tax laws expected to be in
effect at the time the differences reverse.

The Company
recognizes deferred tax assets in its balance sheet which typically represent
items deducted currently in the financial statements that will be deducted in
future periods in tax returns. In accordance with SFAS No. 109, a valuation
allowance is recorded against these deferred tax assets to reduce the total
deferred tax assets to an amount that will, more likely than not, be realized in
future periods. The valuation allowance is based, in part, on managements
estimate of future taxable income, the expected utilization of tax loss carry
forwards and the expiration dates of tax loss carry forwards. Significant
assumptions are used in developing the analysis of future taxable income for
purposes of determining the valuation allowance for deferred tax assets which,
in the opinion of management, are reasonable under the circumstances.

25

The Company
has an accumulated net deficit in its UK subsidiaries, consequently, United
States deferred tax liabilities on such earnings have not been
recorded.

New Accounting
Pronouncements

The following two
pronouncements were adopted by the Company for periods beginning October 1, 2005.

In November, 2004, the
Financial Accounting Standards Board issued Statement of Financial Accounting Standards
(SFAS) No. 151 dealing with inventory costs. The statement clarifies what
costs can be included in inventory, requiring that absorption factors be based on normal
capacities of manufacturing facilities and excess capacity be expensed as incurred. The
Companys historical costing methodology substantially conformed with this standard;
therefore, the Company did not experience any change from this pronouncement.

In December,
2004, SFAS No. 123 (Revised) ("SFAS 123R") was issued dealing with Share-Based
Payments. In general, this statement requires that companies compute the fair
value of options and other stock based employee incentives, and charge this
value to operations over the period earned, generally the vesting period. The
Company incurred expenses, net of tax benefit, of $319,000 in fiscal 2006 (see
Note 1 to financial statements), relating to SFAS 123R.

The following
recent pronouncements may impact the Companys accounting
policies:

In July 2006,
the FASB released Interpretation No. 48, Accounting for Uncertainty in Income
Taxes. This Interpretation revises the recognition tests for tax positions
taken in tax returns such that a tax benefit is recorded only when it is more
likely than not that the tax position will be allowed upon examination by taxing
authorities. The amount of such a tax benefit to record is the largest amount
that is more likely than not to be allowed. Any reduction in deferred tax assets
or increase in tax liabilities upon adoption will correspondingly reduce
retained earnings. The Company has not yet determined the effect of adopting
this Interpretation, which is effective for it in the fiscal year beginning
October 1, 2007.

In September
2006, the FASB issued SFAS No. 157, Fair Value Measurements, which
addresses how companies should measure fair value when they are required to use
a fair value measure for recognition or disclosure purposes under GAAP. As a
result of SFAS No. 157, there is now a common definition of fair value to be
used throughout GAAP. The Company is reviewing the impact that adopting SFAS No.
157 will have on its financial statements. SFAS No. 157 is effective for the
Company in the fiscal year beginning October 1, 2008.

On September
13, 2006, the SEC staff issued Staff Accounting Bulletin (SAB) Topic 1N,
Financial Statements; Considering the Effects of Prior Year Misstatements
when Quantifying Misstatements in Current Year Financial Statements (SAB
108). SAB 108 addresses how a registrant should evaluate whether an error in its
financial statements is material. The SEC staff concludes in SAB 108 that
materiality should be evaluated using both the rollover and
iron curtain methods. We will be required to comply with the
guidance in SAB 108 in our financial statements for our fiscal year ending
September 30, 2007.

Item
7A.    Quantitative and Qualitative Disclosures about Market
Risk.

The
Companys primary market risk exposure with regard to financial instruments
is the changes in interest rates. The Revolving Credit Agreement between the
Company and National City Bank bears interest at a rate of either the
banks prime rate plus 50 basis points, or at LIBOR plus 325 basis points,
depending in each case upon the ratio of the Companys interest-bearing
indebtedness (less subordinated debt) to EBITDA, at the Companys option.
Historically, the Company has not used derivative financial instruments to
manage exposure to interest rate changes. The Company estimates that a
hypothetical 10% adverse change in interest rates would not materially affect
the consolidated operating results of the Company. While the interest on the
Companys revolving line of credit is at variable rates, the Companys
real estate mortgages are fixed at 5.69% interest until June 2007.

The Company
operates internationally and is, therefore, subject to potentially adverse
movements in foreign currency rates change. The effect of movements in the
exchange rates was not material to the consolidated operating results of the
Company in fiscal years 2006, 2005 and 2004. The Company estimates that a
hypothetical 10% adverse change in foreign currency exchange rates would not
materially affect the consolidated operating results of the Company.

# Item 8.    Financial Statements.

26

# REPORT OF INDEPENDENT
REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors
Bioanalytical Systems, Inc.

We have
audited the accompanying consolidated balance sheet of Bioanalytical Systems,
Inc. and Subsidiaries as of September 30, 2006 and the related consolidated
statements of operations, shareholders' equity and comprehensive income (loss)
and cash flows for the year then ended. These consolidated financial statements are the
responsibility of the Companys management. Our responsibility is to
express an opinion on these consolidated financial statements based on our audit.

We conducted
our audit 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 audit provides a
reasonable basis for our opinion.

In our
opinion, the 2006 consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Bioanalytical
Systems, Inc. and Subsidiaries as of September 30, 2006, and the results of
their operations and their cash flows for the year then ended in conformity with
U.S. generally accepted accounting principles.

/s/ Crowe Chizek and Company LLC
Indianapolis, Indiana
December 29, 2006

27

# REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

Board of Directors and Shareholders
Bioanalytical Systems, Inc.:

We have audited the
accompanying consolidated balance sheet of Bioanalytical Systems, Inc. and
subsidiaries as of September 30, 2005, and the related consolidated statements
of operations, shareholders equity and comprehensive income (loss), and
cash flows for each of the years in the two-year period ended September 30,
2005. These financial statements are the responsibility of the
Companys management. Our responsibility is to express an opinion on these
financial statements based on our audits.

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

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

/s/ KPMG LLP
January 7, 2006

28

BIOANALYTICAL SYSTEMS, INC.
Consolidated Balance Sheets
At September 30,

|                                                                              | 2006 |  | 2005
|----------------------------------------------------------------------------- | ---- |  | ----
|Assets                                                                        |      |  |     
|                                                                             
|Current assets:                                                               |      | 
|Cash and cash equivalents                                                     |      |  | $   
|Accounts receivable:                                                          |      | 
|Trade, net of allowance for bad debts of $520,000 in 2006 and $40,000 in 2005 |      |  |     
|Unbilled revenues and other                                                   |      |  |     
|Inventories                                                                   |      |  |     
|Deferred income taxes                                                         |      |  |     
|Refundable income taxes                                                       |      |  |     
|Prepaid expenses                                                              |      |  |     
|                                                                              |      |  |     
|                                                                             
|Total current assets                                                          |      |  |     
|                                                                              |      |  |     
|                                                                             
|Property and equipment:                                                       |      | 
|Land and improvements                                                         |      |  |     
|Buildings and improvements                                                    |      |  |     
|Machinery and equipment                                                       |      |  |     
|Office furniture and fixtures                                                 |      |  |     
|Construction in process                                                       |      |  |     
|                                                                              |      |  |     
|                                                                              |      |  |     
|                                                                             
|Less accumulated depreciation and amortization                                |      |  |     
|                                                                              |      |  |     
|                                                                              |      |  |     
|                                                                             
|Goodwill                                                                      |      |  |     
|                                                                              |      | 
|                                                                             
|Intangible assets, net of accumulated amortization of $749,256                |      | 
|in 2006 and $786,587 in 2005                                                  |      |  |     
|Debt issue costs, net                                                         |      |  |     
|Other assets                                                                  |      |  |     
|                                                                              |      |  |     
|                                                                             
|Total assets                                                                  |      |  | $   
|                                                                              |      |  |     

See accompanying notes to consolidated financial statements.

29

BIOANALYTICAL SYSTEMS, INC.
Consolidated Balance Sheets
At September 30,

|                                                           | 2006 |  | 2005
|---------------------------------------------------------- | ---- |  | ----
|Liabilities and Shareholders' Equity                       |      |  |     
|                                                          
|Current liabilities:                                       |      | 
|                                                           |      | 
|Accounts payable                                           |      |  | $   
|Accrued expenses                                           |      |  |     
|Customer advances                                          |      |  |     
|Income taxes payable                                       |      |  |     
|Revolving line of credit                                   |      |  |     
|Current portion of capital lease obligations               |      |  |     
|Current portion of long-term debt                          |      |  |     
|                                                           |      |  |     
|                                                           |      | 
|                                                          
|Total current liabilities                                  |      |  |     
|                                                           |      | 
|                                                          
|Capital lease obligations, less current portion            |      |  |     
|Long-term debt, less current portion                       |      |  |     
|Subordinated notes payable, including $498,648 in 2006 and |      | 
|$735,989 in 2005 to related parties, less current portion  |      |  |     
|Deferred income taxes                                      |      |  |     
|                                                           |      | 
|                                                          
|Shareholders' equity:                                      |      | 
|Preferred shares:                                          |      | 
|Authorized 1,000,000 shares; none issued and outstanding   |      |  |     
|Common shares, no par value:                               |      | 
|Authorized 19,000,000 shares; issued and                   |      | 
|outstanding 4,892,127 shares in 2006 and                   |      | 
|4,871,127 shares in 2005                                   |      |  |     
|Additional paid-in-capital                                 |      |  |     
|Retained earnings                                          |      |  |     
|Accumulated other comprehensive loss                       |      |  |     
|                                                           |      |  |     
|                                                          
|Total shareholders' equity                                 |      |  |     
|                                                           |      |  |     
|                                                          
|Total liabilities and shareholders' equity                 |      |  | $   
|                                                           |      |  |     

See accompanying notes to consolidated financial statements.

30

BIOANALYTICAL SYSTEMS, INC.
Consolidated Statements of Operations
Years ended September 30,

|                                              | 2006 |  | 2005 |            | 2004
|--------------------------------------------- | ---- |  | ---- | ---------- | ----
|                                             
|Service revenue                               |      |  | $    | 34,318,150 |     
|Product revenue                               |      |  |      | 8,729,525  |     
|                                              |      |  |      |            |     
|Total revenue                                 |      |  |      | 43,047,675 |     
|                                              |      |  |      |            |     
|                                             
|Cost of service revenue                       |      |  |      | 25,690,825 |     
|Cost of product revenue                       |      |  |      | 3,546,893  |     
|                                              |      |  |      |            |     
|Total cost of revenue                         |      |  |      | 29,237,718 |     
|                                              |      |  |      |            |     
|                                             
|Gross profit                                  |      |  |      | 13,809,957 |     
|                                              |      |  |      |            |     
|                                             
|Operating expenses:                           |      | 
|Selling                                       |      |  |      | 2,749,703  |     
|Research and development                      |      |  |      | 1,444,441  |     
|General and administrative                    |      |  |      | 11,976,283 |     
|(Gain) loss on sale of property and equipment |      |  |      | (37,867    | )   
|Impairment loss                               |      |  |      | 1,100,000  |     
|                                              |      |  |      |            |     
|Total operating expenses                      |      |  |      | 17,232,560 |     
|                                              |      |  |      |            |     
|                                             
|Operating income (loss)                       |      |  |      | (3,422,603 | )   
|                                             
|Interest income                               |      |  |      | 10,808     |     
|Interest expense                              |      |  |      | (1,033,308 | )   
|Other income                                  |      |  |      | 9,680      |     
|                                              |      |  |      |            |     
|                                             
|Income (loss) before income taxes             |      |  |      | (4,435,423 | )   
|Income tax provision (benefit)                |      |  |      | (1,825,481 | )   
|                                              |      |  |      |            |     
|Net loss                                      |      |  | $    | (2,609,942 | )   
|                                              |      |  |      |            |     
|                                             
|Net loss per share:                           |      | 
|Basic                                         |      |  | $    | (0.53      | )   
|Diluted                                       |      |  | $    | (0.53      | )   
|                                             
|Weighted average common shares outstanding:   |      | 
|Basic                                         |      |  |      | 4,882,505  |     
|Diluted                                       |      |  |      | 4,882,505  |     

See accompanying notes to consolidated financial statements.

31

BIOANALYTICAL SYSTEMS, INC.
Consolidated Statements of Shareholders' Equity and Comprehensive Income (Loss)
Years ended September 30, 2006, 2005, and 2004

|                              | Common Shares |  | Additionalpaid in |           | Retained |   | Accumulatedothercomprehensive |  | TotalShareholders'
|----------------------------- | ------------- |  | ----------------- | --------- | -------- | - | ----------------------------- |  | ------------------
|
|                             
|
|                             
|Balance at September 30, 2003 |               |  |                   | 4,831,460 |          | $ | 1,168,163                     |  | $                 
|Comprehensive (loss):         |               | 
|Net loss                      |               |  |                   |          |          |   |                              |  |                   
|Other comprehensive loss:     |               | 
|Foreign currency translation  |               | 
|adjustments                   |               |  |                   |          |          |   |                              |  |                   
|                              |               |  |                   |           |          |   |                              
|Total comprehensive loss      |               |  |                   |           |          |   |                               |  |                   
|Conversion of note            |               |  |                   | 38,042    |          |   | 8,427                         |  |                   
|                              |               |  |                   |           |          |   |                               |  |                   
|                             
|Balance at September 30, 2004 |               |  |                   | 4,869,502 |          |   | 1,176,590                     |  |                   
|                             
|Comprehensive income:         |               | 
|Net loss                      |               |  |                   |          |          |   |                              |  |                   
|Other comprehensive income:   |               | 
|Foreign currency translation  |               | 
|adjustments                   |               |  |                   |          |          |   |                              |  |                   
|                              |               |  |                   |           |          |   |                              
|Total comprehensive income    |               |  |                   |           |          |   |                               |  |                   
|Exercise of stock options     |               |  |                   | 1,625     |          |   | 762                           |  |                   
|                              |               |  |                   |           |          |   |                               |  |                   
|                             
|Balance at September 30, 2005 |               |  |                   | 4,871,127 |          |   | 1,177,352                     |  |                   
|Comprehensive (loss):         |               | 
|Net loss                      |               |  |                   |          |          |   |                              |  |                   
|Other comprehensive loss:     |               | 
|Foreign  currency translation |               | 
|adjustments                   |               |  |                   |          |          |   |                              |  |                   
|                              |               |  |                   |           |          |   |                              
|Total comprehensive loss      |               |  |                   |           |          |   |                               |  |                   
|Stock compensation            |               |  |                   |          |          |   |                              |  |                   
|Exercise of stock options     |               |  |                   | 21,000    |          |   | 4,651                         |  |                   
|                              |               |  |                   |           |          |   |                               |  |                   
|                             
|Balance at September 30, 2006 |               |  |                   | 4,892,127 |          | $ | 1,182,003                     |  | $                 
|                              |               |  |                   |           |          |   |                               |  |                   

See accompanying notes to consolidated financial statements.

32

BIOANALYTICAL SYSTEMS, INC.
Consolidated Statements of Cash Flows
Years ended September 30,

|                                                                                | 2006 |  | 2005 |             | 2004
|------------------------------------------------------------------------------- | ---- |  | ---- | ----------- | ----
|Operating activities:                                                           |      |  |      |             |     
|                                                                               
|Net loss                                                                        |      |  | $    | (2,609,942  | )   
|Adjustments to reconcile net loss to net cash provided by operating activities: |      | 
|Depreciation and amortization                                                   |      |  |      | 3,888,899   |     
|Asset impairment loss                                                           |      |  |      | 1,100,000   |     
|Employee stock compensation expense                                             |      |  |      | 318,923     |     
|Bad debt expense                                                                |      |  |      | 473,357     |     
|(Gain) loss on sale of property and equipment                                   |      |  |      | (37,867     | )   
|Deferred income taxes                                                           |      |  |      | (1,335,256  | )   
|Changes in operating assets and liabilities:                                    |      | 
|Accounts receivable                                                             |      |  |      | 4,517,982   |     
|Inventories                                                                     |      |  |      | 154,242     |     
|Refundable and payable income taxes                                             |      |  |      | (919,362    | )   
|Prepaid expenses and other assets                                               |      |  |      | (179,226    | )   
|Accounts payable                                                                |      |  |      | (71,257     | )   
|Accrued expenses                                                                |      |  |      | 291,287     |     
|Customer advances                                                               |      |  |      | (1,747,851  | )   
|                                                                                |      |  |      |             |     
|                                                                               
|Net cash provided (used) by operating activities                                |      |  |      | 3,843,929   |     
|                                                                                |      |  |      |             |     
|                                                                               
|Investing activities:                                                           |      | 
|Capital expenditures                                                            |      |  |      | (1,686,860  | )   
|Proceeds from sale of property and equipment                                    |      |  |      | 270,919     |     
|Payments for purchase of LC Resources, Inc.,                                    |      | 
|net of cash acquired                                                            |      |  |      |            |     
|                                                                                |      |  |      |             |     
|                                                                               
|Net cash provided (used) by investing activities                                |      |  |      | (1,415,941  | )   
|                                                                                |      |  |      |             |     
|                                                                               
|Financing activities:                                                           |      | 
|Payments of long-term debt                                                      |      |  |      | (723,674    | )   
|Borrowings on line of credit                                                    |      |  |      | 12,624,000  |     
|Payments on line of credit                                                      |      |  |      | (13,544,000 | )   
|Borrowings on construction line of credit                                       |      |  |      |            |     
|Payments on capital lease obligations                                           |      |  |      | (438,345    | )   
|Net proceeds from the exercise of stock options                                 |      |  |      | 94,470      |     
|                                                                                |      |  |      |             |     
|                                                                               
|Net cash provided (used) by financing activities                                |      |  |      | (1,987,549  | )   
|                                                                                |      |  |      |             |     
|                                                                               
|Effect of exchange rate changes                                                 |      |  |      | (47,642     | )   
|                                                                                |      |  |      |             |     
|                                                                               
|Net increase (decrease) in cash and cash equivalents                            |      |  |      | 392,797     |     
|                                                                               
|Cash and cash equivalents at beginning of year                                  |      |  |      | 1,254,269   |     
|                                                                                |      |  |      |             |     
|                                                                               
|Cash and cash equivalents at end of year                                        |      |  | $    | 1,647,066   |     
|                                                                                |      |  |      |             |     

See accompanying notes to consolidated financial statements.

33

# (1)    Significant
Accounting Policies

(a)    Nature of
Business

Bioanalytical Systems,
Inc. and its subsidiaries (the Company or BASi) engage in research
services and other services related to pharmaceutical development. We also manufacture
scientific instruments for medical research, which we sell with related software for use
in industrial, governmental and academic laboratories. We conduct our businesses through
our research facilities in Indiana, Oregon, Maryland and the United Kingdom and our
manufacturing facility in Indiana. Our customers are located throughout the world.

(b)    Principles
of Consolidation

The consolidated
financial statements include the accounts of the Company and its wholly owned
subsidiaries. All significant inter-company accounts and transactions have been
eliminated.

(c)    Revenue
Recognition

The majority of our
service contracts involve the development of analytical methods and the processing of
bioanalytical samples for pharmaceutical companies. These contracts generally provide for
a fixed fee for each sample processed, and revenue is recognized under the specific
performance method of accounting. Under the specific performance method, revenue and
related direct costs are recognized when services are performed. Our other service
contracts generally consist of preclinical and clinical trial studies for pharmaceutical
companies. We recognize service revenue on these contracts based on the ratio of direct
costs incurred to total estimated direct costs under the proportional performance method
of accounting. When we revise profit estimates, we adjust on a cumulative basis in the
period in which the revisions become known. The establishment of contract prices and total
contract costs involves estimates made by us at the inception of the contract period.
These estimates could change during the term of the contract, which impacts the revenue
and costs we report in the consolidated financial statements. We provide for projected
losses on contracts in their entirety when the loss becomes determinable.

We generally bill a
portion of service contract fees upon acceptance by our customers. These billings are
classified as customer advances until earned. Unbilled revenues represent revenues earned
under contracts in advance of billings.

Our product revenue is
derived primarily from sales of instruments utilized for scientific research. Revenue from
products not requiring installation, testing, or training is recognized upon shipment to
customers. One of our products includes internally developed software and sometimes
requires installation, testing, and training, which occur concurrently. Revenue from this product is
recognized upon completion of the installation, testing, and training.

(d)    Cash
Equivalents

We consider all highly
liquid investments with an original maturity of three months or less when purchased to be
cash equivalents.

(e)    Financial
Instruments

Our credit risk
consists principally of trade accounts receivable. We perform periodic credit evaluations
of our customers financial conditions and generally do not require collateral on
trade accounts receivable. The Company accounts for trade receivables based on the
amounts billed to customers. Past due receivables are determined based on contractual
terms. The Company does not accrue interest on any of its trade receivables. The allowance
for doubtful accounts is determined by management based on the Companys historical
losses, specific customer circumstances, and general economic conditions. Periodically,
management reviews accounts receivable and adjusts the allowance based on current
circumstances and charges off uncollectible receivables when all attempts to collect have
failed.  Our allowance for doubtful accounts was $520,000 and $40,000 at
September 30, 2006 and 2005, respectively.

Our cash and cash
equivalents, accounts receivable, accounts payable and certain other accrued liabilities
are all short-term in nature and their carrying amounts approximate fair value. We have
both variable rate borrowings, which adjust to the current market, and borrowings with
fixed rates for up to three years. The carrying value of our fixed rate debt also
approximates its fair value.

(f)    Inventories

We state our
inventories at the lower of cost or market, using the last-in, first-out (LIFO) method.

34

(g)    Property and
Equipment

We record property and
equipment at cost, including interest capitalized during the period of construction of
major facilities. We compute depreciation, including amortization on capital leases, using
the straight-line method over the estimated useful lives of the assets, which we estimate
to be: buildings and improvements, 34 to 40 years; machinery and equipment, 5 to 10 years,
and office furniture and fixtures, 10 years. Our depreciation expense was $3,228,000 in
fiscal 2006, $3,047,000 in fiscal 2005 and $3,053,000 in fiscal 2004. Expenditures for
maintenance and repairs are expensed as incurred.

(h)    Impairment
of Long-Lived Assets

Long-lived assets, such
as property and equipment, and purchased intangibles subject to amortization, are reviewed
for impairment whenever events or changes in circumstances indicate that the carrying
amount of an asset may not be recoverable. Recoverability of assets to be held and used is
measured by a comparison of the carrying amount of an asset to estimated undiscounted
future cash flows expected to be generated by the asset. If the carrying amount of an
asset exceeds its estimated future cash flows, an impairment charge is recognized by the
amount by which the carrying amount of the asset exceeds the fair value of the asset.
Assets to be disposed of would be separately presented in the balance sheet and reported
at the lower of the carrying amount or fair value less costs to sell, and are no longer
depreciated. The assets and liabilities of a disposed group classified as held for sale
would be presented separately in the appropriate asset and liability sections of the
balance sheet.

Goodwill and other
indefinite lived intangible assets, collectively referred to as indefinite lived
useful assets, are tested annually for impairment, and are tested for impairment
more frequently if events and circumstances indicate that the asset might be impaired. An
impairment loss is recognized to the extent that the carrying amount exceeds the
assets fair value. This determination is made at the reporting unit level and
consists of two steps. First, the Company determines the fair value of a reporting unit
and compares it to its carrying amount. Second, if the carrying amount of a reporting unit
exceeds its fair value, an impairment loss is recognized for any excess of the carrying
amount of the reporting units indefinite lived useful assets over the implied fair
value of those indefinite lived useful assets. The implied fair value of the indefinite
lived useful assets is determined by allocating the fair value of the reporting unit in a
manner similar to a purchase price allocation, in accordance with Statement of Financial
Accounting Standards (SFAS) No. 141, Business Combinations.
The residual fair value after this allocation is the implied fair value of the reporting
units indefinite lived useful assets. In fiscal 2006 we determined that an
impairment existed, see (i)for additional information.

(i)    Goodwill and
Intangible Assets

We carry goodwill at
cost. Other intangible assets with definite lives are stated at cost and are amortized on
a straight-line basis over their estimated useful lives. All intangible assets acquired
that are obtained through contractual or legal right, or are capable of being separately
sold, transferred, licensed, rented, or exchanged, are recognized as an asset apart from
goodwill. Goodwill and intangibles with indefinite lives are not amortized, but are
subject to an annual assessment for impairment by applying a fair value based test.

In fiscal 2003, we
completed acquisitions of a bioanalytical laboratory performing chemical analyses and a
clinical research unit performing clinical testing in humans to establish drug safety or
bioequivalence. In valuing the intangible assets acquired in these two acquisitions, we
determined that the replacement cost, in a start-up situation, of establishing these two
operations as FDA compliant research sites was $1,267,000 and recorded intangible assets
of that amount. We determined that these assets had an indefinite life, and accordingly
did not amortize the assets. During the fiscal year ended September 30, 2006, we
re-examined the make-up of these assets, and determined that of the total recorded,
$793,000 related to the hiring and training of the in-place workforce. SFAS No. 141
requires that such assets be included in goodwill, accordingly, we reclassified that
amount to goodwill. The remaining $474,000 of the intangible assets relates to the
replacement costs of creating and documenting the operating systems and procedure, their
validation and audit. The evolving nature of procedures in a regulated environment
requires that we constantly monitor and update those procedures. Accordingly, we have
revised our estimate of the useful life of that asset to a ten year life, and recorded the
amortization in Cost of Services.

We complete a
fair value-based impairment test on our goodwill and intangible assets not
subject to amortization at the close of each fiscal year, in addition to other
times if events indicate there is a likely decline in value. Our clinical
research unit acquired in fiscal 2003 had experienced losses since acquisition,
including $2,952,000 in fiscal 2006 before impairment charge. Although
improvement had been achieved in operating results since acquisition and prior
to fiscal 2006, the acquisition of one of our major customers by a company that
had other clinical study providers, and the subsequent cancellation of
previously scheduled studies seriously impacted operating results for this unit
in fiscal 2006. Establishing future profitable operations of the unit will
require additional sales effort to attract new customers. Consequently, in the
third quarter of fiscal 2006, we determined there was a permanent impairment of
the value of the assets acquired and recorded a charge of $1,100,000 to write
down the value of property and equipment by $330,000, other intangible assets by
$387,000 (net of accumulated amortization) and reduce the value of goodwill by
$383,000. The impairment charge was necessary to adjust the carrying values of
the respective assets to our estimate of fair value. We also recorded a deferred
tax benefit of $436,000 related to these charges. The clinical research unit is
included in the Services segment in these financial statements and
footnotes.

35

The carrying amount of
goodwill at September 30, 2006 and 2005 was $ 1,854,652 and $1,444,652, respectively.

The components of intangible assets subject to amortization are as follows:

|                       | September 30, 2006
|---------------------- | ------------------
|
|FDA Compliant Facility |                   
|Methodologies          |                   
|Volunteer database     |                   
|Customer relationships |                   
|                       |                   
|                       |                   
|                       |                   

|                       | September 30, 2005
|---------------------- | ------------------
|
|Methodologies          |                   
|Volunteer database     |                   
|Customer relationships |                   
|                       |                   
|                       |                   
|                       |                   

At September 30, 2005, we also had indefinite lived intangible assets of
$1,266,711 related to FDA compliant facilites, of which $792,711 was
reclassified to goodwill in fiscal 2006. The remaining assets were assigned a ten
year life.

The following is a reconciliation of goodwill and other intangible assets from September 30,
2005 to September 30, 2006:

|                         | September 30, 2005 |  | Reclassification |           | Impairment Loss |   | Amortization |   | September 30, 2006
|------------------------ | ------------------ |  | ---------------- | --------- | --------------- | - | ------------ | - | ------------------
|Asset:                   |                    |  |                  |           |                 |   |              |   |                   
|                        
|Goodwill                 |                    |  | $                | 1,444,652 |                 | $ | 792,711      |   | $                 
|                         |                    |  |                  |           |                 |   |              |   |                   
|FDA compliant facility   |                    |  | $                | 1,266,711 |                 | $ | (792,711     | ) | $                 
|Methodologies            |                    |  |                  | 754,561   |                 |   |             |   |                   
|Volunteer database       |                    |  |                  | 561,993   |                 |   |             |   |                   
|Customer relationships   |                    |  |                  | 359,000   |                 |   |             |   |                   
|                         |                    |  |                  |           |                 |   |              |   |                   
|                         |                    |  | $                | 2,942,265 |                 | $ | (792,711     | ) | $                 
|                         |                    |  |                  |           |                 |   |              |   |                   
|                        
|Accumulated amortization |                    | 
|FDA compliant facility   |                    |  | $                |          |                 | $ |             |   | $                 
|Methodologies            |                    |  |                  | 340,755   |                 |   |             |   |                   
|Volunteer database       |                    |  |                  | 248,382   |                 |   |             |   |                   
|Customer relationships   |                    |  |                  | 197,450   |                 |   |             |   |                   
|                         |                    |  |                  |           |                 |   |              |   |                   
|                         |                    |  | $                | 786,587   |                 | $ |             |   | $                 
|                         |                    |  |                  |           |                 |   |              |   |                   

36

Amortization expense for intangible assets for fiscal years ended
September 30, 2006, 2005 and 2004 was $458,792, $335,116 and $335,116
respectively. The following table provides information regarding estimated
amortization expense for the remaining intangible lives:

|           | 
|---------- | 
|
|2007       | 
|2008       | 
|2009       | 
|2010       | 
|2011       | 
|Thereafter | 
|           | 
|           | 
|           | 

(j)    Advertising
Expense

We expense advertising
costs as incurred. Advertising expense was $284,000, $111,800, and $270,780 for the years
ended September 30, 2006, 2005, and 2004, respectively.

(k)    Stock-Based
Compensation

The Company has an
Employee Stock Option Plan whereby options to purchase the Companys common shares at
fair market value at date of grant can be granted to our employees. Options granted vest
and become exercisable in four equal installments beginning two years after the date of
grant, and expire upon the earlier of the employees termination of employment with
the Company, or ten years from the date of grant. This plan terminates in fiscal 2008.

The Company established
an Outside Director Stock Option Plan whereby options to purchase the Companys
common shares at fair market value at date of grant can be granted to outside directors.
Options granted vest and become exercisable in four equal installments beginning two years
after the date of grant and expire upon the earlier of the directors termination of
board service with the Company, or ten years from the date of grant. This plan terminates
in fiscal 2008.

On October 1, 2005, we
adopted SFAS No. 123 (revised 2004), Share-Based Payment (SFAS 123R), which requires
the measurement and recognition of compensation expense for all share-based payment awards
made to employees and directors under our stock option plans, based on fair values.
Previously, we had not recognized expense for employee stock options.

We adopted SFAS 123R
using the modified prospective transition method, which requires the application of the
accounting standard as of October 1, 2005, the first day of our fiscal year. In accordance
with the modified prospective transition method, our Consolidated Financial Statements for
prior years do not include the impact of SFAS 123R. Stock-based compensation expense for
employee stock options recognized under SFAS 123R for the year ended September 30, 2006 was
$356,000 with a related tax benefit of $37,000.

SFAS 123R requires
companies to estimate the fair value of share-based payment awards on the date of grant
using an option-pricing model. The value of the portion of the award that is ultimately
expected to vest is recognized as expense over the requisite service periods in our
Statement of Operations. Prior to the adoption of SFAS 123R, the Company accounted for
stock-based awards to employees and directors using the intrinsic value method in
accordance with APB 25 as allowed under SFAS No. 123. Under the intrinsic value method, no stock-based compensation expense
was recognized in the Companys Consolidated Statement of Operations for fiscal 2005 and 2004.

Stock-based
compensation expense recognized during the period is based on the value of the portion of
share-based payment awards that is expected to vest during the period, reduced for
estimated forfeitures. Stock-based compensation expense recognized in our Consolidated
Statement of Operations for the year ended September 30, 2006 included compensation
expense for share-based payment awards granted prior to, but not yet vested as of October
1, 2005, based on the grant date fair value estimated in accordance with the provisions of
SFAS 123R. There were no awards granted during fiscal 2006. Compensation expense for all
share-based payment awards are recognized using the straight-line single option approach.

With the adoption of
SFAS 123R, we continued to use a binomial option-pricing model as our method of valuation
for share-based awards.

Stock based
compensation expense recognized in fiscal 2006 is the result of grants in prior fiscal
years.

37

The following table
presents the effect on earnings and earnings per share had we applied the same treatment
to stock-based employee compensation in the fiscal years ended September 30:

|                                          | 2005 |  | 2004
|----------------------------------------- | ---- |  | ----
|                                         
|
|Net loss as reported                      |      |  | $   
|Deduct:  Total stock-based employee       |      | 
|compensation expense determined under the |      | 
|fair value based method for all awards,   |      | 
|net of related tax effects                |      |  |     
|                                          |      |  |     
|Pro forma net loss                        |      |  | $   
|                                          |      |  |     
|                                         
|Loss per share:                           |      | 
|Basic and diluted - as reported           |      |  | $   
|Basic and diluted- pro forma              |      |  | $   

The assumptions used in
computing our stock based compensation expense for the fiscal years ended September 30
were as follows:

|                                         | 2005 | 2004
|---------------------------------------- | ---- | ----
|                                        
|
|Risk-free interest rate                  |      |     
|Dividend yield                           |      |     
|Volatility factor of the expected market |      |     
|price of the Company's common stock      |      |     
|Expected life of the options (years)     |      |     

(l)    Income Taxes

Income taxes are
accounted for under the asset and liability method. Deferred tax assets and liabilities
are recognized for the future tax consequences attributable to differences between the
financial statement carrying amounts of existing assets and liabilities and their
respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets
and liabilities are measured using enacted tax rates expected to apply to taxable income
in the years in which those temporary differences are expected to be recovered or settled.
The effect on deferred tax assets and liabilities of a change in tax rates is recognized
in income in the period that includes the enactment date. We record valuation allowances
based on a determination of the expected realization of tax assets.

(m)    New
Accounting Pronouncements

In July 2006, the FASB
released Interpretation No. 48, Accounting for Uncertainty in Income Taxes.  This Interpretation revises the recognition tests for tax positions taken in tax returns
such that a tax benefit is recorded only when it is more likely than not that the tax
position will be allowed upon examination by taxing authorities. The amount of such a tax
benefit to record is the largest amount that is more likely than not to be allowed. Any
reduction in deferred tax assets or increase in tax liabilities upon adoption will
correspondingly reduce retained earnings. The Company has not yet determined the effect of
adopting this Interpretation, which is effective for it in the fiscal year beginning
October 1, 2007.

38

In September 2006, the
FASB issued SFAS No. 157, Fair Value Measurements, which addresses how
companies should measure fair value when they are required to use a fair value measure for
recognition or disclosure purposes under Generally Accepted Accounting Principles
(GAAP). As a result of SFAS No. 157, there is now a common definition of fair
value to be used throughout GAAP. The Company is reviewing the impact that adopting SFAS
No. 157 will have on its financial statements. SFAS No. 157 is effective for the Company
in the fiscal year beginning October 1, 2008.

On September 13, 2006,
the Securities and Exchange Commission (SEC) staff issued Staff Accounting
Bulletin (SAB) Topic 1N, Financial Statements  Considering the Effects of
Prior Year Misstatements when Quantifying Misstatements in Current Year Financial
Statements (SAB 108). SAB 108 addresses how a registrant should evaluate whether an
error in its financial statements is material. The SEC staff concludes in SAB 108 that
materiality should be evaluated using both the rollover and iron
curtain methods. We will be required to comply with the guidance in SAB 108 in our
financial statements for our fiscal year ending September 30, 2007.

(n)    Use of
Estimates

The preparation of
financial statements in conformity with accounting principles generally accepted in the
United States requires us to make estimates and assumptions that affect the amounts
reported in the financial statements and accompanying notes. Our actual results could
differ from those estimates.

# (2)    Earnings (loss)
per Share

We compute basic
earnings or loss per share on the basis of the weighted average number of common shares
outstanding. We compute diluted earnings per share on the basis of the weighted average
number of common and potential common shares outstanding. Potential common shares include
the dilutive effect of employee and director options to purchase common shares and
convertible subordinated debt, which is assumed to be converted. The convertible
subordinated debt was not dilutive in any period presented.

Because of losses in
each year of the three year period ended September 30, 2006, outstanding potential
common shares were anti-dilutive in each year; therefore, basic and diluted loss per share
are the same.

At September 30, 2006
we had 250,000 shares issuable upon the conversion of our subordinated debt and 403,878 shares
issuable upon exercise of stock options that are not included in our outstanding share
calculation as they are anti-dilutive.

# (3)    Sale of Building

On January 5,
2005 we sold our building in Baltimore, MD, valued at approximately $6.2 million
for a $6.5 million cash selling price. Concurrently, we entered into a three
year leaseback of approximately 85% of the space in the building for $800,000
annually, plus operating expenses. Accordingly, we have accounted for the
transaction as a sale/leaseback transaction. We recorded a deferred gain on the
building of $218,000 which is being amortized over the life of the lease which
expires December 31, 2007. The net proceeds of the sale were used to pay off our
revolving credit facility and for working capital. The unamortized remaining
value of the deferred gain was $91,000 and $163,000 as of September 30, 2006 and
2005, respectively.

39

# (4) Inventories

Inventories at
September 30 consisted of the following:

|                  | 2006 |  | 2005
|----------------- | ---- |  | ----
|Raw materials     |      |  | $   
|Work in progress  |      |  |     
|Finished goods    |      |  |     
|                  |      |  |     
|                  |      |  |     
|Less LIFO reserve |      |  |     
|                  |      |  |     
|                  |      |  | $   
|                  |      |  |     

# (5) Lease Arrangements

The total amount of
equipment capitalized under capital lease obligations as of September 30, 2006 and 2005
was $2,739,454 and $1,112,000, respectively. Accumulated amortization on capital leases at
September 30, 2006 and 2005 was $343,026 and $54,000, respectively. Amortization of assets
acquired through capital leases is included in depreciation expense.

We acquired equipment
totaling $1,473,000 through capital lease arrangements during the year ended September 30,
2006. Future minimum lease payments on capital leases at September 30, 2006 are as
follows:

|     | Principal |  | Interest |           | Total
|---- | --------- |  | -------- | --------- | -----
|2007 |           |  | $        | 472,146   |      
|2008 |           |  |          | 509,993   |      
|2009 |           |  |          | 581,711   |      
|2010 |           |  |          | 424,237   |      
|2011 |           |  |          | 132,302   |      
|     |           |  |          |           |      
|     |           |  | $        | 2,120,389 |      
|     |           |  |          |           |      

We lease office space
and equipment under noncancelable operating leases that terminate at various dates through
2010. Certain of these leases contain renewal options. Total rental expense under these
leases was $1,808,083, $913,514, and $488,294 in fiscal 2006, 2005, and 2004,
respectively.

Future minimum lease
payments for the following fiscal years under operating leases at September 30, 2006 are
as follows:

|     | 
|---- | 
|2007 | 
|2008 | 
|2009 | 
|2010 | 
|     | 
|     | 
|     | 

40

# (6)    Debt Arrangements

Long-term debt
consisted of the following at September 30:

|                                                          | 2006 |  | 2005
|--------------------------------------------------------- | ---- |  | ----
|Mortgage note payable to a bank, payable in monthly       |      |  |     
|principal and interest installments of $36,500 until      |      | 
|June 1, 2007 when they adjust under the terms of the      |      | 
|note. Interest is fixed at 5.69% to June 1, 2007, when    |      | 
|it adjusts based on market rates.  Due November, 2012.    |      |  | $   
|                                                         
|Mortgage note payable to a bank, payable in monthly       |      | 
|principal and interest installments of $18,241 until May  |      | 
|17, 2007 when they adjust under the terms of the note     |      | 
|Interest is fixed at 5.69% to June 1, 2007, when it       |      | 
|adjusts based on market rates.  Due November, 2012.       |      |  |     
|                                                         
|6% convertible subordinated notes payable due January 1,  |      | 
|2008. Interest payable in arrears on the 15th of January  |      | 
|and July after June 1, 2005 (4.67% effective rate).       |      |  |     
|                                                         
|10% subordinated notes payable due October 1, 2007        |      | 
|Holders can require the Company to repay 20% of the       |      | 
|original outstanding balance each October 1. Interest     |      | 
|payable upon demand each October 1 through maturity.      |      |  |     
|                                                         
|Mortgage note payable to a bank, payable in monthly       |      | 
|principal and interest installments of $15,755 until June |      | 
|1, 2007, when they adjust under the terms of the note     |      | 
|Interest is fixed at 5.69% to June 1, 2007, when it       |      | 
|adjusts based on market rates.  Due November, 2012.       |      |  |     
|                                                          |      |  |     
|                                                          |      |  |     
|                                                          |      |  |     
|                                                          |      |  |     
|Less current portion                                      |      |  | $   
|                                                          |      |  |     

41

The following table
summarizes our principal payment obligations for the years ending September 30:

|           | 
|---------- | 
|2007       | 
|2008       | 
|2009       | 
|2010       | 
|2011       | 
|Thereafter | 
|           | 
|           | 
|           | 

Cash interest payments
of $1,169,093, $1,112,000, and $522,838 were made in 2006, 2005, and 2004, respectively.
Cash interest payments for 2004 included interest of $33,834 which was capitalized.

(a)    Revolving
Credit Facility

We have a
revolving line of credit through December, 2007 with our commercial bank which
we use for working capital and other purposes. Borrowings under the agreement
are collateralized by substantially all assets related to the Companys
operations and all common stock of the Companys United States subsidiaries
and 65% of the common stock of its non-United States subsidiaries, and the
assignment of a life insurance policy on the Companys Chairman. Under the
terms of the agreement, the Company has agreed to restrict advances to
subsidiaries, limit additional indebtedness and capital expenditures as well as
to comply with certain financial covenants outlined in the borrowing agreement.
The credit agreement contains cross-default provisions with our mortgages or
other borrowings.

Our revolving
line of credit limits outstanding borrowings to the borrowing base as defined in
the agreement, to a maximum available amount of $6 million. As of September 30,
2006, there were no borrowings on this line. We also have an outstanding letter
of credit to secure our lease in Baltimore, Maryland for $2.0 million (reducing
to $1 million in January, 2007), which is counted against our allowable
borrowings. Under the computation of the borrowing base, we had $1.8 million of
available additional borrowing capacity at September 30, 2006. We were not in
compliance with our loan covenants at September 30, 2006, and have received a
waiver from our bank of the non-compliance. In connection with the waiver, our
bank raised our rate on outstanding borrowings from LIBOR plus 250-300 basis
point to LIBOR plus 325 basis points, or from prime plus 25 basis points to
prime plus 50 basis points, increased our fee on the unused portion of the line
from 25 basis points to 37.5 basis points, and limited capital additions for
fiscal 2007 to $1.2 million. None of the other provisions of the Companys
debt agreements are expected to have an impact on operations.

(b)    Subordinated Debt

In connection
with an acquisition in fiscal 2003, we issued 10% subordinated notes of
$1,800,000. The remaining outstanding principal on these notes was $837,508 at
September 30, 2006. We made principal payments of $360,000, which was included
in current portion of long-term debt at September 30, 2006 and interest payments
of $84,718 in October, 2006. These notes are subordinated to the Companys
senior debt.

In connection with
another acquisition in fiscal 2003, we issued $3,999,840 of 6% convertible notes payable,
including $500,000 payable to a current director of the Company, due January 1, 2008.
These notes were non-interest bearing until June 1, 2005. We are accruing interest expense
over the term of these notes using the effective interest rate method. The holders of
these notes may convert all or part of the outstanding notes and accrued interest into our
common stock at a conversion rate of $16 per common share. These notes are convertible
into 249,990 shares of the Companys common stock. The Company, at its option, may
prepay all or any portion of the outstanding notes plus accrued interest, with prior
written notice to the holders. As of September 30, 2006, we have not made any prepayment
elections. These notes are subordinated to the Companys senior debt.

42

# (7)    Income Taxes

Significant components
of our deferred tax liabilities and assets as of September 30 are as follows:

|                                              | 2006 |  | 2005
|--------------------------------------------- | ---- |  | ----
|Deferred tax liabilities:                     |      |  |     
|Tax over book depreciation                    |      |  | $   
|Lower tax basis on assets of acquired company |      |  |     
|Asset impairment                              |      |  |     
|                                              |      |  |     
|Total deferred tax liabilities                |      |  |     
|                                              |      |  |     
|                                             
|Deferred tax assets:                          |      | 
|Inventory pricing                             |      |  |     
|Accrued vacation                              |      |  |     
|Accrued expenses and other - net              |      |  |     
|Foreign tax credit carryover                  |      |  |     
|Deferred gain on sale/leaseback               |      |  |     
|Foreign net operating loss                    |      |  |     
|                                              |      |  |     
|Total deferred tax assets                     |      |  |     
|                                             
|Valuation allowance for deferred tax assets   |      |  |     
|                                              |      |  |     
|                                             
|Net deferred tax assets                       |      |  |     
|                                              |      |  |     
|                                             
|Net deferred tax (assets) liabilities         |      |  | $   
|                                              |      |  |     

Significant components of
the provision (benefit) for income taxes are as follows:

|               | 2006 |  | 2005 |            | 2004
|-------------- | ---- |  | ---- | ---------- | ----
|Current:       |      |  |      |            |     
|Federal        |      |  | $    | (520,901   | )   
|State          |      |  |      | (89,174    | )   
|Foreign        |      |  |      | 119,850    |     
|               |      |  |      |            |     
|Total Current  |      |  | $    | (490,225   | )   
|               |      |  |      |            |     
|               |      |  |     
|              
|Deferred:      |      | 
|Federal        |      |  | $    | (1,074,438 | )   
|State          |      |  |      | (260,818   | )   
|               |      |  |      |            |     
|Total deferred |      |  |      | (1,335,256 | )   
|               |      |  |      |            |     
|               |      |  | $    | (1,825,481 | )   
|               |      |  |      |            |     

43

The effective income
tax rate varied from the statutory federal income tax rate as follows:

|                                               | 2006 | 2005 | 2004
|---------------------------------------------- | ---- | ---- | ----
|Statutory federal income tax rate              |      |      |     
|Increases (decreases):                         |      |     
|Nondeductible expenses                         |      |      |     
|Tax benefit of foreign sales                   |      |      |     
|State income taxes, net of federal tax benefit |      |      |     
|Nontaxable foreign (gains) losses              |      |      |     
|Other                                          |      |      |     
|                                               |      |     
|                                               |      |      |     
|                                               |      |     

In fiscal 2006, 2005,
and 2004, our foreign operations generated income (loss) before income taxes of $141,645,
$(773,784), and 528,556, respectively.

Payments made in 2006,
2005, and 2004 for income taxes amounted to $498,094, $407,073, and $113,000,
respectively.

The Company has foreign
net operating loss carryforwards of $1,425,377 that have an indefinite life under current
UK tax law.

(8)    Stock Option
Plans

The Company established
an Employee Stock Option Plan whereby options to purchase the Companys common shares
at fair market value at date of grant can be granted to our employees. Options granted
become exercisable in four equal annual installments beginning two years after the date of
grant. This plan terminates in fiscal 2008.

The Company also established
an Outside Director Stock Option Plan whereby options to purchase the Companys
common shares at fair market value at date of grant can be granted to outside directors.
Options granted become exercisable in four equal annual installments beginning two years
after the date of grant. This plan terminates in fiscal 2008.

Options in both plans
expire the earlier of ten years from grant date or termination of employment.

A summary of our stock
option activity and related information for the years ended September 30 is as follows:

|                                | 2006 |  | 2005 |         | 2004
|------------------------------- | ---- |  | ---- | ------- | ----
|
|                               
|Outstanding - beginning of year |      |  |      | 480,253 |     
|Exercised                       |      |  |      | (21,000 | )   
|Granted                         |      |  |      |        |     
|Terminated                      |      |  |      | (55,375 | )   
|                                |      |  |      |         |     
|Outstanding - end of year       |      |  |      | 403,878 |     
|                                |      |  |      |         |     
|Weighted grant date fair values |      |  |      |         |     
|                                |      |  |      |         |     

44

The intrinsic values of options exercised in the years ended September 30, 2006
and 2005 were $37,000 and $4,000 respectively. We received $94,470 and $5,313
from the exercise of qualified employee stock options in fiscal 2006 and 2005,
respectively, for which no tax benefit was recognized. The options on the
403,878 shares outstanding at September 30, 2006 had an aggregate intrinsic
value of $204,783 and a weighted average contract term of 7.1 years.

A summary of non-vested
options for the year ended September 30, 2006 is as follows:

|                                      | Number |  | Weighted Average
Grant Date
Fair Value
|------------------------------------- | ------ |  | --------------------------------------
|
|Non-vested options, beginning of year |        |  |                                       
|Granted                               |        |  |                                       
|Vested                                |        |  |                                       
|Forfeited                             |        |  |                                       
|                                      |        |  |                                       
|Non-vested options, end of year       |        |  |                                       
|                                      |        |  |                                       
|                                      |        | 

At September 30, 2006,
there were 125,500 shares vested, all of which were exercisable. The weighted average
exercise price for these shares was $5.31 per share; the aggregate intrinsic value of
these shares was $63,685 and the weighted average remaining term was 6.3 years.

At September 30, 2006,
there are 300,375 shares available for grants under the two plans.

45

The following applies
to options outstanding at September 30, 2006:

|Range of exercise prices | Number outstandingat September 30,2006 | Weightedaverageremainingcontractuallife (years) | Weightedaverageexerciseprice | Numberexercisable atSeptember30, 2006 | Weightedaverageexerciseprice
|------------------------ | -------------------------------------- | ----------------------------------------------- | ---------------------------- | ------------------------------------- | ----------------------------
|                        
|
|$2.80 - 4.58             | 204,000                                | 6.64                                            | 4.38                         | 68,500                                | 4.33                        
|$4.96 - 5.74             | 180,378                                | 8.34                                            | 5.34                         | 37,500                                | 5.69                        
|$7.18 - 8.00             | 19,500                                 | 1.15                                            | 8.00                         | 19,500                                | 8.00                        

At September 30, 2006,
we had $536,000 of compensation expense to be recognized for non-vested options with a
weighted average vesting period of 2.95 years.

(9)    Retirement
Plan

The Company has an
Internal Revenue Code Section 401(k) Retirement Plan (the Plan) covering
all employees over twenty-one years of age with at least one year of service. Under the
terms of the Plan, the Company contributes 2% of each participants total wages to
the Plan and matches 44% of the first 10% of the employee contribution. The Plan also
includes provisions for various contributions which may be instituted at the discretion of
the Board of Directors. The contribution made by the participant may not exceed 30% of the
participants annual wages. The Company made no discretionary contributions under the
plan in 2006, 2005, and 2004. Contribution expense was $638,398, $554,624, and $432,283 in
fiscal 2006, 2005, and 2004, respectively.

(10)    Segment
Information

We operate in two
principal segments  research services and research products. Our services segment
provides research and development support on a contract basis directly to pharmaceutical
companies. Our analytical products segment provides liquid chromatography, electrochemical
and physiological monitoring products to pharmaceutical companies, universities,
government research centers, and medical research institutions. We evaluate performance
and allocate resources based on these segments. Certain of our assets are not directly
attributable to the service or product segments. These assets are grouped into the
Corporate segment and include cash and cash equivalents, deferred income taxes, refundable
income taxes, debt issue costs and certain other assets. We do not allocate such items to
the principal segments because they are not used to evaluate their financial position. The
accounting policies of these segments are the same as those described in the summary of
significant accounting policies.

46

(a)    Operating Segments

|                                  | Year ended September 30
|--------------------------------- | -----------------------
|
|
|                                 
|Revenue:                          |                        
|Service                           |                        
|Product                           |                        
|                                  |                        
|Total                             |                        
|                                  |                        
|                                 
|Operating income:                 |                        
|Service                           |                        
|Product                           |                        
|                                  |                        
|Total operating income (loss)     |                        
|                                 
|Corporate expenses                |                        
|                                  |                        
|Income (loss) before income taxes |                        
|                                  |                        
|                                 
|                                 
|
|
|
|Identifiable assets:              |                        
|Service                           |                        
|Product                           |                        
|Corporate                         |                        
|                                  |                        
|Total                             |                        
|                                  |                        
|                                 
|Goodwill, net:                    |                        
|Service                           |                        
|Product                           |                        
|                                  |                        
|Total                             |                        
|                                  |                        
|                                 
|Intangible assets, net:           |                        
|Service                           |                        
|Product                           |                        
|                                  |                        
|Total                             |                        
|                                  |                        
|                                 
|Depreciation and amortization:    |                        
|Service                           |                        
|Product                           |                        
|                                  |                        
|Total                             |                        
|                                  |                        
|                                 
|Capital expenditures:             |                        
|Service                           |                        
|Product                           |                        
|                                  |                        
|Total                             |                        
|                                  |                        

47

(b)    Geographic Information

|                             | Year ended September 30
|---------------------------- | -----------------------
|
|
|                             |                        
|Sales to external customers: |                        
|North America                |                        
|Pacific Rim                  |                        
|Europe                       |                        
|Other                        |                        
|                             |                        
|Total                        |                        
|                             |                        
|Long-lived assets:           |                        
|North America                |                        
|Europe                       |                        
|                             |                        
|Total                        |                        
|                             |                        

(c)    Major
Customers

In 2006, 2005 and 2004,
Pfizer (and its predecessor companies) accounted for approximately 7.3%, 10.1%, and 12.5%,
respectively, of the Companys total revenues and 12.8% and 6.0% of total trade
accounts receivable at September 30, 2006 and 2005, respectively.

# (11)    Related Party
Transactions

As of
September 30, 2006, we have a 6% subordinated convertible note payable for $500,000
to one of our directors (a former director of PKLB). During fiscal 2004, we repaid
$350,000 of debt to this director through a series of transactions which resulted in our
paying $200,000 of principal in cash (plus accrued interest to the date of repayment) and
exchanging 38,042 shares of common stock for $150,000 face amount of debt.

48

Item 9.    Changes in and Disagreements with
Accountants on Accounting and Financial Disclosure.

Effective September 15,
2006 KPMG LLP (KPMG) resigned as the Companys independent accountant.
KPMGs reports on the Companys consolidated financial statements as of and for
the years ended September 30, 2005 and September 30, 2004 did not contain an adverse
opinion or disclaimer of opinion, nor were such reports qualified or modified as to
uncertainty, audit scope or accounting principle. During the years ended September 30,
2005 and 2004, and through September 15, 2006, there were (1) no disagreements with KPMG
on any matter of accounting principles or practices, financial statement disclosure, or
auditing scope or procedure, which disagreements if not resolved to the satisfaction of
KPMG would have caused KPMG to make reference thereto in KPMGs reports on the
financial statements for such years; and (2) no other reportable events, as defined in
Item 304(a)(1)(v) of the Commissions Regulation S-K, except for the matters set
forth below.

In connection with KPMGs
review of the Report on Form 10-Q and the First Amendment to the Report on Form 10-Q for
the three and nine months ended June 30, 2006, KPMG presented a letter regarding the
following items to the Audit Committee of the Board of Directors, dated August 29, 2006
relating to its review of the unaudited interim financial statements for the Company as
of June 30, 2006, and for the three and nine months then ended (the Letter).
KPMG noted certain conditions involving the Companys internal control and its
operation that KPMG considered to be material weaknesses.  Material
weakness was defined in the Letter as a control deficiency, or combination of
control deficiencies, that results in more than a remote likelihood that a material
misstatement of the annual or interim financial statements will not be prevented or
detected by the entitys internal control. The material weaknesses noted by
KPMG consisted of a failure to set an appropriate tone at the top to instill
a company-wide attitude of control consciousness; failure to maintain adequate procedures
for anticipating and identifying financial reporting risks and for reacting to changes in
its operating environment that could have a material effect on financial reporting;
failure to maintain adequately trained personnel to perform effective review of
accounting procedures critical to financial reporting; and a lack of adequately trained
finance and accounting personnel with the ability to apply U.S. generally accepted
accounting principles associated with the impairment of certain long-lived assets in
accordance with Statement of Financial Accounting Standards No. 144, Accounting for
the Impairment or Disposal of Long-Lived Assets. Management concurred with the
assessment of KPMG. KPMG discussed the matters described in this paragraph with the Audit
Committee of the Company. The Company authorized KPMG to respond fully to the inquiries
of its successor accountant concerning these matters.

KPMG also communicated
to the Audit Committee in the Letter that the Company had filed its Report on Form 10-Q
for the three and nine month periods ended June 30, 2006, prior to the completion of its
interim review. KPMG has subsequently completed its interim review and the Company filed
an amended report on Form 10-Q/A for the three and nine month periods ended June 30,
2006.

On October 30, 2006
the Audit Committee of the Companys Board of Directors engaged Crowe Chizek and
Company LLC (Crowe Chizek) to be the Companys independent registered
public accounting firm to audit and report on the Companys consolidated financial
statements for the year ended September 30, 2006. During the two most recent fiscal years
ended September 30, 2006 and 2005, and through October 30, 2006, the Company has not
consulted with Crowe Chizek regarding either:  (i) the application of accounting
principles to a specified transaction, either completed or proposed; or the type of audit
opinion that might be rendered on the Companys financial statements; or (ii) any
matter that was either the subject of a disagreement (as that term is defined in Item
304(a)(1)(iv) of Regulation S-K and the related instructions to that Item) or a
reportable event (as that term is defined in Item 304(a)(1)(v) of Regulation S-K).

# Item 9A.    Controls and Procedures.

Based on their most recent evaluation, which was completed as of September 30,
2006, the Companys Chief Executive Officer and Chief Financial Officer
believe that the Companys disclosure controls and procedures (as defined
in Exchange Act Rules 13a-15(e) and 15d-15(e)) were effective as of September
30, 2006. In response to the matters described in Item 9 above, and to ensure
that information required to be disclosed by the Company in this Form 10-K was
recorded, processed, summarized and reported within the time periods specified
by the Securities and Exchange Commissions rules and forms, as of
September 30, 2006, the Company had retained a new Chief Executive Officer with
a financial background to set a better tone at the top regarding the
Companys systems and regard for internal control. The Company has also
instituted additional procedures to more timely identify financial statement
risks. In order to maintain a capability to perform effective review of
accounting procedures critical to financial reporting, the Company decided to
retain an outside accounting firm, separate from its auditors, to consult on
accounting and reporting issues where the Company does not have sufficient
internal capabilities. The Chief Executive Officer and Chief Financial Officer
believe that implementing these new procedures resulted in effective disclosure
controls and procedures as of September 30, 2006.

Except as noted above,
there were no significant changes in the Companys internal controls or other factors
that could significantly affect those controls subsequent to the date of their evaluation,
which was completed as of September 30, 2006.

# Item 9B.    Other
Information.

None.

49

# PART III

# Item 10.    Directors
and Executive Officers of the Registrant.

The following
information concerns the persons who served as the directors of the Company as of
September 30, 2006. Except as indicated in the following paragraphs, the principal
occupations of these persons has not changed in the past five years. Information
concerning the executive officers of the Company may be found in Executive Officers
of the Registrant under Item 1 of this report, which is incorporated herein by
reference.

|Name                      | Age | Position                                             
|------------------------- | --- | -----------------------------------------------------
|
|Peter T. Kissinger, Ph.D. | 61  | Chairman of the Board; Chief Scientific Officer      
|Candice B. Kissinger      | 54  | Senior Vice President, Marketing; Secretary; Director
|William E. Baitinger      | 73  | Director                                             
|David W. Crabb            | 53  | Director                                             
|Leslie B. Daniels         | 59  | Director                                             

Information
 concerning  Peter T. Kissinger,  Ph.D. is incorporated by reference to the discussion
 under Item 1 "Executive Officers of the Registrant" in this report.

Information concerning
Candice B. Kissinger is incorporated by reference to the discussion under Item 1
Executive Officers of the Registrant in this report.

William E.
Baitinger has served as a director of the Company since 1979. Mr. Baitinger was
Director of Technology Transfer for the Purdue Research Foundation from 1988 until 2000.
In this capacity he was responsible for all licensing and commercialization activities
from Purdue University. He currently serves as Special Assistant to the Vice President for
Research at Purdue University. Mr. Baitinger has a Bachelor of Science degree in
Chemistry and Physics from Marietta College and a Master of Science degree in Chemistry
from Purdue University.

David W. Crabb,
M.D. has served as a director of the Company since February, 2004. He has been
Chairman of the Indiana University Department of Medicine since 2001. Previously he had
served as Chief Resident of Internal Medicine and on the Medicine and Biochemistry faculty
of Indiana University. He was appointed Vice Chairman for Research for the department and
later Assistant Dean for Research. Dr. Crabb serves on several editorial boards and
on the Board of Indiana Alcohol Research Center. He was a recipient of a NIH Merit award
and numerous other research and teaching awards.

Leslie B.
Daniels has served as a director of the Company since June 2003. Mr. Daniels is a
founding partner of CAI, a private equity fund in New York City. He previously was
President of Burdge, Daniels & Co., Inc., a principal in venture capital and buyout
investments as well as trading of private placement securities, and before that, a Senior
Vice President of Blyth, Eastman, Dillon & Co. where he had responsibility for the
corporate fixed income sales and trading departments. Mr. Daniels is a former
Director of Aster-Cephac SA, IVAX Corporation, MIM Corporation, Mylan Laboratories, Inc.,
NBS Technologies Inc. and MIST Inc. He was also Chairman of Zenith Laboratories, Inc. and
currently serves as a Director of SafeGuard Health Enterprises, Inc.

The Board of Directors
has established an Audit Committee. The Audit Committee is responsible for recommending
independent auditors, reviewing, in connection with the independent auditors, the audit
plan, the adequacy of internal controls, the audit report and management letter and
undertaking such other incidental functions as the board may authorize. William E.
Baitinger, David W. Crabb and Leslie B. Daniels are the members of the Audit Committee.
The Board of Directors has determined that Mr. Daniels is an audit committee
financial expert (as defined by Item 401(h) of Regulation S-K). All of the members of the
Audit Committee are independent (as defined by Item 7(d)(3)(iv) of Schedule
14A).

The Board of Directors
has adopted a Code of Ethics (as defined by Item 406 of Regulation S-K) that applies to
the Companys Officers and Directors a copy of which is filed as an exhibit to this
Form 10-K.

The information
contained under the caption Section 16(a) Beneficial Ownership Reporting
Compliance in the Proxy Statement is incorporated herein by reference.

50

# Item 11.    Executive
Compensation.

The information
included under the captions Election of Directors  Compensation of
Directors, Executive Compensation and Compensation Committee
Interlocks and Insider Participation in the Proxy Statement is incorporated herein
by reference in response to this item.

# Item 12.    Security
Ownership of Certain Beneficial Owners and Management.

The information
contained under the captions Share Ownership of Certain Beneficial Owners and
Management and Equity Compensation Plan Information in the Proxy
Statement is incorporated herein by reference in response to this item.

For additional
information regarding the Companys stock option plans, please see Note 9 in the
Notes to Consolidated Financial Statements in this report.

# Item 13.    Certain
Relationships and Related Transactions.

The information
included under the caption Certain Relationships and Related Transactions in
the Proxy Statement is incorporated herein by reference in response to this item.

# Item 14.    Principal
Accounting Fees and Services.

The information
included under the caption Selection of Independent Accountants in the Proxy
Statement is incorporated herein by reference.

[Remainder of page
intentionally left blank.]

51

# PART IV

Item 15.    Exhibits and Financial Statement Schedules.

(a)    Documents
filed as part of this Report.

| | 1. | Financial Statements:
Included in Item 8 of Part II of this report as follows: 
Reports of Independent Registered Public Accounting Firms. 
Consolidated Balance Sheets as of September 30, 2006 and 2005. 
Consolidated Statements of Operations for the Years Ended September 30, 2006, 2005 and 2004.
Consolidated  Statements of Shareholders Equity and Comprehensive Income (Loss) for the Years Ended September 30, 2006, 2005 and 2004. 
Consolidated Statements of Cash Flows for the Years Ended September 30, 2006, 2005 and 2004. 
Notes to Consolidated Financial Statements.
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 2. | Financial Statement Schedules:
Schedules  are not required, are not applicable or the information is shown in the Notes to the Consolidated Financial Statements.
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------

(b)    Exhibits.
See Index to Exhibits.

52

# SIGNATURES

Pursuant to
the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.

|Date:  December 21, 2006
Date:  December 21, 2006 | BIOANALYTICAL SYSTEMS, INC.
(Registrant)
By:  /s/ Richard M. Shepperd
Richard M. Shepperd
President and Chief Executive Officer
By:  /s/ Michael R. Cox
Michael R. Cox
Vice President, Finance, Chief Financial Officer
and Treasurer
|------------------------------------------------- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Pursuant to
the requirements of the Securities Exchange Act of 1934, this report has been
signed below by the following persons on behalf of the Registrant and in the
capacities and on the dates indicated.

|Signature | Capacity | Date
|--------- | -------- | ----

|/s/ Peter T. KissingerPeter T. Kissinger | Chairman and Chief Scientific
Officer and Director |  | December 20, 2006
|---------------------------------------- | -------------------------------------------------- |  | -----------------

|/s/ Richard M. Shepperd
Richard M. Shepperd | President and Chief Executive Officer
(Principal Executive Officer) |  | December 20, 2006
|------------------------------------------- | ------------------------------------------------------------------- |  | -----------------

|/s/ Michael R. CoxMichael R. Cox | Vice President, Finance, ChiefFinancial Officer and Treasurer(Principal Financial and Accounting Officer) |  | December 20, 2006
|-------------------------------- | --------------------------------------------------------------------------------------------------------- |  | -----------------

|/s/ William E. BaitingerWilliam E. Baitinger | Director |  | December 20, 2006
|-------------------------------------------- | -------- |  | -----------------

|/s/ David W. CrabbDavid W. Crabb | Director |  | December 21, 2006
|-------------------------------- | -------- |  | -----------------

|/s/ Candice B. KissingerCandice B. Kissinger | Director |  | December 22, 2006
|-------------------------------------------- | -------- |  | -----------------

|/s/ Leslie B. DanielsLeslie B. Daniels | Director |  | December 20, 2006
|-------------------------------------- | -------- |  | -----------------

53

# INDEX TO EXHIBITS

Number Assigned InRegulation S-KItem 601
        
        Description of Exhibits




(3)
        3.1
        Second Amended and Restated Articles of Incorporation of Bioanalytical Systems, Inc. (incorporated by reference to Exhibit 3.1 to Form 10-Q for the quarter ended December 31, 1997).




3.2
        Amended and Restated Bylaws of Bioanalytical Systems, Inc. (including all amendments made through September 30, 2006).




(4)
        4.1
        Specimen Certificate for Common Shares (incorporated by reference to Exhibit 4.1 to Registration Statement on Form S-1, Registration No. 333-36429).




4.2
        See Exhibits 3.1 and 3.2 to this Form 10-K.




4.3
        Form of 6% Subordinated Convertible Note due 2008 (incorporated by reference to Form 8-K filed November 21, 2002).




4.4
        Form of 10% Subordinated Note due 2007 (incorporated by reference to Exhibit 4.3 of Form 10-Q for the quarter ended June 30, 2003).




(10)
        10.1
        Bioanalytical Systems, Inc. 1990 Employee Incentive Stock Option Plan (incorporated by reference to Exhibit 10.4 to Registration Statement on Form S-1, Registration No. 333-36429).




10.2
        Form of Bioanalytical Systems, Inc. 1990 Employee Incentive Stock Option Agreement (incorporated by reference to Exhibit 10.5 to Registration Statement on Form S-1, Registration No. 333-36429).




10.3
        Bioanalytical Systems, Inc. 1997 Employee Incentive Stock Option Plan, as amended January 24, 2004 (incorporated by reference to Appendix A to definitive Proxy Statement filed January 28, 2003 SEC File No. 000-23357).




10.4
        Form of Bioanalytical Systems, Inc. 1997 Employee Incentive Stock Option Agreement (incorporated by reference to Exhibit 10.27 to Registration Statement on Form S-1, Registration No. 333-36429).






1





Number Assigned InRegulation S-KItem 601
        
        Description of Exhibits




10.5
        1997 Bioanalytical Systems, Inc. Outside Director Stock Option Plan, as amended January 24, 2004 (incorporated by reference to Appendix B to definitive Proxy Statement SEC File No. 000-23357).




10.6
        Form of Bioanalytical Systems, Inc. 1997 Outside Director Stock Option Agreement (incorporated by reference to Exhibit 10.29 to Registration Statement on Form S-1, Registration No. 333-36429).




10.7
        Master Equipment Lease Agreement by and between Bioanalytical Systems, Inc. and Keycorp Leasing, dated December 5, 1997 (incorporated by reference to Exhibit 10.9 of Form 10-K for the fiscal year ended September 30, 2002).




10.8
        Amended and Restated Credit Agreement by and between Bioanalytical Systems, Inc., and National City Bank, executed January 4, 2005 (incorporated by reference to Exhibit 10.5 of Form 8-K filed January 10, 2005).




10.9
        Amended and Restated General Security Agreement by and between Bioanalytical Systems, Inc. and National City Bank executed January 4, 2005 (incorporated by reference to Exhibit 10.7 of Form 8-K filed January 10, 2005).




10.10
        Trademark Security Agreement by and between Bioanalytical Systems and The Provident Bank, dated October 29, 2003 (incorporated by reference to Exhibit 10.12 of Form 10-K for the fiscal year ended September 30, 2002).




10.11
        Patent Security Agreement by and between Bioanalytical Systems and The Provident Bank, dated October 29, 2003 (incorporated by reference to Exhibit 10.13 of Form 10-K for the fiscal year ended September 30, 2002).




10.12
        Replacement Promissory Note by and between Bioanalytical Systems, Inc. and National City Bank, executed January 4, 2005 (incorporated by reference to Exhibit 10.6 of Form 8-K filed January 10, 2005).




10.13
        Loan Agreement between Bioanalytical Systems, Inc. and Union Planters Bank, dated October 29, 2002 (incorporated by reference to Exhibit 10.15 of Form 10-K for the fiscal year ended September 30, 2002).






2





Number Assigned InRegulation S-KItem 601
        
        Description of Exhibits




10.14
        Real Estate Mortgage and Security Agreement between Bioanalytical Systems, Inc. and Union Planters Bank, dated October 29, 2002 (incorporated by reference to Exhibit 10.16 of Form 10-K for the fiscal year ended September 30, 2002).




10.15
        Real Estate Mortgage and Security Agreement between Bioanalytical Systems, Inc. and Union Planters Bank, dated October 29, 2002 (incorporated by reference to Exhibit 10.17 of Form 10-K for the fiscal year ended September 30, 2002).




10.16
        Term Loan Promissory Note made by Bioanalytical Systems, Inc. in favor of Union Planters Bank, dated October 29, 2002 (incorporated by reference to Exhibit 10.18 of Form 10-K for the fiscal year ended September 30, 2002).




10.17
        Promissory Note made by Bioanalytical Systems, Inc. in favor of Union Planters Bank, dated October 29, 2002 (incorporated by reference to Exhibit 10.19 of Form 10-K for the fiscal year ended September 30, 2002).




10.18
        Employment Agreement by and between Bioanalytical Systems, Inc. and Michael R. Cox dated April 1, 2004 (incorporated by reference to Exhibit 10.1 to Form 10-Q for the fiscal quarter ended March 31, 2004).




10.19
        Purchase and Sale Agreement between BASi Maryland, Inc. and 300 W. Fayette, LLC, closed January 5, 2005 (incorporated by reference to Exhibit 10.1 of Form 8-K filed January 10, 2005).




10.20
        First Amendment to the Purchase and Sale Agreement dated September 7, 2004 (incorporated by reference to Exhibit 10.20 to Form 10-K for the fiscal year ended September 30, 2004).




10.21
        Second Amendment to the Purchase and Sale Agreement dated on or about November 11, 2004 (incorporated by reference to Exhibit 10.21 to Form 10-K for the fiscal year ended September 30, 2004).




10.22
        Office Lease by and between BASi Maryland, Inc. and 300 W. Fayette Street, LLC, dated on or about January 5, 2004 (incorporated by reference to Exhibit 10.22 to Form 10-K for the fiscal year ended September 30, 2004).






3





Number Assigned InRegulation S-KItem 601
        
        Description of Exhibits




10.23
        Employment Agreement by and between Bioanalytical Systems, Inc. and Edward M. Chait dated August 1, 2005 (incorporated by reference to Exhibit 10.1 to Form 8-K filed August 5, 2005).




10.24
        Form of Grant of non-qualified stock options dated August 1, 2005 to Edward M. Chait (incorporated by reference to Exhibit 10.24 to Form 10-K for the fiscal year ended September 30, 2005).




10.25


10.26
        Form of Grant of non-qualified stock options dated April 1, 2004 to Michael R. Cox (incorporated by reference to Exhibit 10.3 to Form 10-Q for the fiscal quarter ended March 31, 2004).

Severance Agreement and Release of All Claims with Michael P. Silvon, dated July 17, 2006 (incorporated by reference to Exhibit 10.1 to Form 8-K filed July 31, 2006).




10.27
        Summary of Executive Compensation of Officers and Directors.




(13)



(14)
        13.1



14
        2006 Annual Report. This report, except for those portions which are expressly incorporated by reference in this Form 10-K, is furnished for the information of the Commission and is not to be deemed filed as part of this Form 10-K.

Code of Ethics.




(21)
        21.1
        Subsidiaries of the Registrant (incorporated by reference to Exhibit 21.1 to Form 10-K for the fiscal year ended September 30, 2005).




(23)
        23.1
        Consent of Independent Registered Public Accounting Firm Crowe Chizek and Company LLC.




23.2
        Consent of Independent Registered Public Accounting Firm KPMG LLP.




(31)
        31.1
        Certification of Chief Executive Officer.




31.2
        Certification of Chief Financial Officer.




(32)
        32.1
        Section 1350 Certifications.








4